Preserving choice deep into the mergers and acquisition process delivers a compelling competitive advantage to a client. By increasing the real-time knowledge of possible outcomes, the opportunity of closing the transaction that best suits the objectives of the client is significantly enhanced.
Strategic Buyers pay the highest price. They have easy access to cash; they trade at lofty multiples and they have scale and geographic reach which translate into the greatest value created from the target’s operations. For an entrepreneur it’s also the cleanest break from operational responsibility.
However, selling to strategic buyers is not all roses. They prefer to buy assets creating a higher tax profile for proceeds than a stock purchase; they may ask for entangling employment agreements or earn-out provisions after closing, the buyer; and runs the show which means they can run roughshod over the culture and employees of the target.
ESOPs. Of all the “internal sale” or “management buyout” alternatives, the Employee Stock Ownership Plan (ESOP) often presents the most compelling alternative. Its favorable tax treatment can boost after-tax proceeds higher than the strategic premiums; its flexibility permits partial liquidity while allowing participation in future upside; the company’s culture is perpetuated while rewarding the employees who helped build the business.
However, ESOPs are not a silver bullet. Not all the value received at closing may be in cash; residual operational responsibilities may linger depending on internal management talent; bank financing may require some shareholder commitment.
Dual Track. Each of these two competing liquidity strategies has merit. For some, there’s a clear winner right from the beginning, and therefore no reason to waste time studying the alternatives. In many cases, we at PCE have found great benefits from pursuing both strategies at the same time. They complement each other, creating choice for business owners, which translates into superior liquidity outcomes. We call it the “Dual Track”.
Here’s how it works. PCE runs two investment banking engagements simultaneously: an M&A sale-side auction process and an ESOP feasibility analysis.
- The M&A engagement involves preparing a corporate profile of the company, identifying and prioritizing strategic as well as financial buyers, and creating a competitive environment for the highest price and best terms in a letter of intent.
- The ESOP feasibility includes a valuation done to Department of Labor and IRS specifications, an alternatives analysis that considers the various transaction structures that capture the greatest tax advantages, and a financing exercise that delivers term sheets from the most experienced ESOP lenders in the country.
We manage these two complex processes to produce their results at the same time so that the shareholders can compare and contrast the relative benefits and risks with equal ability to execute and close either one.
Outcomes. Shareholder responses at this point in the process have proven difficult to predict. Like Heisenberg’s Uncertainty Principle, the knowledge gained from the process changed the outcomes. Some predisposed to a clean exit to a strategic buyer ended up preferring the protection of their culture via an ESOP. Some predisposed to passing the company on to management valued the freedom of the outright sale. Without the choices of the Dual Track, you risk closing a sub-optimal alternative or perhaps facing a failed transaction.
Additionally, the auction process and the ESOP feasibility when run concurrently produce superior results from each exercise. The ESOP valuation exercise must consider bona fide offers from capable buyers, which the auction process inherently produces. This ensures the ESOP valuation closely tracks fair market value. The preferential tax treatment for the ESOP scenarios challenges the strategic buyers to increase their offers to match the ESOP after-tax proceeds.
The Dual Track puts greater power into the hands of the shareholder at every step in the process by increasing their leverage through choice.