Speaker 1:
As a bank that focuses on business, we work with business leaders all day every day. We have a front row seat to what's working and what has potential. The First Business Bank podcast is dedicated to sharing insights to help you work better, smarter and faster to achieve your goals. Let's get into the show.
Mark Meloy:
Hello, I'm Mark Meloy, CEO of First Business Bank. Welcome to the First Business Bank podcast. Today, we're talking about employee stock ownership plans, or ESOPs. This is something that seems to be talked about a lot, but occurs much less often. We'll talk about why that might be the case. And nonetheless, ownership transition is an important topic these days, as Baby Boomers age into their retirement years. Our experts will share some simple tips and their perspectives about ESOPs and if they might make sense.
Mark Meloy:
I'm joined by three of my colleagues who spend much of everyday at First Business Bank working with clients on planning for transition on both the sell side and the acquisition side. They're each going to introduce themselves before we get our conversation started. Diane.
Diane Smith:
Yes, thank you, Mark. Diane Smith, Vice President, Commercial Lending.
Mark Meloy:
Tom.
Tom Dott:
Tom Dott, Senior Vice President, Commercial Banking.
Mark Meloy:
And Chris.
Chris Doering:
Chris Doering, Senior Vice President of Commercial Banking.
Mark Meloy:
So Tom, I'll start with you. What are employee stock ownership plans?
Tom Dott:
Yeah, thanks Mark. Um, employee stock ownership plans are, are really a way for, for owners to, uh, to, to sell their business and transition it to, you know, the next generation, for lack of a better term, um, with, with the goal of, of, um, incenting employees for, for staying on, creating a benefit for them. And in some cases, you know, allowing themselves to stay on as part of the management team.
Mark Meloy:
Chris, why would an owner or a group of owners consider transferring their business to an ESOP?
Chris Doering:
Yeah, it's a good question. I think it's becoming a bigger and bigger topic, as, you know, su- the succession plan topic in general is talked about, and business owners are looking for an exit strategy and determining, you know, what is the best path? Obviously from a financial standpoint, you know, looking to an outside private equity firm or other, uh, potential acquirer could yield a better, better return for that owner, but if you factor in some of the tax incentives that are involved for both the owner and the business itself, um, to transition to an, to an ESOP, that's becoming, and- and has always been a popular, but becoming a pop- more popular, uh, point of discussion.
Chris Doering:
So, you know, it, it goes back to what does the individual want? What does the, the owner or the group of owners, what are they looking for? If it's really, you know, the, if the culture's important, if it's the sustainability of the employee base, if it's retention, you know, everybody's a part of this, of, of this company, then it's, it, it's something to explore and it's, it's worthwhile, and it can be beneficial longterm for the company, um, you know, beyond just the short period of time.
Mark Meloy:
Sure. Tom, uh, what should business owners keep in mind if they're considering forming an ESOP as a way of, uh, transition of business ownership?
Tom Dott:
Um, lots of things. In general, he needs to start with a feasibility study to determine does this, does this even make sense for the company, um, financially, given the size of it. Does it accomplish the goals of what the current owners are looking to accomplish, some of the things that Chris mentioned about maintaining legacy, employee incentives, tho- those types of things. Um, but then also they need to be thinking about, uh, as a selling owner, what are their goals? What do they want to get out of this, and, and what are their plans going forward? And people should also be thinking about, um, and understand that this, this takes a lot of time, not only upfront, but ongoing, and, and post close, there's a lot of, of maintenance and reporting and those types of things, as well as educating the employees.
Tom Dott:
And so there's a lot that goes into this, and, and I would tell you from, from my experience and from what I've heard from folks who have gone through this process kind of from a post transaction perspective, um, I think there's a lot of things that they wish they would have taken a little bit more time to better understand on the front end, as it relates to, you know, things like cost, what their time commitment is, and, and those types of things, where not that they wouldn't have still done it, but they would have just had a little better understanding of, of what those expectations should be.
Chris Doering:
Yeah, Tom, to, to your point, I think the biggest thing that I've heard for companies that have gone through a partial ESOP transition or a full 100% transition is, is that topic of, of just not planning soon enough. I mean, I think it comes down to succession planning in general, regardless of the ESOP, but it's the one thing that we always hear about. I should have started this two years ago, five years ago, or whatever that might be, especially if you don't have kind of those key people in place already that you're looking to transition the company to.
Tom Dott:
Yeah. And, and you know, that actually brings up another point too, Chris, thanks for, for jarring my memory here as it relates to, you know, how, how people are thinking about this, and, and thinking about planning for it. I, I think a lot of folks look back and say, "It would have been better too if I would have maybe been willing to spend a little bit more time and money on things like quality of financial statements," and, and all those types of things as well, as opposed to just maybe going along and getting, you know, compilations and a tax return, while, you know, maybe I should have been getting a review and/or an audit sooner than later, you know, in preparation to, to put me in a better place, you know, when it comes time to, to do the valuation, and really, you know, have a better and stronger understanding of the quality of the information that's in my financial statements.
Mark Meloy:
Yeah, those are all great points. I mean, I, I don't think I've ever been in a conversation with business owners that have gone through this process that have said they allow the right amount of time to get where they, where, at closing date. It's always like you take ... It's, uh, way more complicated and it takes much longer than anybody ever thinks because there are, to what you guys have all just said, so many parts that have to be considered in the whole process.
Tom Dott:
Yeah. And, and the one last thing I would add to that point too, Mark, is that, um, the other thing that people kind of wish they would have known, if they could do it all over again, is just how key they were gonna be to managing all those parts.
Mark Meloy:
Mmm.
Tom Dott:
I mean, as the seller, as the current owner, I mean it's really you that's, that's engaging all these people, selecting all these partners, and, you know, and then herding the cats throughout this process and keeping track of everything and making sure everybody's on the right path towards, towards close. So there's, you know, there's a lot of individual responsibility that falls on their shoulders as well.
Mark Meloy:
You know, we've talked about this before. There's a commitment of time and there's also a distraction from what-
Tom Dott:
Yeah.
Mark Meloy:
... are the regular ongoing daily responsibilities typically of the owner.
Tom Dott:
Right.
Mark Meloy:
Pr- the primary owner. Uh, Diane, what are some of the benefits and disadvantages of an ESOP?
Diane Smith:
Yeah. So, um, we've all touched on, uh, a few of those already, but, uh, I think the, the biggest one is gonna be the tax benefits of, of the ESOPs because depending on the type of the company, type of corporation, uh, you're gonna get different tax benefits. Uh, one, one example would be company contributions to the trust are tax deductible within certain limits. Another one it is, and mentioned as well, is that it can act as a mechanism to retain your top talent. The employees actually have ownership in the company and a share in the profits of the company, and so they're motivated to work harder and, and help, you know, grow that company. They a- they're a big part of it.
Diane Smith:
Now the disadvantages, we've mentioned that as well. The fact that, uh, the high cost of, uh, creating and then maintaining it costs financially and your time, uh, that goes into, to taking on this, this process. Um, so you've got fees. Examples would be the, you know, the lawyer fees, uh, the trustee fees, your accounting firm fees. Um, so there's, there's a lot that goes into creating these ESOPs and maintaining them, yes.
Mark Meloy:
Chris, uh, do the benefits and disadvantages vary by industry, and, and/or are other components of the transaction, such as number of employees or general size of the company things that matter?
Chris Doering:
Yeah, they're definitely things to take into consideration. I mean, there are industries that are more prevalent, I would say, you know, with going down the path of an ESOP. You know, professional services, manufacturers, those we typically see, um, still kind of on that higher end of the scale in terms of companies that have gone through that process, but it's really across the board. Um, you know, we're seeing it more and more. I read an article recently, where, you know, contractors, for example, 3% of total contractors may have gone through, you know, an ESOP conversion in the past, and, you know, over the last years, that's, that's transitioned up to north of 10%. So, we're seeing it with more non-traditional type companies.
Chris Doering:
Also read recently, you know, it's, it's, we, we touched on the retention part of this, but as labor and staffing and just recruitment of young employees and people that are looking for something just a little bit more than showing up to work, you know, for an 8:00 to 5:00 job, this can be a really good retention and recruitment tool. You know, as it relates to number of employees, there's, there's no set standard. I would say, you know, under 20 is probably too small. It can vary, again, by the type of company. What you really want to make sure of is that you've got those, you know, consistent sustainable earnings. Um, as you look back, you're gonna want to make sure that you're doing the things that Tom talked about earlier, you're getting the right set of financial statements, you're partnering with the right people.
Chris Doering:
You know, there are certain thresholds related to an ESOP where you might not need a full blown audit, for example, um, on the ESOP plan, but those are things that you're really gonna want to consider, whether you're above or below that threshold. Just, um, you know, from a compliance standpoint and just overall record keeping, I think it's just, um, a good practice, even though it can get expensive at times.
Mark Meloy:
Tom, from, uh, the perspective of an advisor who has helped business leaders navigate the transition to an ESOP, talk about a few common oversights or unanticipated issues that sometimes are encountered.
Tom Dott:
Yeah. Um, probably the biggest one was just the amount of time, um, and the responsibility that, that falls on the person who's coordinating it. Um, you know, typically the, the current owner in terms of, um, engaging the partners and, and making sure everybody's on the right page in moving the deal forward. The, the other thing that has come up, um, form an importance perspective, again in terms of, and then also even just understanding why you might do this, is just the employee education part of it. I mean, that, that's a big part of making these successful, is making sure that the employees understand why this is a great benefit for them and what's in it for them, and, and how it all works, and, and, and those types of things.
Tom Dott:
Um, and then too, the other part of it is what's really the goal here, because in some cases, a selling owner maybe wants to completely exit and get out of the company. I mean, that, that is truly they're exit strategy. Um, there's been a couple that I've worked with that's been exactly the opposite, where the, the current owners want to stay in and want to stay, you know, in control as it relates to running the company and, and kind of, you know, things that are, are relatively normal in terms of who's, who's making decisions and who's calling stuff. Now granted, you still have some of the changes that come on with the ESOP as it relates to having a, a board of directors and, you know, kind of different reporting structure, but nonetheless, they want to stay involved and they, you know, they want to continue to propel the company forward.
Tom Dott:
So, I mean, I think that, you know, as you, as you navigate this, these are all things that you need to be thinking about and understand how, how that's gonna work, um, going forward and, and, you know, what you can and can't do, and, and how it changes things.
Mark Meloy:
Yeah. It seems to me that as, as we talk about this today, that, that this path really can't be done completely in a vacuum, that there really has to be a succession planning effort by the owner or the ownership group that is ultimately gonna be the beneficiary of the sale no matter what it is. Is that a, is that a fair statement?
Tom Dott:
I, I think it is, in, in part because, you know, not only from a benefit standpoint as it relates to the employees, but you know, who- who's gonna keep this thing going? Because to Chris' comment earlier about sustainability and consistent earnings, I mean that, that's a big part of this because, you know, remember, every year, you're gonna get an updated valuation as it relates to what the company is worth. And so, obviously from a, a, a longterm benefit standpoint for everyone's sake, you're gonna want that, that valuation to go up every year, um, you know, or at least over, over time because that, you know, that, that's, that's what's in it for folks as it relates to, you know, the value of, uh, of the stock.
Mark Meloy:
So when business owners are deciding between varying transition options, how do you suggest they approach this important evaluation process? And secondarily, what's the most important information they should have in that consideration? Uh, that's really to all of you, but maybe Tom, start with you.
Tom Dott:
Well, and we talked, and we talked a little bit earlier, but initially just doing an initial feasibility study and saying, does, does this even make sense? And, and, and understanding that they're gonna need to make a, you know, financial commitment upfront and early to understand that, first and foremost, does it make sense to move forward with this?
Chris Doering:
Yeah. And I would say, you know, it, get your key advisors in the mix as early as possible. I, I think sometimes businesses are great about bringing maybe one party into the conversation-
Diane Smith:
Mm-hmm (affirmative).
Chris Doering:
... but I've seen the most success when everybody's in the room together, on the phone together, talking about how the pieces fit, and if the banker gets engaged too late in the process, this is gonna slow the matter down. So, if we can start at the beginning and get everybody, um, kind of on that topic at once, it's, it's definitely helpful.
Tom Dott:
Mm-hmm (affirmative).
Chris Doering:
Right?
Tom Dott:
Yeah. And Chris, that's a really good point, because it's also really dependent upon what's, what's the financing structure of this gonna be? I mean, is, is there gonna be bank debt involved? Is this gonna be 100% seller financed? What percentage of the company is, is gonna be sold, because you, you don't have to sell 100% of the company into the ESOP. But there again, that's all part of, of kind of that feasibility study and determining what, what's the real goal here and how do we maximize some of the benefits we talked about earlier, whether it be, you know, the tax benefits and, and that type of thing because at some point, you- you know, if, I mean, not putting enough into the ESOP, it's really hard to get a, a good ROI out of it, um, as it relates to what your- your upfront expenses and your ongoing expenses are.
Tom Dott:
So, I, I mean, I think that's the other part of it, is just, you know, what- what are we really trying to get?
Diane Smith:
Another part of this, folks, is the fact that you need to have a strong team internally, especially as you're wanting to step away, that you have the right people in place. I've had a number of companies start this process and realize that, uh, they do not have, they have a controller in the CFO position, and they need to step that up, step the game up to, um, continue to get stronger.
Mark Meloy:
Yeah, that's a great point. The other thing I was gonna say is, uh, that there are a lot of great experts, professional experts-
Diane Smith:
Mm-hmm (affirmative).
Mark Meloy:
... that operate in this realm every day, every week, all the time, both on the legal side and on the accounting side, and on, just on the expert information as it relates to ESOPs. We've touched on all of it, but they bring great value, and again, depending upon the complexity, depending upon the price, depending upon the leverage that goes into it, um, that, that whole entire team, uh, really is gonna make for a much better process, a much better transaction.
Tom Dott:
Right. And, and you're right, Mark, and there's a number of different folks out there that, that, I mean this is what they do. Uh, you know, they're, they're, they're ESOP specialists, and so when it comes to the, you know, initial questions, feasibility studies, I mean lots of times, I mean they can give you some pretty good information pretty quickly as to whether or not, you know, this is probably gonna make any sense for, for you. And, and ask some tough questions, you know, uh, to the, to the potential selling owners, and it is, again, a, what do you want to get out of this?
Tom Dott:
Just to Chris' point earlier, which I think is a really good one, if you want to maximize the value of your company in terms of, of what you sell it for, ESOP may not be the best route to go, just as an example. But the other thing that we haven't talked about as it relates to the, the selling owners too, in- in terms of advisors is, you know, the- they need to have their financial advisor involved, um, as part of that group as well because at the end of the day, in some way, shape, or form, they're gonna be walking away with something. And that needs to be part of the consideration as to, you know, what, what we do and how we do it as well, because there's gonna be, you know, tax implications for them and longterm implications for them that, that they need to be thinking about and planning for as well.
Mark Meloy:
That's another great point. Well, this is a topic that's obviously very complex. We could talk about it a long time. We'd probably lose a lot of listeners if we kept going, but we, I know that we certainly could. Tom, Diane, and Chris, thanks for taking the time today to share your thoughts, and that could, experiences with our audience. And to you, our audience, thanks for listening to this conversation, and we hope you found this topic helpful. And should you consider an employee stock ownership plan, don't hesitate to give us a call. Also, let us know if there are other topics or information you'd like to learn more about, and join us next time on the First Business Bank podcast.
Speaker 1:
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Speaker 1:
First Business Bank, member FDIC.