EP40 - Interview with Tim Jochim - ESOP Attorney - The Godfather of ESOPs

Welcome back. Thanks for tuning in on the ESOP Guy, and we are continuing on this journey to an ESOP. If you are new to this podcast, I wanted to just say welcome and if you have an interest in other episodes, please go to our website at journey to an ESOP.com. If you have been continuing on this journey to an ESOP, I just wanted to say thank you for continuing. And today's episode, I think will be very interesting. We are going to delve into the subject of ESOP's, um, a guide for company owners. And with that, we are gonna focus on that through an interview with ESOP attorney Tim Yoakam from Columbus, Ohio. Tim is called the godfather of ESOPs, and that's a pretty big title. He has been a partner with Walter Haverfield LLP out of Columbus in Cleveland, Ohio. He's also the author of numerous articles on ESOPs and one of the first books on ESOPs ever written. He's the co-founder of the Ohio, Kentucky chapter of the ESOP Association, former adjunct professor of business policy at the Ohio State University. Former adjunct professor of corporate finance at Capital University School of Law from Columbus, Ohio. So he has quite the resume. So, Tim, thank you so much for joining us today. Phil, thank you for the for the invitation, and let me say upfront that I think it's great what you're doing, the journey to ESOP. I think it's a great service. All information that company owners can get up front before they take the plunge is very helpful, especially your kind of information. Thank you, I guess I don't have to, I don't have to say much about myself because you did most of it. Yeah, just kind of what would be interesting though is kind of where, you know, where did you get, how did you get started in ESOPs? That would be a good place to start. Like I got started. I was teaching economics at University of Akron. Uh, and, uh, I was one of my school nights, and one Sunday night I heard on 60 Minutes I heard Mike Wallace interview this guy Louis Kelso had written a book called The Caist Manifesto, and he talked about ESOPs and, you know, everyone, everyone is, everyone is going to be an owner, and I just, I, as, you know, from my perspective as an economist. I found that very interesting that kind of business model that to me is what it is. ESOP is a special kind of business model. So I did some research, wrote some articles, and out of the blue I got a call from Greenwood Press that had published one of Kelso's books. They asked me to do a follow up, which I did. And they paid for it. They paid my way to do the research, interview companies, go to ESOP conferences, and there wasn't much. There was just the one in DC at the time, ESOP Association had just started a few years, but that's how I got started. That's, that's fascinating. Um, and to come to plunge into that, you're really, you are really one of the godfathers of ESOPs. So if you, if you've helped to create. And uh promote ESOPs even way back then. So with that, why should a company, and the owners of a company consider an ESOP as a strategy for their business? Well, for one thing, and this may be the most important. I think it's the best business model around. That's just my personal opinion, but there's also our research to back it up. Reachers from Rutgers that ESOP companies, majority owned ESOP companies have have better sustainability, longevity, um, and. To me, uh, one of the primary reasons, uh, that in my opinion what company owners should look at is whether they have the type of culture that is conducive to success as an ESOP and longevity as as an ESOP company, and by that I mean a sharing type of culture. You know, you know, Enron had a had a KSOP combination 401k and ESOP, but I wouldn't exactly call Enron a sharing type of culture. It was quite the opposite, but most of my clients, and most of them tend to be successful long term clients, uh, ESOP companies, they have that culture. They didn't all ended at the beginning. But they developed it. They had, they had enough of it to build on it. And to me that all of the tax benefits like the Section 1042 exclusion from capital gains and the the uh exemption of S Corp ESOPs from federal income taxes, those are incentives to do in ESOP because it's a new business model. Uh, and, and it's not going to sustain you in the long term if you don't have a culture that supports that kind of business model. I think that's a, that's a great point because I noticed a lot of the ESOPs that I look at for companies that are looking to go towards ESOP, they usually have a very generous type of bonus pool that they create every year to share with their employees. So, Um, sharing, you know, from a, from a standpoint of they want their employees to be rewarded, um, just as they are now an owner versus an employee, obviously they have different roles, but I find that is definitely a theme of a lot of the companies that I'm looking at as potential ESOP companies. Uh yes, and I mean, if I can put it this way, it's very what I would call common terms, you know, everyday everyday terms. If you have a company, an owner founder, or a group of owner founders that feel that this company is their baby, this is their child, this is something that they brought to life and build, and they want to sustain it. They don't want to go sell to, you know, a private equity firm or engage in investment banker, which they, which they may do, but that's not their, that's not their primary preference. They want their company to, to have longevity, to outlive them, to have, to have a legacy. So that's what I'm looking for, you know, when I first meet uh prospective uh uh companies. Company owners, you know, that's the types of things that I'm looking for, and it's not that I don't do other types of transactions. I do. It's about 40% conventional M&A and 60% ESOP, but if you're going to do an ESOP, those are the things that I'm looking for. And ESO is not for everyone. It's not. It may be that it may be that a sale to a strategic buyer in your industry would be preferable. It depends. It's the facts and circumstances sensitive. And we kind of get there both, you know, Tim and I, as we talked about this earlier, we get there from asking those questions there. I'm a financial person and I, and I love to talk about the, the valuation. I love talking about, you know, the forecast and the numbers and all that. But when you get down to, there's questions that we have to ask that the, the, the potential ESOP company has to be Um, looking at, and that's, you know, what does this look like? Why are you really looking at doing this? And I think a lot of those are not uh financial questions in nature. They're, they're other, other than, and because the finances always worked themselves out if that's, if that's going to um be, you know, a major issue because there's a lot of things you can do with, with ESOP structuring. But when you get down to the heart of what we're talking about, your culture really needs to be in the right place and that really starts at the top and what the business owner wants for their, for their company long term. Uh, it's like it's like just about any, any business or profession that you go into, you know, when you, when you start, you're you're focused on the technical issues. You have to have technical competence and in my earlier years, that's, that's where I where I spent most of my time and my thought was becoming technically competent. You know, the tax issues, the finance issues. In fact, I started out on the financial advisory side. My background's in econ and finance, and even though I had a law degree, you know, my initially I was on the financial advisory and valuation side, but it gradually migrated to legal, so I had to learn that too. But I've done this so long and have so much background in the technical issues that, you know, I'm not concerned about those. I know them. What I'm more concerned about are these soft issues that we're talking about. It's great that are really the heart of an owner founder in my opinion. Uh, that you, that you have to respond to those interests and those concerns. That's great. So, so let's shift into then what types of companies from your perspective should consider an ESOP when you're profiling a, a good, a good profile company. Well, you know, other than the, than the cultural factors that we addressed, uh, I mean, just on the technical side, uh, to make this realistic, you know, given the cost and the amount of work that goes into it, uh, I would say over 20 employees. Uh, and this is sort of the, this is sort of the bottom side. Uh, at least 20 employees, at least $5 million in sales, at least $500 in IEA, and, and that's, you know, that's just on the, on the financial side. Uh, I, I might add. A fairly good line of business. Yeah, they need to have I've I've had well managed ESOP companies that have over the years changed their line of business focus several times because they had to adjust to the market. So they didn't know that. It's not they didn't know that line of business, but that wasn't the emphasis. It wasn't the primary. But good management is so critical to adaptability and innovation that enabled you to survive. I think that's, that's key. I mean, I always say to, the business should have, I like to see a business that has a potential for growth. And the reason that is is because you do want a sustainable company. If they're in a declining, you know, when you look at the, uh the, the lifetime of a company and it moves up to a mature company, but if they're in that declining part of Their business because they're becoming obsolete or something's happening in their industry. That's not a good situation because now you're really kind of predicting possibly a, a fall off on their future evaluation and, and that's, so looking at where, where their possibilities of growth are and how, how did they get there and then that's gonna also Um, ask questions related to their existing management team. Are they, are they sufficient to bring that company through, you know, this next stage of, of what's happening in the economy or what's happening politically or what's happening, you know, and all these other environmental changes that are, that are occurring in our business world. Absolutely correct. We do feasibility studies, feasibility analysis on the larger transactions, and one of the things that we use is a stress test, you know, not unlike what was applied to the banks after the Great Recession. You know, your your management projection is fine, it doesn't look bad. Uh, now let's, let's drop, let's drop your margins by 10, 15% and see what happens, or this product line by 10 or 15% and see what happens. Can you sustain that stress and what is your, what's management's reaction to it? Sort of what you're saying also. Yep. And, and the interesting part was you don't always have a perfect fit with management. Transition plan, sometimes it's, it's gonna, you can grow your way into that. And then there's a, there's a lot of concerns sometimes, you know, where companies think I'm not ready to go yet only because I don't have all these different people I need. Um, but the, one of the great things about ESOPs that I've learned is just the amount of flexibility you have in building that out, that management plan and As long as they're committed to, to making sure that they got the right people in place, then I think that kind of thing works where, um, where you're gonna sell it or you need to get it ready to, to sell it on a strategic sale, um, and you don't have the right people in place and you are selling it to somebody that needs a good transition team, then that could be a more problematic type of um transaction for you as a selling shareholder. Right. Yeah. So, um, going in, I know you have a ton of experience. Um, I wanted to ask you kind of like from your perspective, what does it take to put, you know, an ESOP transaction together? Well, the team, uh, I must say your, your company is part of the team, you know, the owners, the CFO, the CFO, the CFO, I can't say enough about good CFOs. They're so critical, and as, as well as the CEO, obviously, but I think to a degree in, in, uh, uh, ESOP transactions, uh, the, the CFO probably should have a A larger role than they do. I know they have it in conventional M&A because I do that too, but anyway, and there's a let's go on to the, let's go on to the ESOP team. Obviously it starts with the trustee. That's, that's, you know, what I would call. The Truman fiduciary because the buck stops there. Ultimately, the trustee under ERISA has a fiduciary duty to make certain that the transaction is financially fair to the ESOP and the ESOP participants. So that's number one. And then there's the valuator, which is a financial adviser to the trustee that values values the company as well as assesses the fairness, particularly the fairness of seller financing and seller employment agreements, key employee employment agreements, warrants, retention agreements, that type of thing. It's all part of that financial package. And then there is legal counsel, people like me. Uh, as part of the team and uh frequently, more often these days than not, there's a financial adviser to the sellers or an investment banker to the sellers that's part of the team also. Uh, so, uh, everyone here is important. Everyone has a role, and, uh, you know, usually what I try to do is sort of coordinate those roles. Sometimes I have that position, sometimes I don't. Sometimes I represent trustees. It's not very often. Sometimes I do, but generally I represent the company as the plan sponsor and the obligor. The company is obligated to pay the purchase price. The trustee does not. The company does, so it's the obligor in the transaction. Truste is the buyer. Selling shareholders are the seller. So how, how have you seen just kind of looking at that, you know, you've had a lot of experience and so from, from my perspective, I, I will do the, I'll do the feasibility work, but I'll also be the sell side advisor through the whole entire transaction, coordinate the teams and all that. And so I'm very, you know, experienced with the arm's length, you know, uh negotiation between a trustee and, and. side, which is, you know, me representing the selling shareholder. How have you seen over all this time that you've been doing it, how has that changed, you know, from when you were doing deals earlier till now? Yes, a very important change and then you, you touched on it. When I started out with this, you know, I, I was sort of the, the, uh, you know, what I would call not necessarily quarterback because the quarterback is a is a player. I would say sort of a general counsel with oversight of everything or coach, you might say. Uh, but that has changed over the years because more and more transactions, especially major transactions, uh, have an investment banker or Southside Advisor, and usually they're the first ones in. And it could be you fill your organization. It could be various others that we work with. So frequently when I'm brought into the transaction, that is already in place. So my role is then more limited on representation of the company sponsor, but I still have counsel to give if I see that something is out of place or is high risk, uh, that I can advise. So that has been a major change over, over, I would say the last 30 years. Great. Yeah, I mean, I think that's, I, I think personally that has made the transactions become better only because you have um more of a real type of negotiation going on as much as it's controlled by this pro this DL process agreement that you've got to, the trustee's got to work through. Um, let me ask you kind of like a, a, like a different question just kind of in that vein of this experience that you have. Do you have you ran into really transactions that have gone really bad, and if you have, like, what, what happened and what would you, you know, have advised to be different in that, in that type of thing? Well, uh, there have been a couple, and one of them I represented, uh, the bank, uh, a major bank, a regional bank, uh, based here in Ohio, very good bank, and, uh, they were the chosen lender in a significant ESOP transaction. Uh, as I indicated to you, Phil, when I started out on this, I started out on the financial side and my review of the evaluation indicated problems. And I passed that on to the bank, uh, which passed it on to their, their ESOP team. They had an ESOP specialized ESOP team, which agreed with me. The, the bank backed out of the transaction. Uh, sellers found another bank to do the deal. They did the deal, and they, it was an investment banker deal, and the when the bank that I represented dropped out, the investment banker called me and chewed me out. However, however, DOL brought a lawsuit against the trustee in that transaction. So this has actually happened 4 times, excuse me, 5 times. Oh my gosh, and 4 times out of 5 I've been, I've been right. D, DOL came in and and and brought an action against the transaction. Well. What does that tell you? I mean, you get down, you get down to it and what you do for a living and, and what I do for a living. You, you sometimes you got to give people some bad news, you know. I personally like to do it early in the process so it doesn't get too deep into it. Um, I wouldn't want to get into that where you, where everybody's, you know, spent a lot of money on, on, on, yeah, you have to raise the red flags. Yeah, and so I think a lot of like what I've seen are like for us, our processes, um, have a lot of um flags in them when we go early in the process and, and the client is, is alerted to things way early on so that you don't get into that, uh, to that deep water. But I think that's, it's very, it's always very interesting because I think sometimes, um, you find people that have heard stories and they don't want to do an ESOP because they've heard this bad story. And some of the, some of this podcast has been really designed to try to debunk some of the myths, but there are some bad stories. There's some real things that happen. And I think that if you're prudent about who you're selecting as your advisor, And they have a very prudent process of identifying those potential issues early on, then I think you're in a very good, comfortable, safe place to explore ESOP as an opportunity for your, for your business. Absolutely correct. I have, I have so much invested in the ESOP community that it hurts whenever I see. And action against an ESOP or the publicity you're the press, you know, we were doing one in in in in Philadelphia, you know, when the first process agreement came out and had a chilling effect upon my client that was that was in 2014. The Great Bank process agreement and there have been, there have been 6 of them now, 6 of these process agreements, and, and it's just not good for us. It's not good for the ESOP community. And that's why, and that's why this is such an important podcast, because I think it does get people more where I, I had a real quick case, you know, where I had a client who came back from a conference. They immediately hired a trustee, and they went right into due diligence without doing any feasibility work. And they ended up getting an offer and they, the client was like, I don't, this, I was not involved at this point. They were like, I don't know what what to do with this offer. And um so fortunately, they just kind of said no, we're, we're not going to do anything, but they already spent a good chunk of change on the, on the, um, the trustee and the and the valuation firm and the due diligence process and. So long story short, I got a call from the attorney and we ended up getting involved and went very to the, to the very beginning of the process and, and kind of got it back on its track where it needed to be. But I think that, that kind of showed me very clearly, this process that we're going through is very, very important and um you don't want to skip a step. Phil, I do have a suggestion for you, when you do this podcast for company owners that might be listening and considering, considering an ESOP, uh, and, and that's to make sure that everyone has skin in the game. Obviously the trustee does, number one, because of fiduciary dues under the ERISA. And valuators and attorneys have the malpractice issues, but if the sellers are represented by a financial adviser, you know, I would suggest that they ask for identification provisions. So if they, if, if, if there's a, if there's litigation or a deal, the challenges the transaction and and the the sellers have to give something back. Uh, and, and they followed the advisor's advice and ask for identification. Make sure everyone is skin in the game. Yeah, I think that's great advice and firms like ours have malpractice and like you said. Um, they're, they're definitely, if there's not skin in the game, then it becomes, you know, no accountability in a sense, not that they won't do their job right, but it's still going to keep, um, everybody doing the best job they can in terms of representing the client and hopefully at the end of the day, what this is about is creating uh strong ESOP companies and helping owners, you know, work through that transition process of selling their, selling their companies into ESOPs. Um, so with that, and you kind of touched on this, what, what else should we look for when we talk about putting a team together? What would you advise the listener to look for in terms of putting their ESOP team together? Well, now that I've identified the team, I think the next step is look at, look at everybody's track record, you know, what's, what's, in particular, the, the, the track record, not just in terms of deal size and deal complexity. You know, but have your deals ever been in trouble with the Department of Labor or with plan participants, you know, make sure, make certain that everyone on on your team is clean. That's very important and frequently overlooked, uh, but make that's part of the your company owner looking to do an ESOP, you know. Get the right team in place and this is one of the ways to to be assured that that it is the right team. Exactly. That's great. Well, so we covered a lot of ground, uh, Tim, I just kind of wanted to kind of say a few final comments on my side and I'll let you say, say a few things. Um, you know, first off, to be able to interview someone like Tim is really a great honor and privilege for me only because you have somebody that's been working in the ESOP world for so long, has authored so many, um, publications. And has seen so many different stories going, you know, back into the 80s. Um but I think what, what, what I got from Tim was today is, is be prudent about how you select your team. Um and then, you know, be in the right place in terms of, of why you want to have an ESOP company. Is it, do you have the that type of sharing culture? Um, does that, is that more than, is it more than just financial numbers? Um, so all of those are really, I think, solid pieces of advice for, for those that are listening. Uh, Tim, what would you share as your final comments? Uh, I, I would, I would share what you just said. That's a very good summary. I was, I was listening. The other thing I would would share is, uh, is, is organizations like yours, uh, that more information, good information that's out there. Uh, for company owners, the better. Part of part of the, uh, you know, there are fewer ESOPs today than there were 20 years ago. The number of it's almost double 20 years ago what it is today, and that's, that's unfortunate. So the more good education, the more good learning that we can have from organizations like yours, you know, like the IO Employee Ownership Center, uh, the National Center for Employee Ownership. The ESOP Association learning, education, diligence that the university should be doing more than what they're doing. There's so few that are doing it. That's true. Rutgers Kent state, uh, but there's very few that that have programs, ongoing programs, and they are business model. That is true. I think that's great. That's great advice, um. I think getting as much education as you can is really important, especially knowing your responsibility as a potential ESOP selling shareholder down the road, you want to know what you're getting into. So, just wanted to say thank you, Tim, for your time today. You are the godfather of ESOPs and um I appreciate your perspective and, and the time that you've spent with me. So, So thank you again and um and look for us next time on this journey to an ESOP and have a great day. Thank you.