Ep1 - Enough Information to be Dangerous

Thank you so much for listening to a journey to an ESOP. Uh, this podcast is, uh, really designed to um help educate business owners that are not currently an ESOP, um, but really have an interest in looking at them as as possible, um, or potential succession and exit strategies, either in the near term or in the, in the, in the long term. Um, the podcast is also really designed to displace the wrong notions that are really in the marketplace about ESOPs is sometimes being too complicated or sometimes being, um, uh, really costly and different, and different things that are out there. Um, and, and I also find that this, there are a lot of wrong notions about the process and so just all of those things I think are important, um, that we want to cover in this idea of like a journey to an ESOP, um. If you like what you hear at the end of the podcast, please share it with a friend. Um, so the title of this, the first episode is called Enough Information to Be Dangerous. And I got the idea of doing this podcast from just in, in the years gone by, of, of going to different conferences and, and dealing with different clients and seeing the uh the frustration and I mean sometimes the confusion, um, or the confusion that causes this frustration in, in, in clients. Uh they've got so much information and they have all these different questions and, and as you sit down with them and you start unpacking some of their questions, you find that uh That the information that they have is good and it, and it's come from, it's coming from all kinds of very credible sources, but it's in the wrong places and, and it creates um really some stumbling blocks so they get stuck in this, in this process of moving through, um, what I think can be, you know, could very well be a very simple or a very straightforward process. In addition to that. This is the time of year that as ESOP professionals, we're looking at scheduling ourselves out to go to conferences, um, and meeting a lot of people. So, you know, we've really been thinking a lot about, you know, the conferences that we have coming up and in this conferences, you just, you meet a lot of uh new business owners that are, are, are business owners that are new to the ESOP process and. And so this is really more thinking about what, what they're gonna be experiencing as they go. When a business owner has an idea that they, they, they find out about ESOPs, um, one or two types of people come out of the woodwork. The first type of people, uh the first type of person is, you know, and they see this could be friends, advisors, whoever, um, they come out and they're really just very negative, um, from a really black and white perspective. Um, and they, and their response to the business owner is, nope. Way too complicated. You shouldn't do an ESOPs, Stay away from them. Um, they might mention ESOPs that they've known and, and rightly so, that they, they didn't work well. Um, they might look at, hey, it's just too costly, um, there's a lot of other ways to go about it. And so in those kind of cases, obviously, that's gonna that could either shut the business owner down and say, I'm not gonna pursue that until somebody else comes along, so you really should look at that as a strategy. And the other type of people that come out are, you know, the again, friends and advisors, people that they know, um, that say you should go for it. I've heard ESOPs really be successful or they had experience with them, their own, um, and they just encourage that to, to, uh, the business owner go ahead and, and, and go forward on it. Um, and then there, the next thing is gonna come out of, of that, which is, hey, you should attend one of these conferences because the conferences are very helpful, um, to get information out if, if you're, uh, getting new to the world of ESOPs, a lot of the conferences are, are hosted by either the ESOP Association or the NCEO. And so if you go in and Google those organizations, you're gonna, you're gonna find out all kinds of information on the conferences. Um, but in addition to that, once you start Googling ESOPs, you're gonna get a lot of articles and there's just a lot of, of, uh, blogs and different things that are written. And so, again, that's, there's a lot of information, and even me doing a podcast, here, here's some more information, but what I'm hoping to do with this first one is really set the stage to help provide some clarity as far as how to use that information. And it's, and it's clear to me that the information or the source of information is, it really does come from um experts. You know, being an expert at anything takes years and it takes education, it takes a dedication and um it takes making mistakes and, and working through a process. And so year after years and years go by, you know, there are just absolute experts in, in the area of, of ESOPs. Um, one thing that happened to me not too long ago, which was, um, really good illustration for me about expertises I had in my house, um, These doors that just were, were breaking down and they, they needed to be repaired and and actually replaced. And so, um, I hired a company and they came out and, and the guy that did the door repair, his name was Norm. And so when Norm came out, I said, hey, Norm. And then I paused and and there was, there was no laughing, but I was kind of thinking of, of the norm on cheers, but he didn't get it. He was, he's very serious-minded door repair man, which was, which was good. And, and when he, when he finished up his work, I said, Norm, could you look at my front door? Because I had um tried to do a repair on the front door and It wasn't closing and, and, um, and it was just a problem. So I, he said, oh, sure, I'll, I'll take a look at it. And so I'm standing there with him and in seconds, he has the door off and um he's looking at it, he's like, oh, here's your problem, boom, boom, and he fixes it. And, and he does this to hold door repair within like say 5 minutes. And I'm standing there just astonished. I mean, like, you know, wow, I'm, I clearly see like the, the ability of somebody to be truly an expert at something. That I can see that I truly am not an expert at. Um, so I don't fix doors, but um norm really helps me out that day and, and, um, and, and it just kind of made me start thinking about How important expertise is in anything that you do, um, whether it be in the trades or professional work or whatever. So, as I, as I think about the conferences, and I think about the experts that you're gonna find, conferences are in me, in my experience, are just a rush, and they're a rush because there's so many people at conferences. And I really, I remember my first conference that I went to in Minneapolis. And I am from Florida. I have, I've grown up in Florida and I really don't know anything really about living in the cold. And I remember the conference is so big. That unfortunately, I wasn't able to book my hotel in the main hotel for the conference. So I was several blocks away, and every day, every morning, I had to get up and go walk towards the conference. And I was new to Minneapolis too, so, um, but I would walk through the cold and it was freezing and I had, um, Florida winter clothes on, which are really not winter clothes. It's A Florida sweater is really a sweater that's really light. So I'm freezing, walking through, and I finally realized that there's these catwalks that you can take from the hotels that actually will keep you warm the whole time. And, um, once I figured that out, I was, I was good to go and I started to, um, obviously really, really enjoy what I was doing at the conference. But so I get to the conference and there's over 1500 people there. And it's overwhelming and there's people, um, they've got badges on and there's trade show booths and there's workshops and, um, and, and in some way for me, it was just a lot of, a lot of fun and it was exciting because I was able to, to get so much information and I was so excited to be, you know, with this group of people and doing um in this one area where everybody's really so heavily focused on ESOP. So, um, But I had experience with them before and it wasn't something I was, I was walking into for the first time. So I'd imagine in that experience for somebody that walks in for the first time, it just has to be overwhelming and and one of the, one of the overwhelming parts and pieces of this is, who are all these people? You know, there's, there's people coming up from valuation firms and from attorney offices and trustees and, and it's just like this, this mad rush of people that you're talking to. And, um, and then when you go to the workshops, they talk about a lot of very um um high-level things and sometimes just beyond like, what are you really saying they're using, and then they're using expertise language and, and it's, and it's almost like a foreign language and you're like, what, what are you saying? What are you talking about? And so you're trying to like listen and, and take notes. Um, I would imagine that for some business owners, and they maybe their teams that go. They get back to the office and they, they debrief on all that information and um and, and maybe they make sense out of it and they figure out what they need to do and um they get good contacts and all those contacts can really help them. But I would imagine for some people, and this is really my, not just imagination I've experienced this with, with some new clients, is this idea that um these are the, these are the things that happen with too much information. So the whole title of this was, you know, enough information to be dangerous. So some of the dangers that I see are that you, you get overwhelmed and what do I do with all this information and then the whole process itself, and what I mean by process is moving it from where you are right now towards uh a step towards what you would be if you're trying to make to see something work. And so I see this delay happens because so much information is there, um, the, the, the business owner just stops and delays and delays and delays and then maybe a year goes by and another year goes by, um, and they get older and older and they're getting closer and closer to this, this real need, which becomes more of a sense of urgency than, than it really should be. So one, One rule of thumb of just business planning itself is, is 5 years is a good window. 5 years is a healthy, nice space of time to conceptualize maybe all things in succession and exit planning that are possible for a business, and then lay out some groundwork at the front end to determine whether or not the ESOP is actually the right vehicle for you. Um, there might be things in that five-year window that really do need to be worked out before you get into that. Um, that time frame that we're gonna get into, which is start and finish the ESOP process. Uh, there might be things you want to work on within the strengthening the evaluation or bringing on some key people or um getting into some new markets. Um, we've had situations where we wanted to consolidate some entities and, and all those things. So 5 years is just really comfortable. But when delays happen, you start losing that planning time period. The second danger happens, and I just would call it, again, um the the business owner so overwhelmed, I would call it, um, a real loss of continuity and planning. And so, parts and pieces get picked up and then they get put down, they get picked up and they get put down. So that the effect of all that is that there's just this scattered type of planning where um it it zigzags and it's, it's confusing not just to the business owner, but maybe the management team that's involved. Um, if it's confusing maybe to the employees that might be involved as well, or it's confusing to the banks and the bonding companies or anybody else and, and, and that's affected by this business. So, You know, really to avoid scattered planning and come back to that, that rule of thumb of, of, of, you know, having a good number of years to plan accordingly. Um, it's important to be able to, to organize this information and put it in the right place. So the 3rd and the 3rd, I would say danger of having, you know, enough information to be dangerous is this idea that sometimes you come back from a conference or you get all this information from people. Um, and there's a sense of pressure to start engaging professionals to do stuff. And it logically it makes sense. And this is the business owner that has a, they're, they're more of a decision maker and not as much of a procrastinator. And so in that kind of personality, like, hey, we're doing this, let's get it done, and then, you know, it makes sense to them or at least they think it makes sense to them. But the problem with that and the danger is they might have hired the wrong person. To do things. So they may even even have engaged a trustee way early in the process than they should have because they didn't even know what they were getting into. So here's retainer money going out, engagement fee money going out, and now they're into the process and they need to go all the way back to the beginning. And so they've wasted not only say maybe some money, but they've also wasted time in the process. So, so again, those are just kind of like they're at the very outset, just what I would say are dangers of having so much information. So the rest of the podcast, we're gonna do is we're gonna focus on trying to organize that information by really to scale everything back to what I'm gonna call a, is a pre-ESOP timeline. And the pre-ESOP timeline is going to help us understand who is helping during what parts of that timeline. So that what information you do get at conferences or that you read, you're trying to put it into perspective of the timeline. And just as there's a pre-ESOP timeline, there's also a post ESOP timeline. There's also what happens after the ESOP. And so some of the information that you're gonna get, you're gonna want to make sure that you put in the right category and it may end up applying more towards the post ESOP as opposed to the pre-ESOP. For example, um, a lot of the repurchase liability discussions around ESOPs really belong more on the post ESOP side. And so, if we, if we pick up information, we're gonna want to be able to put it in the right place. So the first step of the timeline is, is what I would call the goals and objectives of the owners. This is the conceptual planning and sometimes this happens just internally with the business owner and, and maybe their, their team of people, maybe even their, their existing professional team, um, that, that could include their, their attorney, that could include their banker, that could include their CPA firm. And so the, the business owner is like, I, this is what I want the succession and exit plan to look like. And so they're getting feedback from, from everybody they can think of. If they're serious about doing an ESOP, um, then I would highly recommend that they That they use a deal advisor, a professional deal advisor that has experience in working through the whole process to get those ideas down and to understand what life looks like as an ESOP company. Um, and so given their goals and objectives and one and one comes to mind right away is, um, I had a client who one of their goals and objectives was they wanted to work in the business for the rest of their life. And they felt like if they sold the business to somebody else, that that wasn't a reality for them. And so it's not a financial goal, but it was a goal that was very important to that person and, and we were able at the very front end of the, of the um deal advising goal and objective session to identify this was a possibility. This ESOP was a possibility of, of meeting the goal and objective at the front end. The second phase is going to move into the evaluation or where I would say the calculation of value. This calculation of value is going to need to be done by um some type of um Deal advisor that has valuation experience and that understands the way that ESOPs are valued with the, in accordance with the recommendations of the Department of Labor. And primarily, that's gonna be centered around a, a discounted cash flow model which in future um episodes we'll go into more detail on that. But, but again, this might be the same Deal advisor you started off with, most likely it is, but that's the deal advisor. So if you meet deal advisors um at these conferences, um they should be able to help you with that portion of, of the timeline. Um, the next thing is going to be moving into the feasibility model. So once you have the value range of the business that would be contemplated as sold into an ESOP company or being converted into an ESOP company, now you're ready to determine Exactly the structure of that ESOP, the cash flow, the taxes, um, it's a Corp, S corp environment, how, what's the percentage of sale of the company? How would that, would that, how would that actually work with the existing payroll? All of those questions and more would be dealt with in the feasibility. Um, but again, that was gonna, that needs to be done by uh again a professional deal advisor that understands ESOPs and that can guide the client to the process of understanding. Um, all of the aspects of their goals and objectives, the value range, and then putting it all together to make it make sense. Once those first three phases are, are completed, at the end of that, the deal advisor should be guiding their client into what I would call an ESOP strategy. And the ESOP strategy is going to incorporate everything that included their goals and objectives, but what you're gonna accomplish at the end of this, at this strategy. Because that ESA ESOP strategy is going to really lead into the actual plan going forward. Um, now, in the timeline, the next, the natural next step, if everything is, is good and the clients still ready to move forward, is going to be now, there's gonna be a team of people that are going to need to be hired. And that's gonna be, and that's gonna include an independent transaction trustee. They will end up engaging. A business appraiser evaluation firm. And they may also engage an attorney to represent the trustee. Now, on the other side of it, which is the business owner side and their deal advisor, they are going to also engage an attorney to be the one that writes the ESOP document plan. And so, once that team is assembled, And those engagement letters are done, um, and all that stuff's happening, then, then from an efficiency standpoint, due diligence needs to start as soon as possible. And due diligence is gonna normally be led by the trustee and their business valuation firm, and they're gonna lead off with a list of items in that due diligence phase. So in keeping with all, getting all your information figured out, um, that checklist is a very important checklist and it's something that the Deal advisor should be talking about at the very front end of the process because you don't want to be scrambling around looking for items on that checklist in the middle of due diligence. And so preparing a data room through the, through the first few, few phases of the, of the actual project is very important. Um, so that that's ready to go, so due diligence can be handled, um, efficiently and effectively. So once due diligence is, is done, um, and again, that is primarily handled by the uh the client with the deal advisor and then on the other side, the trustee, and his team with the business, business valuation firm. They, and they're completely done with the process. Now we're ready to go through the next phase which is negotiation. So then now the deal is negotiated, um, and again, the deal advisor is going to be consulting and really quarterbacking this whole process with the business owner on the negotiation, so that, so that specific items can be truly addressed and these items should have already been addressed within the ESOP strategy at the front end. And that's gonna include their idea of what the value is. It's gonna include what they think the seller financing or bank financing is gonna look like. It's gonna include um what the board structure is, um, if there is seller financing, what the notes are, um, and just various things like that. There are other things that will be contemplated in, in that, but once that is negotiated on both sides, then there is um. Like a final term sheet that's done, and that, and that means documents can be prepared and that document plan is gonna take the attorney that we, we talked about earlier on to write the documents, um, that'll include the ESOP plan documents that will include the promissory notes and any other um um items of record that need to be um published in the documents that then will be reviewed by the trustee and then again the deal advisor and his um client. Once the documents are approved, then everything is ready to go to closing, and then it's just a matter of signatures. And then that brings us all the way to the completion of the, the what I call the pre-ESOP timeline from the very beginning of goals and objectives all the way through the process to completing it, um, as now a new ESOP company is born out of that closing, and then you can get into other things with post ESOP. So, so I hope that helps when you look at all the different um aspects of people. Now, in addition to what I mentioned in the pre-ESOP timeline, you're also going to meet in these conferences. Um, People that do third party administration or companies that do third party administration, absolutely important um to be involved in, in sometimes involved in in that whole pre pre-ESOP timeline, but especially once you become an ESOP company, they're going to be very important to make sure that they keep the records correctly and participant statements. Um, in addition to that, there are investment advisor groups that are gonna be there that want to manage the whole qualified retirement plan, which we'll get into later, but which would be that if you're gonna do a 1042 exchange and defer your taxes on capital gains. So the investment, um, people are at these conferences. Um, there are going to be CPAs at this conferences that do tax advice. And so the deal advisor, um, if they don't have a, uh, an attached tax firm with them, which is how we are structured, then they're gonna need the CPA firm to do some tax planning alongside during that pre-ESOP timeline. And then there are banks at the ESOP conferences as well, and, and there are ESOP advisory groups within the bank that help look at those transactions and whether or not they can finance them. And so their role is to figure out the, the lending side, and then typically the bank is gonna have its own counsel as well or its own legal team. So, so I hope that as you look at the pre-ESOP timeline, those main roles and responsibilities of of those professional experts are really critical to the whole process. But again, when I, when I look at what they know, collectively, they know a lot. And they can be, it can be very confusing, um, when you're talking to so many different people and just being able to sort through that, um, I hope really helps you to, to put that into it's, it's right compartments so that, that process makes more sense when you go to your, your conferences this year. So with that, I just wanted to say, you know, thank you for listening to the first episode of Journey to an ESOP. I hope you found it to be helpful. And if you do like it, please share it with a friend and look for the next episode.