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Suggest questionThis episode is generated out of many recent conversations with different folks all over the country - it is intended to discuss an important topic that selling shareholders that are considering the ESOP as an option need to nail down early in the process - How do I get my money for the stock I just sold? Once they understand this - they can either continue on their journey to an ESOP or take another route towards a different solution.
Transcript provided by the publisher.
<p><!--block-->[0:00] Music. <br> <br> [0:19] Show you the money show me the money. <br> <br> [0:31] Music. <br> <br> [0:38] Show me the money welcome to the ESOP Guy this is a journey to an ESOP are podcast that, goes into and tries to help you if you are a first-time listener or have continued to listen to this podcast. <br> With all of the things that might help you understand what an ESOP is and how you might want to use it in your. <br> Company if you want to transition to an employee stock ownership plan so today I thought it would be a good day to get into this idea of what Jerry Maguire is kind of yelling out to save, his one client that he's going to have left in this whole scene is is a little. <br> Obviously a little stressful and a little comical at the same time because he literally is getting fired from his job. <br> And he's trying to call his clients to try to save all of them. <br> In this one client is just totally dominating and saying you know leaving him keeping them on the phone the whole entire time. <br> And he's requiring to say show me the money and so what I want to talk about today. <br> <br> [1:54] The money you know what's the neat when we think about a sap transactions were typically thinking about a transaction where you're selling your stock. <br> To the ESOP and you're selling your stock obviously for. <br> A purchase price and so the question that you get from people in any stops now whether you know a lot about Aesop's or you know a little body stops the one question that's going to always kind of come to the surface and conversations is going to be, where am I getting my money so ESOP guy show me the money and the first thing I'd say is as we get into this topic is I want to cover the reason I want to cover this, is because I think it's really important because I had a situation when another company that I was talking to just recently. <br> <br> [2:47] And for some reason they just didn't some things just didn't click. <br> In when I say that it's like is as far as how they're going to get that money you know we think about an ESOP transaction. <br> <br> [2:59] Not like an m&a transaction but like an ESOP transaction there the buyers buying the company. <br> <br> [3:05] And so this case he didn't realize that the buyer is using, the cash flow of the company right I mean where's the money come from it comes from the cash flow of your company so just right off the the get-go I wanted to kind of make a point here this is a really important topic and we're going to cover all forms of the the ESOP transaction in terms of showing you where the money comes from, because it's a little more complex to saying that than saying hey it's just the cash flow of the company because structure is really very important in terms of, the ESOP transaction so it's going to be this is a really good topic I think I would kind of Mark this out as kind of the similar topics this early season which of season 4 we're kind of just dealing with some things that I think are categorically. <br> Conceptualizing more conceptualizing the ESOP and this is one of those areas where we need to conceptualize this this idea but then also kind of bring it to some practical. <br> Term so that's what we're going to do today I'm so excited that you're joining us today if you do like this podcast, then please share it with a friend you can subscribe to the podcast by going into I think Apple, has their own podcast so you can subscribe and kind of get the updates as things automatically get new released new episodes released you can also go to our website at journey to an ESOP.com. <br> <br> [4:31] Find all of the the podcast there plus, there's a place where you can say hey I have a question that I want to ask in it may not be you know something that you've somebody's been able to answer for you so please submit those questions I'll be more than happy to, respond and we may even create a topic out of it just because if it's a question you have then it's probably a question somebody else has. <br> So with all of that I would just want to say again thank you for joining today. <br> <br> [5:01] Let's just talk about the movie for a second just because it's one of those movies that you might have seen was out there a long time ago obviously Tom Cruise, it's all about the sports agency and, the main character Jerry Maguire and this is based on a true story which I think is always cool is having a life. <br> <br> [5:23] Crisis in a sense he's having a I'm going to really think about what I'm doing with my life and what I'm what I'm not doing so. <br> He ends up writing a mission statement and submits that to his place of employment. <br> That really is geared around this idea that hey we're just taking people's money left and right which. <br> You know shouldn't we be helping people kind of is the idea behind the premise behind it is shouldn't we be doing more. <br> And the whole business itself is built around. <br> They just come in and make sure that they you know take an agent or a or an athlete through this whole process and of becoming, you know maybe a star athlete and then from there. <br> Kind of getting as many things that can get endorsements or whatever and so the whole movie is about that. <br> Is this is about that the world like a perspective into that world. <br> But when you think about it just for for discussion purposes and again around the topic of show me the money. <br> One of the things I like about the way that this movie is kind of portrayal. <br> You know the world is that for Aesop's in our world of Aesop's Employee Stock ownership plans. <br> <br> [6:43] One thing that's true is that there isn't a you know their first off there's a sense for the owner. <br> That there's more to the transaction a selling their stock then just this just the money part. <br> <br> [6:58] And so if there's not if it's only a mean to say it this way if it's only about the money for the stockholder not anything wrong with that I've said this a lot of different ways I'll say it again there's nothing wrong with it if you own the stock at your company. <br> You do what you want it's your house you own it you sell it you want to do whatever you want with it you fix your car you sell it you do or it's your property you own it, you can sell however you want but for the owners primarily if we took that grouping and said on average most of them aren't just concerned about the money. <br> They are concerned about the company's Legacy they're concerned about the employees the future of their employees and what their lives are going to look like they're concerned about their customers and what their lives are look like so, one of the things I like about this is that we when we think about that business of the of the sports agency that this character was part of. <br> He wake he woke up one day and said you know this is just an empty place an empty life right so he wanted more and just I think it's very similar to an employee or an owner who owns a company that saying I really kind of want to transition my business to an ESOP, because of this because of that reason it's just kind of how much money can you have because at the end of the day how much can you spend. <br> <br> [8:12] Is the idea behind it all but shouldn't we be helping people do those kind of things now, ironically when we think about the show me the money one of the things I'm going to get into in talking about the Employee Stock ownership transaction is the cost of an ESOP so when we think about show me the money. <br> I'm going to give you kind of some examples of what I've heard that's happened in the industry that I think are helpful to be honest and I am not going to say who I'm not going to say anything specific to it but just in general what happens, in the cost of an ESOP because I think that's part of the whole like great if you think about, the like the idea of what am I going to get out of the transaction from a financial standpoint I'm the owner I have the stock I'm selling my stock to the company, the company is going to buy my stock and the whole thing is going to turn into an employee stock ownership. <br> <br> [9:06] So in the same thought process of thinking about showing me the money certainly the net cash coming out of the transaction. <br> Is going to be where what we really need to dial into when we think about what we have as a business and what we should focus on right so. <br> That's going to be when we think big picture right so we have the net if we think about the business valuation for a second we're going to have the net Enterprise value of the business first, that dollar amount is what we're going to Target in the sell-side to figure out what we're going to sell it for now that number is going to be. <br> <br> [9:46] Typically connected to the cash flow value of the business now, some people that go do ESOP work they're going to come in and say oh it's a it's a multiple of ibadah okay and so you know that's the same thing I'm saying the same thing but to understand it really it's it's connected to the businesses cash flow, on a normalized basis so that first number the Enterprise Value when we think about showing me the money, we're going to then take that number and we're going to adjust it at the time of closing. <br> For any non-operating assets so any excess working capital that might exist once we've established a Target working capital. <br> <br> [10:28] That we're going to both and both of those numbers in both of those, ideas we're going to end up negotiating that Enterprise Value we're going to negotiate the target working capital now that Enterprise Value plus or minus that. <br> Target working capital is going to give us at a point in time, an equity value then we're going to take that number and we're going to subtract any debt that company owes and then we're going to take a discount if it's 100% Esau we're going to take a discount for lack of marketability, so so just start off with that's kind of the beginning step right but then to get to the net proceeds right the next thing we're going to have to do for the seller is we're going to have to run through the net proceeds from a tax perspective, all right so now we're going to take that number and we're going to say all right well the way that this is structured say it's an s-corporation. <br> We're going to take the company's the selling shareholders tax basis which is also called AAA. <br> And we're going to net out that difference and whatever's left over and we could do a triple a node or we can just take it out of the total, what they're collecting whatever is left over after capital gains tax after the AAA is going to be taxed at the capital gains tax rate so then that's our that's another number we're going to get closer and closer to the what the net proceeds are. <br> <br> [11:44] Then from there we're going to then take what we're going to then take all of the interest that their company is going to pay, for the seller note that's going to be received by the owner and that interest income is going to be taxed at an interest income tax rate which is close to ordinary income rates so now we've got, the net proceeds of capital gains net of capital gains net proceeds from the interest net of interest income tax and so as we funnel down that we're going to get a cash flow, after tax for the selling shareholder. <br> <br> [12:15] But we're not done yet right because now we still then have to think about in terms of the the whole transaction we have to then think about what are they actually paying for it that's where the cost of the Aesop's come from. <br> And that's why it's so important to dial into that now one of the other sources of cash flow for the selling shareholder is if you do a transaction, there are tax benefits to contributing to the ESOP in the year that your dear, transacting in so we can always reduce ordinary income as part of additional money that the company is generating and reduce the taxes that they had in the prior year, that increase the cash to the owner as well so we're just again we're focusing in on just show the me show me the money so once all of that is because played out, and we figure out all the transaction costs then that's the number they're walking away with, now here's my point as I get into that now getting to the actual liquidity we're going to get to that in a second but I want to get with I want to First deal with the cost of the ESOP because that's going to be, that's going to be what's going to be part of, um reducing the net cash to the employee are to the stock to the selling shareholder at the time of the closing. <br> <br> [13:30] So the cost of putting an ESOP transaction together art it's very confusing and very convoluted but and I say that only because it, I'm a I'm a little bit like in this place where it shouldn't be right so let me give you an example of when we think about the cost and we're going to come back through this net cash show me the money piece in the. <br> <br> [13:53] I am out here. <br> <br> [13:56] You don't know what it's like to be me out here for you it is an up at dawn pride-swallowing see. <br> That I will never fully tell you about okay. <br> <br> [14:11] Help me help me help me. <br> <br> [14:22] Me help you. <br> <br> [14:27] Okay what a great scene so as we as we talk about the example I wanted to throw that out there and just because it was. <br> Part of our our theme today of show me the money. <br> And it just made me think about like what it is like to be a cell site advisor trying to help a client go through this process and it's like. <br> <br> [14:51] All we want to do is help you right help me help you it's just I think mostly I didn't do that for anything but just the fun of listening to that part of the. <br> Of the movie and angry connect it back to this idea of an example we're thinking about. <br> <br> [15:10] You know all the components are all the things about the cost and the show me the money idea behind. <br> Where's the money come from and so before we get into other aspects of it. <br> <br> [15:28] You know the example is this we had I had talked to somebody about this recently it's just a good hypothetical example but it's coming from real data the. <br> They're a client was looking at doing an ESOP company was looking at doing an ESOP this is not my client this is not somebody actually worked with. <br> One organization came in and said hey your company is worth. <br> Let's just call it 30 million dollars and then the investment banking firm comes in and says hey no it's worth which is a different approach your company is worth. <br> <br> [16:04] Thirty-five million just to just say that was the differential between the two for this example now. <br> On its surface the owner of the company is thinking wow I can get 5 million dollars more from my company right. <br> Now one provider once outside advisors only going to charge you know maybe a third of the total the other, advisor who's going to get this bigger amount of money an ESOP world is going to charge like in this example it was it worked out to be around a million dollars for a cell site advisor fee. <br> For an ESOP okay and so I'm using this example because I do want to make a good point here in terms of when we it comes to show me the money and on its surface. <br> What what you could say is well I'm investing a million dollars versus maybe a quarter of a million dollars in this. <br> Transaction and they're going to give me 5 million more so that makes sense right it makes sense from a. <br> <br> [17:09] But a seller standpoint at its surface now they're going to pay a million dollar fee to get this number. <br> The problem with the scenario is we're thinking about it's not all about show me the money what is this about well. <br> The selling shareholder in this situation in every ESOP transaction isn't just selling their stock to a buyer. <br> <br> [17:33] They're selling it to a trustee. <br> They're selling it to a trustee who ends up representing a trust where this stock is going to go from the selling shareholder into this to the into the trust and eventually be be, released as a benefit plan, to the employees that's what an ESOP is it's a benefit plan it's a retirement plan and so. <br> On its surface it might seem like that's the better deal but if you dig deeper the problem is. <br> If he's over if these people have really overvalued the company and in this analysis 30 to 35 million is probably not a good scenario I think the real story was was maybe a maybe a 15 million dollar differential. <br> Which even makes it even more right I'll show me the money here it is here's all your money buddy but the point is is that, what is the selling shareholder going to be thinking in three years or four years when the company potentially was overvalued and now can afford the debt payments regarding that. <br> Now even at the very beginning they're thinking wow this was a great deal but three or four years from now they're not thinking that. <br> <br> [18:45] And if you go back into looking at any case precedence when it comes to ESOP transactions and you look at why are companies ESOP companies pursued by the Department of Labor. <br> The main theme of that is going to be that the company was overvalued. <br> So in the end if it gets unraveled in there's a purchase price, number one it's done it's going to affect the selling shareholder they are not selling to a buyer and just walking away from this thing, so then thinking that they're going to get some major benefit of having you know paid some you know Investment Banking firm, to sell this company at a larger multiple that actually makes sense even if they have to get a trustee to buy off on it but this happens they do get trustees to buy off on this so that's not a impossibility. <br> <br> [19:37] N The selling shareholder is going to have to live with this if it is overvalued than they're going to have a problem later down the road because eventually the company is not going to have the cash flows. <br> To pay the debt payments back to the selling shareholder even though on paper it might look great now the Cell at the investment banking firm has walked away with their fee. <br> And they could care less what happens in the future because they've gotten paid for all of this and. <br> That's what happens in when we think about the the cost of an ESOP. <br> You have to ask yourself when you are aligning yourself with with whoever your sell-side advisor is does it make sense when we think about what you're really getting what you're really getting in. <br> Compensation for your stock. <br> <br> [20:27] It's not as it's not as simple as what might be presented to you and that's one of the major points I want to make today in this podcast is that, that it might seem like you're getting more at the front end but if the whole thing unravels then you have a headache to deal with do you have a fiduciary problem the trustee has a fiduciary problem, and everything that you have wanted to do the ESOP for benefit your employees now becomes, less and less of a reality in maybe the Legacy part that you thought we were you were selling your people is not going to happen and so. <br> <br> [21:03] Within that structure the cost of the ESOP as we think about it if it's a fair market value and not this overvalued proposition if we just go to to that type of analysis and say are on an equal basis, the other question is who should if it's just fair market value and nobody's messing with the numbers you know and you're going to be straight up this is the real deal. <br> Then the other question is how much do you pay for the ESOP because that's going to be part of your net number so all we're dealing with right now is making sure that there's an awareness and an education when it comes to mapping out what your ESOP should cost. <br> Now one of the reasons I'm so passionate about this is I'm coming off some of these conferences that we've gone to and the problem with the conferences is that the people that get to talk at the conferences, are firms that, our sponsoring big money in these conferences so these associations that are supposed to provide a unbiased approach to esops, they're not. <br> <br> [22:09] Unfortunately they're not because they're getting the money for the sponsorships and there and the main speakers are promoting their businesses their business models. <br> <br> [22:20] You know which are all in. <br> Competent but the same time they could be charging three four sometimes ten times what the what the market would charge for an ESOP transaction, going into that meeting, you're thinking one thing you leave the meeting and I can't tell you how many clients are companies they're not even clients companies I've talked to that walk away with hey that's what an ESOP cost I mean I will so they gonna know and they're going to a resource that says, that we're a non-profit we're here to help we're here to educate and what they're getting are biased, presentations from companies that are that are making on an average of 700 to a million dollars per transaction. <br> <br> [23:05] So cost of it when we talk about show me the money this is a serious part of the cost of an ESOP and if it is misconstrued it is, wrong and that's why I want to make sure we talk about that aspect of where your where my money is going where my money is coming from well your funding those fees so that's going to be a big part of it now the other fees that now are in line now are going to be the other parts of the costs you have didn't you know outside of the sell-side advisor you're going to have the trustee fee for the buy side you're going to have the trustees valuation firm for the buy side and the attorney for the by side. <br> Now those can range kind of all over the place depending on where you reside in the country there are certain Pockets that you're going to see in certain markets going to be a lot more expensive there are certain markets that are going to be less expensive. <br> And then by provider they're going to be more or less. <br> The reality is the quality of the work is going to be consistent as long as they know what they're doing on the ESOP side. <br> <br> [24:11] Now let's put it into some other parts of the show me the money aspect so clearly one thing I have left to the end here is that you're going to want, to get your money out of the business, and how do you get it you're going to get out of the business into forms and we've we've done a lot of podcasts on interviewing Banks to determine like the senior debt financing and how the structure of that works. <br> And the other side of that is how the seller knows so that's what happens in the show me the money concept so we can explore that conceptually a little bit deeper is that. <br> It's going to really matter. <br> For some people be based on their objective so if a company or selling shareholder is thinking I want to get as much liquidity at the closing as possible. <br> <br> [24:58] One one thing in planning it needs to happen is that there needs to be an exploration with some lenders now. <br> Going into this process when should you do that like that's a question like when should you ask the question to the lenders should you do that at the end when you're putting the whole closing together once you've gone through all of these these different steps for planning the ESOP or should you do that, earlier now. <br> For what I do in sell-side advisory I highly recommend that you have some very early conversations with your incumbent Bank the Commercial Bank that you work with. <br> To see and explore what they can do and financing so I'll normally. <br> Talk to them and I'll normally give them some some of the data that we've used, to create the cash flow models for the valuation itself I'll normally explore the balance sheets with them and really get into some some maybe just preliminary conversations, so that we can understand the combination of senior debt financing and the seller note financing, and so that's really key and it's kind of important because it'll create the right expectation so let's just say you go through that process, and for whatever reason the industry that you're in. <br> <br> [26:21] You know the incumbent Bank says now we're just not interested in in that type of financing and some of the reasons they're not going to be interested in it first off they may not as a bank they may not have the ESOP education to really understand, the, potential for a tax-exempt entity with the cash flows they may not really understand they may they may not get the complexity of how the ESOP works and so some banks have just said hey we don't really want to do that financing, and I can take I can think of a couple right off the top of my head so so we need to nail that down number one if the if you're going to have to move Banks. <br> Through the transaction you need to know that early right so if not they'd say know that they're not going to now you're in a good position to now go at after lenders that maybe are specific to doing ESOP transactions. <br> <br> [27:13] Ultimately what we want to do in the very first couple steps here is we want to nail down what's the proportion of the senior debt financing and the proportion of the seller financing. <br> <br> [27:25] If the senior debt financing is not going to work then of course the whole thing is going to be seller. <br> Because we're going to use that number to estimate the cash flow that is going to come into the cellar and in terms of receiving their in exchange for the stock that they have is sold so that's, ultimately what they're going to be receiving now. <br> Keep in mind the limitation here and this is something that came up at a conversation that I had at a conference to the the limitation is that the this is limited by the company's ability to borrow based on their cash flow. <br> <br> [28:03] And in this might seem obvious to everybody but I'll say it just because I think sometimes it's some things that come up in these conversations the buyer isn't coming up as an ESOP the buyer is the trustee who is just a representative of, the trust that's going to be created to purchase, the shares so they're not coming up with obviously in the cash everything is being created and derived from the company's cash flow so the owner is making a decision, to take now they own that Cashflow all they they just but they want to keep holding the company they're going to keep getting that cash flow as time goes on right it's still their cash flow, why would an owner. <br> Say well I just want to sell my stock give up the rights to the cash flow to the company and let the company buy me out with bank financing and seller financing, because the ready to transition the ownership. <br> <br> [28:56] That's why and because of the tax benefits of being an ESOP assuming you're an S corp the company now has this additional subsidy from the IRS let's just call it 30 percent. <br> Of cash flow that was originally going out to the owner to pay income taxes so so the cash flow is the connecting piece for what the selling shareholders can hope to get in the proportion between senior debt financing and seller financing, is really important to nail down when it comes to, the what what the liquidity is going to look like and then what the other parts of the of the structure of inflows our cash inflows to the seller going to look like which include interest payments on the seller note. <br> And it'll include potentially if we do design a warrant payment a warrant payment that will really kind of it will really not kind of we really will depend. <br> On the company's ability are the future value of the company. <br> And the warrant itself will be will be calculated at some future period when all the seller note financing is paid off so we know we've we've done, some podcasts even just the beginning of the season on the warrant calculation so you know if you want go back into the journey to an ESOP, website.com and just look at that podcast because I think it's kind of helpful to understand warrants. <br> <br> [30:22] Warrants can be a substantial additional amount of money that the owner is getting by taking the seller note risk. <br> <br> [30:31] And so if the company does really well in the future that weren't payment can be higher if it doesn't do well then the warrant can be not in the money or out of the money and so, those are some examples of how for the selling shareholder they're going to get paid out of this transaction but I we really wanted to make the point that there's a Connecting Point to the company's cash flow. <br> So you have to give up the cash flow obviously and normalizing the cash flow is the other side of things so if you're used to, paying the company paying for you know all of your vacations as marketing you know if you're used to the company you know paying out different things that that are not. <br> Really normal operating business expense then that money is now coming out of your pocket that you were getting before but it's coming back into the company's cash flow, so as you plan out what your real cash flow is you need to knit net out everything that you were getting from the company before you do the ESOP transaction. <br> Now that's really important for both hundred percent Aesop's and partially steps because if you sell your company to an ESOP. <br> <br> [31:37] In you're still pulling out discretionary cash that's not really necessary to be spent then that's probably not a good. <br> That's not going I don't see a problem that is not a good you know thing to do because you're you're taking money out of the shares of the ESOP by, by putting it over here and discretionary spending so be prepared as we talk about money in this part of the podcast, to make those changes now some in some cases we're going to also net out some some owner comp you know and that becomes an ad back so everything but everything on that side of things when we do get the ad backs into the cash flow model the valuation itself then gets to be improved because there's a typically a multiple of those, of cash flow or add bat or a multiple on that cash flow for whatever is added back into the cash flow so although you're not going to get it in the future. <br> <br> [32:35] Your art you are getting paid on it in the valuation so you're not technically losing anything but when we, really thought about this one episode I wanted to make sure that people understood what life is going to look like from their side of things when they're coming out of the company's ownership, from a pure cash flow standpoint and what they're getting and that's that's kind of the whole idea behind it was was what, when we think about show me the money what is really happening in terms of paying for, the ESOP so we covered we cover the cost of these up what is really happening with the actual cash coming out of the company and what's happening again with the existing cash flow going forward, in this scenario so that you so there's a realistic understanding of what the ESOP really does and doesn't do. <br> <br> [33:28] And so one thing I know this sounds contrary to doing an ESOP podcast and I'm not trying to discourage anybody but I think that one of the main things I try I'm trying to do is help people, not get too far down the road of an ESOP when they have something else in mind, and they've wasted their time they've gone to these conferences and they've they've spent and invested all this energy maybe they've even engaged somebody to do some work and there are some basic things that they didn't know so, part of our part of our mission of the ESOP, theesopguy journey to an ESOP podcast is to really nail down some of the main things that I'm hearing. <br> <br> [34:09] In talking to people I'm going to I'm I'm I'm really looking to try to interview some people, that have decided that they didn't want to go to the ESOP because of certain things because I think that's that might be helpful so it might sound like I'm trying to, you know deter people from doing these up I'm not I'm trying to make sure that they they know that this is the right thing the right path for them. <br> We live in a cynical World cynical world we work in a business of tough competitors. <br> <br> [34:44] So right then I stopped us because Jerry Maguire is about to tell her the classic line you complete me. <br> <br> [34:53] And I just have to say as we as we close this one podcast out that podcasting and talking about the ESOP is just phenomenal and. <br> Although it's not as emotionally gripping as this last scene in Jerry Maguire it is. <br> Very very fun and I enjoy it and thank you for listening today and hopefully this was helpful to you and if you do again. <br> Like what you hear please subscribe and if you think it might be helpful for somebody then share it with a friend you know so with all of that. <br> <br> [35:30] I think that I just wish you the best in your journey to an ESOP and we'll see you next time on this journey to an ESOP. </p>
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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