Recent studies and polls by the Institute for the Study of Employee Ownership and Profit Sharing at Rutgers University concluded that ESOPs are good. They are good for business and good for employees. Customers opt to purchase from businesses that are employee owned, and when choosing between similar jobs, recruits opt for the job that provides them with employee ownership. With all the positivity surrounding ESOPs, why were industry experts and transacting business owners left so frustrated during 2021 following a flood of failed transactions and resulting sunk costs?
The structure of a deal involving an ESOP can be complex from both legal and financing standpoints. Most service providers including commercial banks, transaction advisors, attorneys, trustees, and accountants are quick to get involved with an ESOP transaction, but often are not experienced enough to understand and navigate the pitfalls that ultimately lead to a deal falling apart.
In a recent town hall discussion hosted by the Beyster Institute of UC San Diego’s Rady School of Management, panelists concluded that deals regularly fell apart or ended up burdening business owners with excessive transaction costs when an ESOP specific banker, supported by ESOP savvy bank legal counsel was not used. Additionally, although local branches of banks may have an appetite for lending to ESOPs, the national office may have different rules for engaging and lending to employee-owned companies. Traditional commercial banks often focus on deal metrics including pre and post transaction EBITDA and leverage ratios, but don’t understand that entering into an ESOP transaction will cause the Company’s balance sheet and income statement to look very different post-close. ESOP savvy banks on the other hand, place more emphasis on the attorneys, accountants and sell-side transaction advisors listed on the deal and may decline participation in financing if they aren’t satisfied with the credentials of those service providers.
If you or your company is considering flipping to employee ownership, you should start planning a number of years in advance. This includes grooming the next generation of torch bearers for your company’s ongoing success, as well as hosting kick-off conversations with the right group of service providers. From being involved in various ESOP associations and industry groups across the country, Withum has a solid network of ESOP specific bankers, attorneys, trustees and transaction advisors, all of which we are happy to introduce to ensure that your ESOP transaction has the greatest possible chance of success in benefiting both you and your employees.