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IS AN ESOP RIGHT FOR YOUR COMPANY?
Presented by: Jeffrey Gluck, Cindy Dwyer, Hal Hunt
and Mark Welker
May 1, 2014
2#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 To view this webinar in full screen mode, click on view
options in the u...
3#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 This webinar is eligible
for CPE credit. To receive
credit, you will...
4#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
The information in this Executive Education Series
course is a brief summa...
5#CBIZMHMwebinar Co-presented by ‹#›
Today’s Presenters
Cindy Dwyer, CPA
Shareholder
913.234.1022 | cdwyer@cbiz.com
Cindy ...
6#CBIZMHMwebinar Co-presented by
Hal Hunt, CPA
Shareholder
913.234.1012 | hhunt@cbiz.com
Hal leads MHM’s Employee Benefit ...
7#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
Today’s Agenda
1
2
3
ESOP Overview
ESOP Transaction Case Study
Manufa...
ESOP OVERVIEW
9#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 78.2 million Americans were born between 1946 and
1964 (the "Baby Boom" ...
10#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 More than 12,000 ESOPs in U.S. (10% of private
sector workforce—ESOPs c...
11#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
An ESOP is a tax-qualified, defined contribution, employee
benefit plan (...
12#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Provide a market (at fair market value as determined by an
independent ...
13#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Independent valuation of privately held employer securities,
must be pe...
14#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 The ESOP receives a loan and uses the proceeds to
purchase stock from c...
15#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
1) Lender lends to company.
2) Company lends to ESOP.
3) ESOP buys stock ...
16#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Creates liquidity at fair
market value (as
determined by an
independent...
17#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 If company is an S Corporation:
 If 100% ESOP-owned: no U.S. income ta...
18#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
(The ESOP can own less than 100%, with a proportional
reduction in tax-fr...
19#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Employees share directly
in equity growth of
company
 ESOP employer
co...
ESOP TRANSACTION CASE
STUDIES
Manufacturing Company, Inc.
21#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Background
 Privately owned manufacturer of high quality, industrial s...
22#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Objectives
 The majority stockholder owns 70% of the Company and is in...
23#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
FMV of Company Stock
Fair Market Value Estimate:
EBITDA $21,235,201
Multi...
24#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Can the Company do a 100% ESOP using a normal
structure?
 FMV after AA...
25#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Transaction Overview―Company:
 On December 1, 2014 the Company for...
26#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Transaction Overview—ESOP:
 On January 1, 2015, the Company loans ...
27#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Sources and Uses of Cash
Sources Uses
Excess Cash $ 9,900,000 AAA Distrib...
28#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Debt Terms and Assumptions
Senior
Amount (3 X EBITDA) $63.7 million
Amort...
Subordinated
Note
ESOP
Mezzanine
Lender
Manufacturing
Company, Inc.
70%
Owner
30%
Owner
$30.8MM
Bank
Warrants
Note
$9.9 MM...
30#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Management Incentives
 Typically grant Stock Appreciation Rights (SARs...
31#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Post-Closing Capitalization
ESOP 900,000 shares 70.93%
Mezzanine Warrants...
32#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
ESOP Debt
Service Limits
Post
Transaction
Year 1 Year 2 Year 3 Year 4...
33#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
Manufacturing Company, Inc. ESOP
Cash Flow –
Post ESOP Transaction
Po...
34#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
Manufacturing Company, Inc.
FMV of Company Stock –
Post ESOP Transact...
35#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›#MHMWe
Manufacturing Company, Inc.
ESOP Participant
Account Balances
P...
36#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
ESOP
Benefit
Analysis
Company
Annual
Contribution to
ESOP
Annual Eligible...
37#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
SAR Values Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9...
38#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 ESOP Repurchase Liability
 This should be modeled
 Typically rest...
39#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Planning Opportunities for Sellers:
 Employment agreements?
 Part...
40#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Planning Opportunities for Sellers:
 Warrants may be worth very li...
41#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Planning Opportunities for Company:
 Defer revenue from 2014 to 20...
42#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
 Who controls Company post-ESOP sale?
 The Board of Directors
 Boa...
ESOP TRANSACTION CASE
STUDIES
Energy Company, LLC
44#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 At least one owner of Energy Company, LLC is demanding
liquidity:
 Pri...
45#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Reduce board – member strife by liquidating owner who
demands exit
 Co...
46#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Find a buyer for owner
 Who? Will buyer be a good fit for Energy Compa...
47#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 ESOP purchases owner units to provide liquidity
 Record owner is Energ...
48#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Units to be sold would be transferred to a new corporation
(Newco)
 Ne...
49#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Seller sells Newco Stock to ESOP
 How does ESOP pay for the stock?
 E...
50#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
 Energy Company, LLC issues K-1 and distributions to owners,
including N...
51#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Status Quo
Selling
Owner
Energy
Company,
LLC
Continuing
Owners
52#CBIZMHMwebinar Co-presented by
Step One
Selling
Owner
Energy
Company,
LLC
Continuing
Owners
Newco
LLC Interest
100%
Sel...
53#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Step Two
Energy
Company,
LLC
Continuing
OwnersNewco
Selling Owner
Transfe...
54#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Step Three
Energy
Company,
LLC
Continuing
Owners
Newco
ESOP
$ Payment on
...
55#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Step Four
Energy
Company,
LLC
Continuing
Owners
Newco
ESOP
* Cash will be...
56#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Energy Company, LLC Illustration
Energy
Company,
LLC
Lender
Newco
ESOP
25...
57#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
Questions?
58#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›
If You Enjoyed This Webinar…
 Join us for these related EES courses:...
59#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar
Connect with Us
linkedin.com/company/
mayer-hoffman-mccann-p.c.
@mhm_pc
y...
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Webinar Slides: Is an ESOP Right for Your Company?

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Air Date: May 1, 2014
Recording at http://www.mhmcpa.com

Case Studies and Factors to Consider in Succession Planning

As we look at today's economy, there is a significant population of businesses that are owned by baby boomers. These companies will undergo ownership transition in the near future and need to understand options available for succession planning. More companies are starting to look at Employee Stock Ownership Plans (ESOP) as a transition strategy as well as a way to broaden ownership and further incentivize top management.
This webinar will explain the main financial and tax advantages, ERISA requirements and potential disadvantages of ESOPs, including illustrative case studies on several different companies representing manufacturing, distribution and architecture industries. We will discuss basic company profiles and financial data, along with organizational structure and current benefit plan offerings for employees. From there we will move into a succession planning conversation and look at what factors from these case studies are important when considering whether an ESOP or other alternatives might accomplish a company's succession and financial objectives.

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Transcript of "Webinar Slides: Is an ESOP Right for Your Company?"

  1. 1. IS AN ESOP RIGHT FOR YOUR COMPANY? Presented by: Jeffrey Gluck, Cindy Dwyer, Hal Hunt and Mark Welker May 1, 2014
  2. 2. 2#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  To view this webinar in full screen mode, click on view options in the upper right hand corner.  Click the Support tab for technical assistance.  If you have a question during the presentation, please use the Q&A feature at the bottom of your screen. Before We Get Started…
  3. 3. 3#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic polling questions throughout the webinar.  External participants will receive their CPE certificate via email immediately following the webinar. CPE Credit
  4. 4. 4#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar The information in this Executive Education Series course is a brief summary and may not include all the details relevant to your situation. Please contact your service provider to further discuss the impact on your business. Disclaimer
  5. 5. 5#CBIZMHMwebinar Co-presented by ‹#› Today’s Presenters Cindy Dwyer, CPA Shareholder 913.234.1022 | cdwyer@cbiz.com Cindy is the President of MHM Retirement Plan Solutions and a Shareholder of Mayer Hoffman McCann P.C. She supervises staff, oversees technical research, and provides quality control services. She has previously served as the national Chairperson of the American Institute of Certified Public Accountants Employee Benefits Technical Resource Panel (TRP) and currently serves as an advisory member of the TRP. Additionally, Cindy has been a recurring speaker at the American Institute of Certified Public Accountants National Conference on Employee Benefit Plans. Cindy is also a committee member and former chair of the Employee Benefits Institute sponsored by UMKC School of Law. Jeffrey Gluck, CPA Shareholder 212.790.5844 | jgluck@cbiz.com Jeff is the CBIZ Senior Managing Director and an MHM Shareholder in the New York office and leads the office overseeing client service and strategic direction. Jeff joined CBIZ and MHM in 1992 and has more than 20 years of experience. Jeff works closely with privately-held businesses in various industries and specializes in accounting and transaction services for employee stock ownership plans (ESOPs).
  6. 6. 6#CBIZMHMwebinar Co-presented by Hal Hunt, CPA Shareholder 913.234.1012 | hhunt@cbiz.com Hal leads MHM’s Employee Benefit Plan (EBP) Audit Practice. With over 25 years of diverse experience with EBP accounting, auditing and compliance issues, he is also a member of the firm’s Professional Standards Group as EBP subject matter expert. As the EBP National Practice Leader, Hal is responsible for providing internal training, along with providing technical support to engagement teams, serving as engagement quality reviewer and developing resource tools for our EBP audit professionals. He served on the AICPA’s Employee Benefit Plan Audit Quality Center (EBPAQC) Executive Committee and is currently a member of the EBPAQC ESOP Task Force. ‹#›#MHMWe Today’s Presenters Mark D. Welker Partner, Husch Blackwell 816.983.8148 | mark.welker@huschblackwell.com Chair of the firm's Tax & Benefits Department, Mark is considered clients’ go- to advisor on any important benefit or compensation matter. He focuses on all benefit and compensation matters, including the creation and operation of employee retirement plans, deferred and equity executive compensation, employee stock ownership plans, and health and welfare plans. Mark is highly regarded for his strategies and management of fiduciary and tax disputes.
  7. 7. 7#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› Today’s Agenda 1 2 3 ESOP Overview ESOP Transaction Case Study Manufacturing Company ESOP Transaction Case Study Energy Company
  8. 8. ESOP OVERVIEW
  9. 9. 9#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  78.2 million Americans were born between 1946 and 1964 (the "Baby Boom" generation).  It has been estimated that Baby Boomers own about 7 million privately held businesses with over 2.5 million of these held by individuals who are age 55 or older.  Surveys and studies have indicated about half of business owners over the age of 55 may want to consider selling their business in the next 5 to 10 years.  This means that over 1 million Baby Boomers may be selling their business in the near future. “Baby Boomer’s” Need for Transition Planning ‹#›
  10. 10. 10#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  More than 12,000 ESOPs in U.S. (10% of private sector workforce—ESOPs cover over 11 million employees)  30% to 40% are 100% owned by an ESOP  40% to 45% are S-Corporation ESOPs  Approximately 50% are ESOPs with <125 participants  ESOPs are found in all industries  Most ESOPs are or were leveraged, (i.e. they used borrowed funds to acquire stock bought by the ESOP) (Source: National Center for Employee Ownership, A Statistical Profile of Employee Ownership, updated January 2014) ESOP Population
  11. 11. 11#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar An ESOP is a tax-qualified, defined contribution, employee benefit plan (ERISA)  Invests primarily in the stock of the sponsoring company  “Tax-Qualified” in that sponsoring company and selling shareholder receive various income tax benefits What is an ESOP?
  12. 12. 12#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Provide a market (at fair market value as determined by an independent appraiser) for partial or complete sale by existing shareholders  Borrow from a bank, the sponsoring company, or sellers to purchase a block of stock  Make corporate tax-deductible contributions, including loan principal and interest payments via the ESOP (25% of payroll for S Corporations, more if a C Corporation) Why ESOPs?
  13. 13. 13#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Independent valuation of privately held employer securities, must be performed annually.  This annual valuation is reported to participants and is used to redeem shares from retiring plan participants. ESOP Complexities
  14. 14. 14#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  The ESOP receives a loan and uses the proceeds to purchase stock from current shareholders.  These shares are held in trust and are released into employee accounts at a rate corresponding to the ESOP’s debt amortization. Leveraged ESOPs
  15. 15. 15#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar 1) Lender lends to company. 2) Company lends to ESOP. 3) ESOP buys stock from existing shareholders. 4) Company makes annual tax-deductible contributions to ESOP. 5) The ESOP then in turn repays company. 6) Company repays Lender (but note that amortization schedule demanded by Lender is typically much shorter than schedule on ESOP loan, which is typically 20-30 years). 7) Employees typically receive cash after they retire or leave (vesting schedule). Leveraged ESOP
  16. 16. 16#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Creates liquidity at fair market value (as determined by an independent appraiser)  Control maintained (if desired)  Deferral of capital gains taxes available to qualified sellers of C corporation stock (IRC 1042)  Establishes value and provides liquidity for estate planning Advantages for Selling Stockholders  May continue employment; additional equity incentives still available (stock option, bonus, purchase, phantom stock, etc.)
  17. 17. 17#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  If company is an S Corporation:  If 100% ESOP-owned: no U.S. income taxes owed  If <100% ESOP-owned: ESOP’s share of tax distributions can be used to repay debt  Whether S or C Corporation, the company may deduct ESOP contributions  Allows company to redeem a minority shareholder or shareholders whose interests are no longer aligned with the company  Keeps ownership of the company in the local community  Motivation and retention of employees: proven to improve profitability and employee satisfaction Advantages to Operating Company and Remaining Shareholders
  18. 18. 18#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar (The ESOP can own less than 100%, with a proportional reduction in tax-free income.) 100% ESOP – Five-Year Value of Tax-Free Operations by Electing S Corporation Status Assume: $500,000 pretax income 10% growth rate 40% effective tax rate Total Tax Savings: $1,221,020 = more than two times the current income! 1 2 3 4 5 Pretax Income $500,000 $550,000 $605,000 $665,500 $732,050 Tax Savings $200,000 $220,000 $242,000 $266,200 $292,820
  19. 19. 19#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Employees share directly in equity growth of company  ESOP employer contributions tend to be larger than profit sharing contributions  ESOP accounts accumulate tax-free and are tax-favored at distribution Advantages for Employees
  20. 20. ESOP TRANSACTION CASE STUDIES Manufacturing Company, Inc.
  21. 21. 21#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Background  Privately owned manufacturer of high quality, industrial safety equipment sold through a worldwide network of supply distributors.  Operations are conducted from company-owned facilities and employs approximately 250 people (25% union).  The Company is fiscally conservative and debt free.  Annual revenue of approximately $75 million and income from operations of approximately $19.7 million, increasing at a compound growth rate of almost 3% per year.  The Company is an “S” corporation.  The Company has a profit sharing plan and discretionary contributions were approximately $2 million annually. Manufacturing Company, Inc. ‹#›
  22. 22. 22#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Objectives  The majority stockholder owns 70% of the Company and is in his early 70s.  The minority stockholder owns 30% of the Company and is in his early 60s.  Although the Company has been highly profitable, the stockholders are unable to find a buyer who would pay the cash asking price.  Preliminary calculations of the FMV of the Company’s stock is $99.5 million after distribution of AAA of $33.6 million. Manufacturing Company, Inc. ‹#›
  23. 23. 23#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar FMV of Company Stock Fair Market Value Estimate: EBITDA $21,235,201 Multiple X 6 Enterprise Value 127,411,206 Excess Cash/Investments 16,700,000 Debt (distribution of previously taxed earnings) (33,600,000) Equity Value 110,511,206 Non-marketability Discount (10%) (11,051,121) Fair Market Value $99,460,085 Outstanding Shares 900,000 Fair Market Value per Share $110.51 Manufacturing Company, Inc. ‹#›
  24. 24. 24#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Can the Company do a 100% ESOP using a normal structure?  FMV after AAA distribution: $99.5 million  Employee eligible compensation: $12.2 million  Maximum contribution for S corporation: $3 million  Difficult to fully amortize $99.5 million with limitation on annual debt service of $3 million. Manufacturing Company, Inc.
  25. 25. 25#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Transaction Overview―Company:  On December 1, 2014 the Company forms an ESOP effective January 1, 2014.  On December 31, 2014, the Company makes a distribution of previously taxed earnings of $33.6 million.  On January 1, 2015, the Company redeems 90% of the Company’s outstanding shares for $89.5 million.  Stock redemptions and distributions of previously taxed earnings are financed using a combination of senior, mezzanine and seller financing at 3% interest, amortized over 10 years with a balloon payment after 7 years. Manufacturing Company, Inc.
  26. 26. 26#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Transaction Overview—ESOP:  On January 1, 2015, the Company loans $9.9 million to the ESOP out of excess cash at 3% interest payable over 30 years.  Also on January 1, 2015, the ESOP purchases the remaining 10% of the Company’s outstanding shares for $9.9 million.  The Company executes a stock split, resulting in the ESOP owning 900,000 shares representing 100% of the outstanding stock, valued at $11/share. Manufacturing Company, Inc.
  27. 27. 27#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Sources and Uses of Cash Sources Uses Excess Cash $ 9,900,000 AAA Distribution $33,600,000 Senior Secured Debt 63,700,000 Stock Redemption 89,500,000 Mezzanine Debt 30,800,000 ESOP Loan 9,900,000 Seller Notes 28,600,000 Total $133,000,000 Total $133,000,000 Manufacturing Company, Inc. ‹#›‹#›
  28. 28. 28#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Debt Terms and Assumptions Senior Amount (3 X EBITDA) $63.7 million Amortization 10 years Maturity 7 years Interest rate 4% Mezzanine Sellers Amount (1.5 X EBITDA) $30.8 million Amount $28.6 million Amortization 10 years Amortization 10 years Maturity 7 years Maturity 7 years Interest rate 11% Interest rate 3% Internal rate of return 14% Internal rate of return 18% Warrants (# issued) 42,887 Warrants (# issued) 199,083 Warrants (exercise price) $11.00 Warrants (exercise price) $11.00 (Assumes excess cash is used to fund debt) Manufacturing Company, Inc. ‹#›‹#›
  29. 29. Subordinated Note ESOP Mezzanine Lender Manufacturing Company, Inc. 70% Owner 30% Owner $30.8MM Bank Warrants Note $9.9 MM $63.7 MM Secured Note *70% Owner: [70% x $28.6 MM] Redemption Note [70% x $60.9 MM] Redemption Cash [70% x $33.6 MM] AAA Distribution **30% Owner: [30% x $28.6 MM] Redemption Note [30% x $60.9 MM] Redemption Cash [30% x $33.6 MM] AAA Distribution Stock **Cash,Note &Warrants
  30. 30. 30#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Management Incentives  Typically grant Stock Appreciation Rights (SARs) to management  Typically not exercisable until only debt remaining is Senior, Secured Debt and can borrow to pay it off  Typically 5% to 15% on a fully diluted basis  Assumed 10% in this deal, exercisable at $11/share Manufacturing Company, Inc. ‹#›
  31. 31. 31#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Post-Closing Capitalization ESOP 900,000 shares 70.93% Mezzanine Warrants 42,887 shares 3.38% Seller Warrants 199,083 shares 15.69% SARs 126,885 shares 10.00% 100.00% Manufacturing Company, Inc. ‹#›
  32. 32. 32#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› ESOP Debt Service Limits Post Transaction Year 1 Year 2 Year 3 Year 4 Year 5 Total wages $ 19,200,000 Less non- participating wages (6,400,000) Less non-eligible wages (600,000) Eligible wages 12,200,000 25% Total maximum contributions to all DC plans $ 3,050,000 $ 3,141,500 $ 3,235,745 $ 3,332,817 $ 3,432,802 $ 3,535,786 Less assumed 401(k)/Profit Sharing contributions - - - - - - Assumed maximum ESOP contribution $ 3,050,000 $ 3,141,500 $ 3,235,745 $ 3,332,817 $ 3,432,802 $ 3,535,786 #MHMWe Manufacturing Company, Inc.
  33. 33. 33#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› Manufacturing Company, Inc. ESOP Cash Flow – Post ESOP Transaction Post Transaction Year 1 Year 2 Year 3 Year 4 Year 5 EBITDA $ 21,235,201 $ 21,872,257 $ 22,528,425 $23,204,277 $23,900,406 $24,617,418 Less capital expenditures (1,000,000) (1,030,000) (1,060,900) (1,092,727) (1,125,509) Cash flow available for debt service 20,872,257 21,498,425 22,143,377 22,807,679 23,491,909 Company cash contributions to ESOP (507,387) (507,387) (507,387) (507,387) (507,387) ESOP debt repayment to Company 507,387 507,387 507,387 507,387 507,387 Transaction Financing Debt service interest (6,794,000) (6,304,324) (5,781,626) (5,223,049) (4,625,449) Debt service principal (9,642,310) (10,131,986) (10,654,683) (11,213,260) (11,810,861) Annual cash flow $ 4,435,947 $ 5,062,115 $ 5,707,068 $ 6,371,369 $ 7,055,600 Cumulative excess cash $ 6,754,100 $ 11,190,047 $ 16,252,163 $ 21,959,230 $ 28,330,600 $ 35,386,199 Warrants/SARs would be exercised in Year 10 for $49.4 MM cash payment by Company: $32.1 MM for warrants & $17.3 MM for SARs
  34. 34. 34#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› Manufacturing Company, Inc. FMV of Company Stock – Post ESOP Transaction Post Transaction Year 1 Year 2 Year 3 Year 4 Year 5 EBITDA $ 21,235,201 Multiple X 6 Enterprise Value $127,411,206 $131,233,542 $135,170,548 $139,225,665 $143,402,435 $147,704,508 Cumulative Excess Cash/Investments 6,754,100 11,190,047 16,252,163 21,959,230 28,330,600 35,386,199 Outstanding Debt (123,100,000) (113,457,690) (103,325,704) (92,671,021) (81,457,761) (69,646,900) SARs FMV * - (154,165) (562,101) (1,299,937) (2,393,051) (3,816,066) Warrants FMV * - (2,161,928) (4,581,628) (7,485,268) (10,630,878) (13,776,488) Equity Value 11,065,306 28,811,734 42,953,278 59,728,670 77,251,345 95,851,253 Non-marketability discount (10%) (1,106,531) (2,881,173) (4,295,328) (5,972,867) (7,725,135) (9,585,125) Equity Value $ 9,958,775 $ 25,930,561 $ 38,657,950 $ 53,755,803 $ 69,526,211 $ 86,266,128 Equity value per ESOP share (without dilution) $ 11.07 $ 28.81 $ 42.95 $ 59.73 $ 77.25 $ 95.85 * Warrants/SARs would be exercised in Year 10 for $49.4 MM cash payment by Company: $32.1 MM for warrants & $17.3 MM for SARs
  35. 35. 35#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›#MHMWe Manufacturing Company, Inc. ESOP Participant Account Balances Post Transaction Year 1 Year 2 Year 3 Year 4 Year 5 Shares Allocated - 30,000 30,000 30,000 30,000 30,000 Cumulative Shares Allocated, End of Period - 30,000 60,000 90,000 120,000 150,000 Unallocated Shares, End of Period 900,000 870,000 840,000 810,000 780,000 750,000 Total Shares, End of Period 900,000 900,000 900,000 900,000 900,000 900,000 Total Eligible Compensation $ 12,200,000 $12,566,000 $ 12,942,980 $ 13,331,269 $ 13,731,207 $ 14,143,143 Participant # 1 ESOP Account Statement Annual Compensation $50,000 $51,500 $53,045 $54,636 $56,275 $57,964 Shares Allocated - 123 123 123 123 123 Cumulative shares allocated - 123 246 369 492 615 FMV per share $ 7.85 $ 20.00 $ 30.00 $ 42.00 $ 55.00 $ 68.00 Total participant account at FMV $ - $ 2,459 $ 7,377 $ 15,492 $ 27,049 $ 41,803
  36. 36. 36#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ESOP Benefit Analysis Company Annual Contribution to ESOP Annual Eligible Compensation Contribution as a % of Compensation FMV of Stock Released Each Year Stock Released as a % of Compensation FMV of all ESOP Stock Year 1 $ 507,387 $ 12,566,000 4.04% $ 600,000 4.77% $ 18,000,000 Year 2 507,387 12,942,980 3.92% 900,000 6.95% 27,000,000 Year 3 507,387 13,331,269 3.81% 1,260,000 9.45% 37,800,000 Year 4 507,387 13,731,207 3.70% 1,650,000 12.02% 49,500,000 Year 5 507,387 14,143,143 3.59% 2,040,000 14.42% 61,200,000 Year 6 507,387 14,567,437 3.48% 2,460,000 16.89% 73,800,000 Year 7 507,387 15,004,460 3.38% 2,880,000 19.19% 86,400,000 Year 8 507,387 15,454,594 3.28% 3,360,000 21.74% 100,800,000 Year 9 507,387 15,918,232 3.19% 3,840,000 24.12% 115,200,000 Year 10 507,387 16,395,779 3.09% 4,320,000 26.35% 129,600,000 Total $ or Avg % $ 5,073,865 $ 144,055,101 3.52% $ 23,310,000 Manufacturing Company, Inc.
  37. 37. 37#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar SAR Values Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 FMV/share $20.00 $30.00 $42.00 $55.00 $68.00 $82.00 $96.00 $112.00 $128.00 $144.00 Exercise Price/share (7.85) (7.85) (7.85) (7.85) (7.85) (7.85) (7.85) (7.85) (7.85) (7.85) SAR value/share $12.15 $22.15 $34.15 $47.15 $60.15 $74.15 $88.15 $104.15 $120.15 $136.15 X SARs Granted 126,885 126,885 126,885 126,885 126,885 126,885 126,885 126,885 126,885 126,885 SAR Value $1,542,000 $2,811,000 $4,333,000 $5,983,000 $7,632,000 $9,409,000 $11,185,000 $13,215,000 $15,245,000 $17,275,000 Vesting % 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% SAR Vested Value $154,000 $562,000 $1,300,000 $2,393,000 $3,816,000 $5,645,000 $7,829,000 $10,572,000 $13,721,000 $17,275,000 Manufacturing Company, Inc.
  38. 38. 38#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  ESOP Repurchase Liability  This should be modeled  Typically restrict ESOP distributions until after ESOP Debt is paid down Manufacturing Company, Inc.
  39. 39. 39#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Planning Opportunities for Sellers:  Employment agreements?  Participation in ESOP?  Company has until the due date of its 2014 corporate income tax returns to make an ESOP contribution of up to 25% of qualified compensation.  Tax deduction flows through to sellers  If Company’s business is cyclical and typically has a loss in January, then could delay closing to February 1, 2015.  January 2015 loss would flow through to Sellers. Manufacturing Company, Inc.
  40. 40. 40#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Planning Opportunities for Sellers:  Warrants may be worth very little at closing  Consider European Style warrants  Consider Deal price ($11/share) versus Post-Deal value (nearly $0/share).  Consider contributing warrants to intentionally defective grantor trust.  Trust contributes warrants to partnership for capital account equal to warrant value. Heirs receive profits interest.  Heirs pay mostly capital gains taxes on future warrant appreciation. Manufacturing Company, Inc.
  41. 41. 41#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Planning Opportunities for Company:  Defer revenue from 2014 to 2015  Accelerate expenses into 2014  If Company has income outside U.S., pursue maximizing U.S. income and minimizing income from outside U.S.  Sale/leaseback of real estate, as an example:  Client in hospitality/entertainment industry  100% leveraged ESOP: total debt $170 million (FMV $175 million), tight loan covenants, $28 million EBITDA  Sold real estate for $140 million to REIT for $14 million annual rent  Borrowed $43 million senior secured debt from REIT  Repaid all deal debt, much more lenient covenants Manufacturing Company, Inc.
  42. 42. 42#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#›  Who controls Company post-ESOP sale?  The Board of Directors  Board appoints/removes trustee  Trustee votes stock in board elections  Trustee can be subject to Board direction  Typically Board would be sellers at least until seller notes are repaid Manufacturing Company, Inc.
  43. 43. ESOP TRANSACTION CASE STUDIES Energy Company, LLC
  44. 44. 44#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  At least one owner of Energy Company, LLC is demanding liquidity:  Private Equity Fund that has run its course owns 25%  Proxy contest with board; litigation pending The Problem
  45. 45. 45#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Reduce board – member strife by liquidating owner who demands exit  Concentrate ownership in friendly in-community hands  Provide means for employee ownership (currently problematic in LLC structure) to enhance retention  Improve employee commitment to business profitability  Minimize use of Energy Company, LLC cash for buyout  Maximize tax efficiency Energy Company, LLC Goals
  46. 46. 46#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Find a buyer for owner  Who? Will buyer be a good fit for Energy Company, LLC goals?  Avoids use of any Energy Company, LLC funds  Energy Company, LLC repurchases units  Must be done with after-tax funds – tax inefficient  Increases proportionate ownership of remaining owners Energy Company, LLC Alternatives
  47. 47. 47#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  ESOP purchases owner units to provide liquidity  Record owner is Energy Company, LLC-selected trustee  Keeps control with Energy Company, LLC board  Beneficial owners are the employees, but they don’t vote (except on certain sales of the business)  Employees have stake in Energy Company, LLC profitability  Keeps the value in the community  Energy Company, LLC can fund the buyout entirely with pre-tax funds – very tax efficient Energy Company, LLC Alternatives
  48. 48. 48#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Units to be sold would be transferred to a new corporation (Newco)  Newco elects to be taxed as S Corporation  Energy Company, LLC employees become employees of Newco  Energy Company, LLC and Newco enter into services agreement  Newco adopts a form of qualified retirement plan – Employee Stock Ownership Plan (ESOP) How Would ESOP Work?
  49. 49. 49#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Seller sells Newco Stock to ESOP  How does ESOP pay for the stock?  Energy Company, LLC loans to Newco  Newco Loans to ESOP  How does Newco repay Energy Company, LLC?  Energy Company, LLC and Newco enter into services agreement  Newco elects to be taxed as S Corporation  Because ESOP is tax-exempt trust, it pays no tax on Energy Company, LLC distributions or service payments it receives. How Would ESOP Work?
  50. 50. 50#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar  Energy Company, LLC issues K-1 and distributions to owners, including Newco  ESOP can use full amount of distribution to repay loan from Newco, which repays loan from Energy Company, LLC  Energy Company, LLC makes fully tax-deductible payments to Newco in exchange for services (employees)  Can set payments to Newco at a margin above actual cost of employees  Any excess can also be used to pay down loans  Diagrams follow How Would ESOP Work?
  51. 51. 51#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Status Quo Selling Owner Energy Company, LLC Continuing Owners
  52. 52. 52#CBIZMHMwebinar Co-presented by Step One Selling Owner Energy Company, LLC Continuing Owners Newco LLC Interest 100% Selling Owner
  53. 53. 53#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Step Two Energy Company, LLC Continuing OwnersNewco Selling Owner Transfer Employees ESOP Loan $ $ 100% Newco Stock 100% Newco Stock
  54. 54. 54#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Step Three Energy Company, LLC Continuing Owners Newco ESOP $ Payment on Services Contract* *100% tax deductible to Energy Co., LLC, but Newco pays no tax on this Structure; include amount sufficient to enable Newco to repay its loan from Energy Co., LLC. This allows Energy Co., LLC to essentially fund buyout with pre-tax dollars. The “price” is that the stock remains outstanding (beneficially owned by employees) rather than being redeemed. Distribution to Owners $ Payment on Loan Distributions to Owners $ Payment on Loan $ Contribution to ESOP 100% 100% Newco Stock
  55. 55. 55#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Step Four Energy Company, LLC Continuing Owners Newco ESOP * Cash will be needed to fund buyouts of terminated employees. However, that can be mostly delayed until after the loan from Energy Co., LLC to Newco is repaid. Energy Co., LLC can deduct those payments if they are funded as part of payment under services contract.100% $ ESOP Repurchase Liability Terminated Participants
  56. 56. 56#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Energy Company, LLC Illustration Energy Company, LLC Lender Newco ESOP 25% Total Tax Considerations (1) Energy Co., LLC payment on services contract fully tax deductible: $160M tax benefit (2) Energy Co., LLC tax distribution paid back to Energy Co., LLC: $800M tax Benefit (3) Energy Co., LLC payment of interest to Lender fully tax deductible: $200M tax benefit (4) Energy Co., LLC receipt of interest on loan to Newco included in income: $200M tax cost (5) Net tax benefit: $960M (4) $330 M Contribution $2 MM Loan Payment Non-ESOP Shareholders 75% (5) Loan Payment = $330 M Debt to Newco =$10 MM Annual Loan Payment $330,000 (1) Taxable Income = $8 MM Debt to Lender = $10 MM Annual Payments = $2 MM (2) Tax distribution = $2.4 MM (6) Pay $1.2 MM Loan Payment (2) Tax distribution = $800 M (3) Payment on services contract = Cost + $400 M Debt to Energy Co., LLC - $10MM Annual Loan Payment = $1.2MM
  57. 57. 57#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› Questions?
  58. 58. 58#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar ‹#› If You Enjoyed This Webinar…  Join us for these related EES courses:  8/19 & 8/28: ERISA Plan Internal Controls and Your Fiduciary Responsibilities  10/9 & 10/21: Actions with Unintended Consequences in ERISA Plans  12/9 & 12/17: Understanding Your Employee Benefit Plan’s Investments  Read these related publications:  Employee Stock Ownership Plan Primer
  59. 59. 59#CBIZMHMwebinar Co-presented by#CBIZMHMwebinar Connect with Us linkedin.com/company/ mayer-hoffman-mccann-p.c. @mhm_pc youtube.com/ mayerhoffmanmccann slideshare.net/mhmpc linkedin.com/company/ cbiz-mhm-llc @cbizmhm youtube.com/user/ BizTipsVideos slideshare.net/CBIZInc
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