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Summary of Podcast on EP3 - Buy-Side Valuation on ESOP Transaction with Adrian Loud from Censeo - The Grid Wiki

EP3 - Buy-Side Valuation on ESOP Transaction with Adrian Loud from Censeo

Journey to an ESOP & Beyond

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| February 3, 2023

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When should a business owner start succession planning?What advice do business owners who sold to third parties have to offer me?Will all of my employees become owners if I sell the business to them?

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This episode - Adrian Loud - ESOP Buy-Side valuator and I talk through the role of the process that a financial advisor to the ESOP trustee plays in the process of valuing the business specifically for the transaction as well as their role in other aspects of the transaction. What is helpful is to better understand what they are thinking, how they go about their process as the sell-side estimates the value that will come from negotiations. Adrian also shares some case study areas that you should be aware of as you continue your journey to an ESOP.

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[0:11] Welcome everybody this is the ESOP guy and we are on a journey to a nice app I'm so glad you could join us today and continuation of learning more about esops this podcast,  has been designed as a resource to help people that are thinking about an employee ownership and Employee Stock ownership plan for their company,  if they're thinking about that internet and trying to learn more it's really designed to give some very key information compartmental e so that it can be done over over a period of time so,  if you are new to the podcast thank you for joining today please check out our website at journey to an ESOP.com.  Today we get the opportunity to kind of dig into a topic that it's it can be kind of confusing when we think about business valuation for esops.    [0:59] One of the things we have to think about is the the way that the valuation is actually  established when you're doing the transaction itself and so the primary way it's established is that it's a negotiated value between a sell-side and a buy-side,  and so today we're going to dig into the business valuation and really look at the buy-side support of the transaction,  so as we think about that what we're going to want to do is talk to an expert and so we get to do that today which is always,  exciting because you don't have to just listen to me if you are wondering if you're watching Youtube you'll notice that my face is all messed up,  I did go to the dermatologist today and so it is what it is and just I covered every everything with a Band-Aid so you don't have to look at.  But so if you're if you're just listening to the podcast obviously you're going to you're going to go jump on YouTube to check it out.  So really as we think about this I want to introduce this this person I've been asking him to be on the podcast forever his name's Adrian loud he has his own valuation firm and Adrian how do you pronounce the name of your firm.    [2:07] Oh good question can say can't say almost like we care the way with a camera yeah the way it's just the way it's spelled it's like some people say since and I didn't want to mess that up right at the beginning so alright so he owns a valuation firm called can say oh,  and they're very strong ESOP,  valuation firm they do other types of valuations but they do a lot of Aesop's use an ESOP expert out of Atlanta Georgia has a great reputation and working on,  the buy side of the transaction and as we get started Adrian I wanted to kind of just kind of just walk into this a little bit because this is your very first podcast tell me what your very favorite movie is of all time.  And tell me why as we get started.    [2:51] Um so I was going to say tenant but then you did your most recent podcast I realize it's to that one because if we're to confusion well that because that's because you're super smart.    [3:05] No I don't get tenant I've watched several times if I'm going Christopher Nolan it's probably Inception otherwise I'll go with probably one that a lot of people go with Shawshank Redemption.  That just algebra that kind of is really the generation before you and me yeah there's no technology in it and it's kind of like our friendship at its greatest yeah so,  that's probably my favorite that's awesome and I will tell you that tells you tells me a lot about you,  that means you're deep person in that you have deep thoughts  so anyway let's move on my candy yes exactly alright so you are an ESOP expert because I just said you were but tell us how you started working in Aesop's like how did you all get how did you get started in this whole industry.    [3:55] I'm probably most people just by chance by luck really if we go back safe 30 years right out of school,  either the job I got a job working with a small valuation firm.  And he had one or two ESOP clients and I didn't know the difference between Lisa and an estate valuation or anything else it was just.    [4:21] It was something I had to sort of learn so fast forward a couple years I left that little firm and went to,  a big public accounting firm and they had a client that was considering doing an ESOP in someone had heard that I had value D stops in the past so I became the local expert,  even though doing the wine evaluation yes I no idea what I was doing and it turns out that company did not do any stop.  But at the time was like okay I'm starting to get this actually kind of interesting and if it's done for the right reasons this is pretty cool so yes 30 years 30 years goes by quick doesn't it.    [5:00] It does yeah so so navigating through like some of the things that I want and some people are brand-new listening to so I'm going to be kind of very basic,  is that the roles that everybody plays within an ESOP transaction,  can be a little confusing so I'm just going to back up a little and just to explain that and then we'll kind of get you into the discussion on the buy-side so the roles.    [5:23] That come up are you have the sell-side team and that's the company and the selling shareholders who are going to sell their stock are normally going to have a cell site advisor,  that's kind of what I do and then other kind of people do that,  they'll also have on that side of the team they're going to have a ESOP attorney who's going to be responsible to draft documents again for,  the sell side of the equation,  but an ESOP transaction is a an arm's length negotiated transaction so you need the buy-side and the buy-side starts with a trustee who will be the transaction trustee which will be the financial buyer of the Esau,  Ori of the shares that go into these,  that person is going to need or institution is going to need a valuation advisor and so that's what Adrian and his firm that's what they do,  and their role would be to in and on the buy-side would be to evaluate all the all the,  qualities of the business and do a have a business valuation to support the trustee so I want to make sure we explain that we're Adrian comes into the equation,  we can call him the adversary he's the enemy but not really they do they do basically a very good job but what they're doing is they're an independent source of information to the trustee,  so that the transaction can truly be passing the department of labor standards so.    [6:51] I just explain kind of that but let's talk a little bit about like your as you support the trustee why is it so important for the trustee to make sure that they pick somebody maybe you know maybe your firm or somebody else,  why is it so important for the trustee to have that done in the right way.    [7:10] Right and I think what you laid out makes perfect sense fill and the trustee.  I think a lot of folks and I know you've addressed this previously on a podcast a lot of folks may not realize that the trustee is ultimately responsible for.  Your purchase price determining what the purchase price is or the value so both of the time of the transaction and the trustee is ultimately deciding this is how much we are willing to pay for the company,  and then for the ongoing evaluation updates its setting that stock value,  so that's a big responsibility right it's maybe I'm being a little biased here that's maybe the biggest responsibility that the trustee has at least from the transaction sentiment that purchase price,  um probably prudent for the trustee to have somebody else who was kind of crude expert notion,  have a financial advisor evaluation expert come in,  in fact I think the GOL mandates that and you've got this process agreements the last several years that say Hey you need to go hire somebody independent too.  Abused valuation so that's where we come in is on that buy-side trying to help the trustee like like you said.    [8:28] Probably initially established value so that's kind of the valuation engagement,  um and then that usually Morse into that Financial advisory role right where evaluation professional is now.  Hoping as far as looking at deal transaction structure in terms to interest rates make sense do some of the assumptions make sense is by do dilution from warrants or SARS is that reasonable.  Um all the way to eventually likely issuing some sort of opinion.  Um tell your trusty hey we understand you're interested in acquiring the stock of.  So here's Incorporated and we think the purchase price is reasonable and we think all the terms reasonable.  And go for it so that's that's in a nutshell what we're trying to do is the financial advisor to the trustee.    [9:27] Exactly and so,  bringing in an expertise to the trustee may have some experience at but they need somebody independent and be able to look at it with the with the you don't ever see a trustee doing their own valuation were cry or being their own advisor in that do you.  It's been a long time since I've seen that thank goodness yeah yes and I think a lot of Trustees have uation folks on staff.  But still have that independent valuation firm that independent financial advisor working on the transaction,  I think that's the prudent thing to do and I think the twin The Dol the process agreements I think that's what we need to do at this point.    [10:08] I think that's the right it's the right way to do a transaction which when we start thinking about like that that comment of the right way to do a transaction,  what is being considered when I say that I'm saying that for everybody involved in obviously the trustees going to have a lot of response of fiduciary responsibility in the transaction.  And the selling shareholders are going to have responsibilities as well,  it's not going to go well if this thing does get pulled for audit and then there's a big problem later down the road so having those people be in place that the things that Adrienne does actually does protect everybody,  and making sure that it was done in accordance with the Department of Labor and so that you can avoid anything go down the road that's that's problematic.    [10:54] One of the couple things that you mentioned I want to kind of highlight and just jump into a little bit deeper is the,  you know the obviously there's a there's a whole role of being an advisor as opposed to just your not just doing a business valuation but it's you're helping the trustee make a decision based on a lot of different elements of a transaction which.    [11:14] A lot of times when people think about I'm selling my company everybody kind of gets hyper focused on the actual.  Sale price whether that's the Enterprise Value or whatever you call it but there are a lot of other elements of the transaction that,  Adrian alluded to which it include the structure of the death of seller the seller debt and how that gets structured,  and what interest rates would be put into place obviously if there's going to be a warrant so there's a lot of parts and pieces that have to be planned for to make sure that the selling shareholder.  Looks at this whole picture like all of these pieces together both on their side when they're evaluating even going into a transaction and on the buy-side really evaluating that from how what the trustees going to.  And so planning is going to be very important,  all of that gets brought together and you mentioned the opinion which is what we're going to call the fairness opinion in a transaction,  and that's going to be,  but by Adrian's firm or a firm like Adrian's that's that's going to be something that you're going to document for everybody so with all of that kind of those are those are kind of the parts and the pieces.    [12:28] One of the things that get that I always kind of will look at is theirs,  there's a combination of things when you're putting together an offer and then that's being reviewed by the trustee.  And how do you how do you evaluate the combination of I got a purchase price here.  With a Target say a Target working capital here I've got a warrant payment here are you looking do you look at those separately or do you look at those together are how do you give good gut good guidance or advice to the trustee when,  when they're evaluating if you just look at them and you know just by themselves it might not it may not be the big picture right.    [13:06] I agree I think you have to look at them in a totality and I can't really think you had will Wherever You Go sir somebody on a couple weeks ago sort of talking about the warrants and that a guard right it's.  It's like the bad analogy is going to the car dealership and the dealer says hey I'll give you both leave and $10.  And you're completely ignoring with the purchase prices or if you're getting the steering wheel with car so yes I think you have to look at the combination of the purchase price.  Um what sort of dilution there's going to be and I think what you and I are talking about what you and I are accustomed to seeing us.    [13:43] If the sellers are going to least partially financed this transaction are going to take back paper.  With an interest rate and presumably to help the company with cash flows especially early on because it's got all this new deck right.  It might be prudent to have a lower interest rate but,  to compensate the cells from a lower interest rate okay maybe they deserve some sort of equity component Equity kicker so warrants like you and I are talking about.  So I think that dilution number has to be addressed the strike price needs to be addressed.  You know another form of synthetic Equity stock creation Ranch usually going to management team.  That needs to be addressed as far as have diluted that's going to be obviously what the interest rate is on the seller that we can't have an interest rate of,  25% and also do 50% warrants some being silly but right it's out of hand you could be out of handling yeah,  you could be so chances are it's going to be looked at at some point down the road so I completely agree with you kind of looking at all those pieces.    [14:57] Individually but as part of the collective that's critical to making sure that the transaction worse for both sides frankly yeah,  and so so for folks that are listening and they're like hearing some of these words for the first time my first my first comment there is just don't get overwhelmed you just start taking in some of the what I would call the ESOP terminology,  because it's like it's not I mean we're kind of throwing out dilution and strike price and and all these different these different terms and,  first off there's the big picture that that I'm trying to do that we're both trying to make is I all that fits together in into in terms of an actual deal and.  When you look at some of those pieces by themselves like dilution for instance is how much how much stock were going to or with synthetic Equity when we think about warrants and SARS,  how much are we going to dilute the value of the ESOP shares to the employees I mean that's that's kind of a major issue for the trustee because that's their job is to make sure that,  taking care of those people so when Adrienne talks about dilution what's happening is there's some level of,  interpretation of what dilution should be and that and that's what's fun about Aesop's right age and I'm like there's nobody that told you that dilution should be exactly this right on a deal.    [16:21] Like unfortunately and fortunately know there's the right so there's yeah so you can have like so it's cool about Aesop's and it's also difficult is that.  It's a trustee and a financial advisors interpretation of what dilution should be.  Some of that I think has a lot to do with maybe deals that they've done some of it probably has to do with the experience with the Department of Labor,  I don't know how do you how do you do that how do you,  gravitate towards understanding like what your the adviser so you have to have something for the trustee I'm sure it's a combination of things but how do you advise them on something like dilution for instance.  Well and I think you and I probably know trustees to that are just adamantly opposed to any sort of leadership they just won't do transactions that have.  At least on the warrant side maybe a Stockbridge station right yeah they'll do that because that's good for them all right yeah,  but yeah it's it's difficult and.  If I were to go back and look at all the transactions that we worked on I'm sure the dilutions been very different but your earlier point.  Purchase prices have been different interest rates have been different.  So there's a lot of moving pieces there I think it's part.    [17:44] What are Best Practices as far as what are we seeing in the industry its parts.  We don't want to go down a rabbit hole unless unless you want to go down we go down the rabbit hole of sort of this internal rate of return type abscess of seer unit in plain English,  if we were to look at how much warrant I Lucien.  We permit or allow and what kind of return that creates for the selling shareholders yeah all in all in all in right yeah.    [18:15] Yeah that does that he hasn't kind of jive with maybe you know other Alternative forms of financing if it's,  nope asset-based lending or Mezzanine Financing or something like that to the rates kind of look like they might be consistent with each other if they don't if the rate looks too high.  Chances are the warrant Aleutian is too much.  Damn so that's another barometer for kind of check that's actually a reason that's a good answer actually because because the marketplace and now the rates are going up right so I would imagine that that.  Warrant dilution can be a little more acceptable because you have to do to get a higher internal rate of return on the whole transaction so,  that and again not now to get down to a rabbit hole to me the internal rate of return for people that don't know what that is it's so it's basically if I could just get my interest rate online my seller note so if I got five percent on my seller note,  and that's all I got at the end of the payments of that note I got a five percent internal rate of return.    [19:15] But if I reduce that rate and I make it up with warrants then I could get a ten percent say internal rate of return and make up another five percent or whatever the differential and the rate is,  and so my all in internal rate of return at the end with interest with interest income plus the warrant payment would total a total internal rate of return,  and so if I can get senior debt financing at five or six or seven percent and Mezzanine Financing at what do you think double-digit something.  10 12 15 percent whatever now rates go up there's more opportunity for for that so I think that's a good that's a good answer on on that but I think the bigger the bigger thing I'm trying to illustrate is is that you were roll.    [19:59] Is including a lot of things that have to be first off you have to be able to advise the trustee on all of the aspects and fit it all together like a puzzle.  And it needs to kind of also be relevant to the point in time that we are which,  as we just talked about what's changed over the last year interest rates other things change to that you have to be kind of you know aware of and be putting that in so every deal can be somewhat.  You know unique the LMS are there but they're unique that you kind of have to look at all that individually which means I guess for in this is partly a question you can't just have some staff person work for you and jump in and be the advisor.  Um is that true or is that how does that really work for you guys to know it's  try as we might it's very difficult to leverage these transactions because you do need the experience may not I think to your earlier Point as far as these opinions that were issuing their really addressing two things right one is,  hey are we paying.  No more than fair market value for the stocks that if it's back to our kind of our purchase price analysis that second piece what you're talking about there are fillers,  do the transaction terms.    [21:19] Makes sense from a financial point of view I mean very fair from a financial point of view if we're to go out in the market kind of like your analogy of going out,  and loaning money at 5% are all the terms of this transaction reasonable enough that you can get somebody like us on behalf of the trustee to say yes this makes this make sense.    [21:39] And it takes a lot of sort of experience in time and education to be in that position.  I don't know what's going on it's one of those things where you've got evaluation background.  There are some things that you just would not accept as an engagement because you didn't feel comfortable you didn't have the experience doing it great I'm not a not a healthcare compensation expert so I stay in my leg,  yeah I've been doing ESOP work as you have for a long time now so we've got this familiarity with kind of how they structure should look.  Yeah and they and they play off one another and then you do learn you learn things from people as you do,  you know you do look at different types of personal transactions which one of the things that we didn't mention is,  the concept of deal structure and putting like earn outs and clawbacks which can can come up from time to time on your side looking at that can you kind of explain.  The justification for,  whether it be an iron out or a clawback type of structure on a on a deal why would you use that why would you advise the trustee to use that.    [22:54] Yeah good good.    [22:55] Music.    [23:00] Our backs helps to what what I think you're asking is okay.    [23:05] The earn out would provide for the seller to perhaps increase the purchase price.  It's some point down the road I'm probably not far down the road but maybe it's two or three years and if you disagree let me know Phil but it's probably a yeah your window yeah such that.    [23:28] Typically you'd seen her now situation where the seller says you know I like the idea of doing this ESOP transaction I'm not enamored with the purchase price I think it's perhaps a little bit on the low end.  And the trustee is saying maybe but we like for you to prove that you can actually generate the cash flows that you're telling us you can generate.  So the purchase price again maybe a little bit on the low end but there's upside for the seller in case those cash flows actually come to fruition so that's the earn a scenario clawback scenario.  I would think of it's almost the exact opposite yeah maybe the trustee is paying a little bit towards the higher end both of their comfort zone.  Um it's not too sure about cash flows in the projections but is willing to go along with a slightly higher purchase price but says.  Well if you don't hit these numbers.  I'm going to need you to reduce the purchase price so that in effect we paid a lower purchase price than what we've agreed to on the date of the transaction.  So I think.  You see those either one of those situations where there's there's negotiation that takes place and the buyer the seller really just can't come to terms and what the purchase price ought to be.    [24:47] If that's the case it's probably appropriate to consider a burnout and Oracle back.    [24:53] I think you nailed it I think that is a great explanation and I wanted to throw that in there because.    [25:00] One thing is that some people just don't know that that's going to that could come out whether they would hate for people to get.  In they get through a transaction in the trustee says you know I can't I can't.  Even get close to your price the only thing I'll do is to offer you a call back or an urn out so one of the one of the things I try to do and the sell-side is just.  Is look at that as a potential issue going way way early going into it and saying and it you can kind of usually spot it if you see a tremendous change in the forecast if because because one of the things I always tell people when they forecast is like,  history repeats itself you know in general history is going out you're going to have.    [25:43] Potentially new customers but to go from a an average growth rate of 10% to 30% or something higher it's hard and you got to explain like how you're going to get there so if they're going to do that and I'm like look and they really are confident,  I'm going to support that but I'm always going to say hey we're are facing the possibility of having,  earn out or claw back and so then they know about it before we even get into it I mean.  And you know just like you probably you you learn from your mistakes I had one deal a long time ago it was like.  That came up and the clients like I can't do the deal and so a lot of money was wasted and so you just kind of make sure that you watch for those types of pitfalls going into it yeah I want to fill if.  If you and I are going to see a little bit more burnout and clawback structures in the immediate future only because coming out of covid-19.  Where company's revenues might have been temporarily depressed or eight it from for all we know mean some companies did really well as a result of covid-19.    [26:50] And if there's not a great track record.    [26:53] And your point now we've got sort of a hockey stick in either direction does it make more sense to have that flexibility to have urine out or the claw back there to kind of,  actually see what happens if spheres yeah and when you think about it it's a fair proposition,  because the buyer is not going to want to take the potential risk of that not happening right so if they overvalued it it's fair that it would be just it back.    [27:22] You know and of course the cash flow wasn't really going to come then everybody,  gets normalized if you start thinking about it that way so yeah if I'm a trustee and I'm just a financial buyer and I wanted to just pay fair market value just have to pay for America value I mean it's just it makes sense,  but you are protecting the employees too so I think the biggest issue is don't be surprised by it,  I've used it you know in a way that like look I think that the clock I like I like the claw back personally only because you start off with a higher number.  And in this scenario we used it and we incentivized the key managers with the differential and some portion of the differential on the claw back,  so we built it into their incentive plan and said that was that was effectively a good way to use it and then you know we'll see.  We'll see what happens because we're still kind of going to see what happens with the forecasted cash flow but.  Good motivation yes yeah so you can kind of like put all that together and that's what that's what's fun about esops because there's a lot of parts and pieces to thinking through a deal.  And really understanding kind of the lay of the land and partly this is why we do the podcast because I want people to know about those Concepts and,  and whether they're whoever they're using as their advisor to be equipped to ask the right questions,  early in the process so you nobody is really surprised or they didn't know that that was something that could be available to them.    [28:52] So talking about being surprised let's jump into this one right have you ever been like you jump you get hired by a trustee and you're like all right kind of moving into it but.  Something just kind of came out of the blue you were kind of surprised by the deal you weren't expecting something so.  You know if you had those kind of situations where it's like what what did I get myself into you know and I told you can't pick one of my deals.  No no it well I'd be hard-pressed to come up with one of your deals that is the issue and only you and I you know if we had a nickel for every time we've been told hey this is the most straightforward simple as transaction you ever going to work we're going to work on,  um no I think I think every transaction has nuances or wrinkles I mean I think.    [29:41] You're always been a.    [29:43] So you know you doing a lot of sell-side type work Phil I would say there's a huge benefit to the seller having someone an advisor,  um because let's face it the sellers don't often know what they don't know and they're trying to run a company keep it successful,  and so it all the same time,  um so as much as us evil trustee buy-side people you are you are called that by the way,  now all you guys all you guys now I'm just kidding you guys are great all of us no I mean it's  we need each other right it's it's really hard to do a transaction in do it accurately reasonably and Dot all the I's and cross the t's,  um if we don't have both parties there with really good professional advisors you know as far as surprises go.    [30:45] I've run into things where's a manufacturer that claim they had a facility in Chicago and push comes to shove it was an abandoned warehouse,  what we had a transaction years ago where.  And shame on me I've learned to address this issue so it doesn't become an issue but the management team had no idea.    [31:13] Nice of transactions taking place wow okay yeah wow they just weren't going to tell him.    [31:20] It was a met the owner yeah and didn't meet the the next in charge you know The Heir Apparent.  And it just kind of assumed that that person knew what we were there or okay it was a bad assumption yeah,  well it's like that well sometimes people don't want to say anything about the I mean there's there's definitely like when do you tell your key managers.  That you're going through the ESOP process because if you're just exploring it and you don't do it then it can create some.  Wrong expectations but there's definitely a time to get them involved for sure.  Um going through obviously to make sure that they're aware of it because they're going to be part of the whole succession plan yeah.  Yeah it's otherwise it's heck I've had a pretty good I think I mean it's a little things you mentioned sort of.  Working capital just remnants how do you define working capital you know a we had a unfortunate situation of years ago where this is just after covid-19,  sellers primary vendor because of supply chain issues that I am so sorry I'm not going to be able to get you the building supplies you need to fulfill your contracts for,  probably several months that's so that point everything just got put on hold and never got resumed reso.    [32:44] Yeah you never you never know quite what's going to come up yeah yeah I mean that's where I think you have to just look at it I think for your standpoint you just kind of look at it factually.  Evaluate and then ask questions and then you know and then go from there.  Hopefully their advisor sees some of the major flags and says saying says everything before they even you guys even get engaged like this is,  this is what you should be thinking about our concern with so you're not you know you're not surprised what about like just a difference in valuation numbers like if you're if you're coming in at something super low and somebody else's.  Negotiating something very high I mean if you had that situation where you having a hard time getting the the Gap figure it out.    [33:31] Yeah it's that comes up,  quite a bit honestly you can go back and forth a couple times sort of holding your cards close to close to your vest and not disclose kind of what assumptions but eventually sometimes you have to talk about,  okay well what working capital level are you using and what discount rate are you using and oh gosh you picked six of a companies that we thought were just so different than what this company does that,  in a wonder you're coming up with a higher value yeah,  so again usually if you've got good folks on both sides Good Financial Advisors on both sides,  if you're going to be able to reconcile those differences maybe not all the way no but but close enough that it makes sense and it still reasonable lip to go ahead and do a transaction.  And to be honest I mean nobody really wants a I don't ever want a big gap at the same time you get a better I think you get a better transaction when you have somewhat of a difficult negotiation,  not like I want a difficult one but and I say that because both sides have looked at different things you know and I think sometimes you know the buy-side Can are on concerns on the conservative party.    [34:47] The sell-side can are on the liberal part but when you bring out together and you start compromising on this and that you really truly are negotiating out you know the very best Fair Deal you know at the end if everybody can be reasonable,  you know you know it's tough to because you on the south side.    [35:06] Your deal with people it's personal yep for them right I mean this is this is their baby yeah this is something that they might have.  They might have birthed and nurtured for who knows 25 35 40 years and for me.    [35:25] I think I'm a pretty caring guy Shawshank Redemption reminder it's it's I've got to be you are careful.  Yeah I've got to be apathetic to some degree right it's more of a financial issue because that's frankly that's all the trustee can consider the trustee really can't consider the fact that.  Gosh Joe does seem like a super nice guy so maybe next return on eBay does is appropriate here.  So it's difficult because you've got a dynamic that we really don't have on the buy-side right I've him the emotions are there yeah correct and I'm not sure that the seller is really understands it.    [36:08] Hey they're not being insensitive they really just can't consider anything else and so it's kind of tough yeah it is and I think that's why on the sell side,  it's really important to establish realistic expectations,  and you know but just like we talked about there's a lot of ways you know you can look at valuation in multiple ways like you take Market approach and focus heavily on the comps.  You know I always and honestly I just look at cash flow and for the most part because cash flow.  Is going to dictate a real more of a real realistic value for the subject company but ultimately if they have an idea that that expect that valuation is going to be much higher for whatever reason,  you should blow that out at the beginning but if it if they go into it like that it could really make the deal difficult because they're coming.  They're thinking they should get something in the other thing they need to understand the sellers need to understand.    [37:06] The other aspects that we talked about earlier like what what is working capital and why is that important what are some realistic working capital targets that are going to be required.  Because that's going to affect the net purchase price,  and they all in like what does that all mean to you somebody has to translate all of this in terms of what they actually are going to get out of the deal you know and that's important but expectations are really important,  especially because the emotional side this is the only time they'll ever probably do this sell their business and,  you want it to go well you want it to be positive and you want it to be you know at the end of the day you want them to feel like they won as well as,  the whole the company and the employees so.  I agree I didn't hit this at all but I would kind of like to make sure that when we think about independence like you're independent what to beat the trustees advisor  what are the qualifications that you have to have as a as a buy-side valuation advisor.    [38:10] No qualifications experience education.  I would say knowledge of the industry that you're that doesn't mean I necessarily have to be an industry expert but.  If I don't know enough about the industry I better make sure I can be a quick study if I'm going to accept this disengagement yep.  So this app valuation experience I think it is is a critical.  You know this is again you and I've done valuation work for a long time this is different than.  A divorce valuation or an estate tax valuation that's right it's the valuation but there's a lot of stuff that that is it was a new one so you got to understand that.  We  I don't know you and I have worked on stuff in the past so I don't know there are some trustees that will require us to,  I'm effectively independent financial adviser certification it's usually a one or two page document.    [39:18] So it's something to be effective yes I actually know what I'm doing here and I do this for a living but it goes beyond that to say.  Your I'm not secretly employed by the seller or have been employed sellers not my my twin cousin.  Yeah I don't stay under to make any money off of this I'm not issuing a fairness of being in.  In the hopes that I get paid in other words yeah it's not like a reward for yeah reward for the deal right yeah.  That's a good that's a good point and I you know some case law where people have gotten into trouble is where the valuation firm.  Did work for the company and then they come back and they do the work for the trustee and that's a big No-No so you know and I think that's kind of an obvious but it definitely needs to be,  you know you can't I have two people sometimes come to me and they already got evaluation from somebody.    [40:22] And not that purse that firm would ever do it but to me the evaluation isn't as helpful I can use components of it I mean they've done some,  some good work but I got to do my own work to make sure I understand the the way we're putting a deal together because there's a lot more than just.  Just the numbers right it's how it's all getting structured but,  but on your side that's important because you you know you want to make sure that they're the trustees represented correctly so there is no problem,  but then moving past that you can become then the trust the valuation firm that does the that's kind of what happens typically is you'll kind of move into the role of now doing an annual business valuation for the company.    [41:05] So you don't you bring up a good point I forgot to mention this those processes agreements that we've alluded to a couple times those agreements kind of entered into between the Department of Labor and various trustees I think to a tee they all have language in there that says.  Is a financial advisor to the trustee on a transaction,  um has not worked on behalf of the plan sponsor or worked on we have the ESOP committee and sort of a preliminary findings capacity so,  see that's really important normally yes if we're working on behalf of the trustee at the time of the transaction you see stock valuations have to be done at least annually,  so normally we will stay on and become the,  it's more of a valuation past as opposed to a financial advisor Cassity at that point but the yes we'll stay on weather,  it's for that same institutional trustee or.    [42:03] If the plan sponsors just decides they want to bring the trustee internal chance our work product still staying on.    [42:11] And that's and that's good for everybody because you already have that experience you've built the files.  Cost effective in new and you are building an ongoing relationship at that point with the company in the capacity of being an independent valuation firm to help.  Make sure that we've got a classic gosh idea I'm getting old here JD myself again but we got planter class would probably do the valuations for.  20-plus years yeah that's a pretty good yeah considering you know you probably started when you are 15.  So because you can't be a day pass for tea.  Anyway let's not talk about what I was doing at 15 I'm sure it was yeah sure it was nothing for granted yeah now that's good but I think partly we and I say all that is because the ESOP Community is a bit small.    [43:01] And you do kind of we are concentrated we all kind of work that's what we do we just do Aesop's for the most part that's what we focus on.  It's it's just helpful that you have that much experience because it just builds your value in the process of doing the support work that you do so.    [43:19] So we're almost out of time just kind of real quick I would just say thank you again for thank you for coming on the podcast it took us a while to get you here,  any any advice for people that are thinking about going towards an ESOP just kind of a thing that you see out there that it's like important for people to know because that's really the audience that we have is people that are thinking about becoming an employee-owned company.    [43:41] Not rocket science it's  cliche I'm sure it's been addressed by you and others many times you got to hire the right professional advisers we have this conversation with a potential Vista client last week.    [43:58] It was a little alarmed by the fees that were being quoted from various service providers and.  I've started doing the math with them and that it's time I get it I understand it's a lot of money I'm not doubting that whatsoever.  But they all serve a hugely valuable purpose in this you got a lot of players in here and they all serve a very important role.  And you can cut corners and say hey I'm going to have fill do several things at once put on multiple hats.  But you've got to worry about if there's going to be blowback at some point the future because something went wrong make sure you've got the right professional advisors and then.  Probably goes without saying but I'll say it anyway I think the key subculture is going to be there before the ESOP is in place it doesn't make sense to say.    [44:52] I want to sell my company I try to sell to private equity and strategic nobody's interested so I'm just going to be stopped because it seems like a good way for me to get out yeah you I'm see that too often fill in it.  It just doesn't work long-term yeah I like that you said that because I see that to and you know we all we both probably have a lot of conversations with people.  And you know there's just a misconception of.  You know if you're going to go that route go that route and commit to it and otherwise you're you're probably not,  goodies up candidate because you're you got to be thinking a bigger a bigger picture its value but its culture and its longevity and Legacy as opposed to I just got to get my multiple and I got to get my money out.    [45:39] Because you because you know on a normal deal you're going to get some of your money out and Bank financing but you're going to be hanging out on that seller note for a little while so it's not,  it's not going to probably be what you think it is so I was right,  which I think is really good advice Adrian only because you know people can waste a lot of time and you know let's just kind of get through the deal Killers first like that's not going to work then,  then go ahead and do that and that might be a better better fit for you and terms of all the other things that you could do with your with your company so,  yeah it's not a it's not a solution for everyone it's a solution for certain certain companies and certain Sellers and certain employee basis and.  If it's the right solution it's fantastic but yes you and I are not advocating that it's a One-Stop solution exactly.  Well hopefully somebody that's listening will be lucky enough to have you on the other side of the table someday but yeah so free I appreciate your time and your knowledge base and your expertise are really doing,  so for everybody else thank you for joining today and we'll see you on our next step on this journey to a Nissan.

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About Journey to an ESOP & Beyond

ESOPs are gaining traction. In the "Journey to an ESOP & Beyond” podcast, Phillip Hayes explains the process of the ESOP transaction and addresses ESOPs from a business owner’s perspective. The "ESOP Guy" illuminates the simplicity of ESOPs as he debunks common misconceptions that ESOPs are immensely costly and complicated.

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