CASE STUDY: A Deep Dive into the ESOP Transaction Process

June 17 2022 | 4 Min Read Time

Eric Zaleski

E: ezaleski@pcecompanies.com

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Selling your business to an employee stock ownership plan (ESOP) can be a complex, confusing process. What path does this type of transaction follow? What should sellers expect from the journey? How long will it take to complete? Among our clients, these are often significant concerns.

Are you considering an ESOP sale of your business? If so, you may be unsure of where to start. The case study below (which, for privacy reasons, uses terms such as “the company” and “the client” instead of actual names) sheds some light on the ESOP process and timeline, from your initial thought of selling the company to completing the transaction and receiving the funds.

Our Client’s Situation

Our client was the 100% owner of a construction company in the Midwest. He had built the business over three decades, which achieved a well-deserved reputation for stability and expertise and earned respect in different market sectors. The company generated an annual EBITDA (earnings before interest, taxes, depreciation, and amortization—a proxy for cash flows) of $5 million. Forecasted earnings were consistent and strong. The client had chosen an excellent time to explore the possibility of a sale. Revenues and margins had grown year over year in the preceding five years, and the company had developed a strong pipeline of contracts to back up the financial forecast.

Our Client’s Challenge

The client had been contemplating retirement for several years and was ready to pursue his options, including the possible sale of his cherished company. However, he lamented one thing about selling: his family would no longer play a role in maintaining the tight-knit culture built over the years by the company’s 100-plus employees. The client sought a way to solve this dual-faceted challenge while also gaining liquidity from the sale of his business. He shared his concerns with his attorney, who mentioned the benefits of selling to an employee stock ownership plan. Suggested reading: ESOP's - Keeping Family Businesses in the "Family".

The concept sounded foreign at first, but the client followed the attorney’s advice and contacted PCE Investment Bankers to gain a better understanding of (1) the mechanics of an ESOP, and (2) the benefits of an ESOP versus an outright sale. The PCE team not only offered our ESOP expertise but advised the client on our full range of resources and our proficiency in locating strategic or financial buyers, such as private equity firms. With an expanded awareness of his options—and still determined to fulfill all his goals and retain the longstanding company7 culture and operations—the client decided to pursue an ESOP transaction.

The PCE Solution

PCE met with the client to further educate him on ESOPs and outline the transaction process. First, the PCE team provided a high-level valuation to help the client determine whether to hire PCE to perform a thorough analysis and valuation modeling through a feasibility study. Once he had absorbed the high-level valuation analysis, the client moved forward with the feasibility study to explore multiple transaction structures, which would allow him to determine which structure best fit him, his company, and his employees. Throughout the feasibility study, PCE held weekly meetings with the client via conference calls to ensure ongoing communication, facilitate the timely flow of information, and address all open tasks and questions.

PCE produced the feasibility study just 45 days later, offering multiple transaction structures with both full and partial sale options and outlining the benefits to all stakeholders in two different types of corporations: S and C. Thanks to the information gleaned from the feasibility study and the ensuing conversations, the client was able to weigh his options properly and select the ideal structure for his business. The final feasibility study outlined that structure, which included a full sale of the company, providing him the desired liquidity and the company and its employees numerous benefits.

Once the decision was made to sell to an ESOP, PCE collaborated with the client and his management team to produce a confidential information memorandum (CIM)—a robust presentation detailing all relevant aspects of the company and the transaction structure. After the CIM was presented during an in-person meeting at the company’s headquarters, the ESOP trustee (or “buyer”) and its team (an attorney and a valuation advisor) spent the next 30 days continuing their diligence, analyzing all aspects of the company in preparation for negotiations. Simultaneous to this presentation, PCE began searching for the best financial partner for the transaction, approaching 12 banks with a one-page marketing document that described the company and its financial needs.

Just 75 days after being engaged, PCE provided the first offer to the ESOP buyer, known as the “term sheet.” It covered all deal points of the transaction, from the asking price for the company, the amount of bank and seller financing (including rates and terms), financial conditions to benefits for the employees, financial targets, benefits for management and the owner, and other legal and financial requirements. The ESOP buyer and team now had all the information they needed to make a counteroffer. In the month to come, multiple rounds of negotiations and counters occurred between PCE and the ESOP buyer as each party considered its options. When PCE put forth a final offer, the ESOP buyer agreed to all terms and conditions.

Throughout these term sheet negotiations, PCE continued its search for an ideal financial partner. Multiple banks were interested in partnering with the company for this transaction and provided offers that included terms for a loan. After two weeks of bank negotiations, PCE and the company together selected the most suitable bank for moving forward. The bank’s diligence process overlapped with the term sheet negotiations to ensure maximum efficiency in reaching a timely close. Learn more about financing your sales to an ESOP.

PCE Delivers Results

Upon completion of the term sheet negotiations, the company’s attorney assumed responsibility for creating all the necessary legal documents for the transaction, including a stock purchase agreement; employment agreements; and documents related to the ESOP plan structure, employee and management benefits, and more. The ESOP buyer’s attorney then reviewed, commented on, and suggested changes to these drafts. Meanwhile, the bank’s legal team put together its loan documents and reviewed the transaction documents as they arrived. Approximately 30 days passed from delivery of the initial draft to the final signoff on the documents, with the closing occurring virtually and signatures delivered electronically to ensure the greatest possible efficiency. Upon closing, the bank funded its loan to the seller, giving the client his desired cash in hand.

Thanks to the continuous information flow, the timely diligence, and PCE’s ability to orchestrate the transaction and keep all parties on task, this successful transaction took approximately five months from initial ESOP education to closing. The result was satisfactory for everyone involved—especially the client, who was empowered to use all the information and insights PCE provided to make an educated decision and then put his trust in PCE to deliver the desired outcome.

After the closing, PCE remained in contact with the client and the management team to further advise on ESOP matters and other issues as needed. To this day, the company and PCE maintain a productive relationship and continue to provide opportunities for either other to benefit.