Considerations for financing ESOPs — a banking perspective
By Mark Paetznick and Jeff Campbell
July 21, 2021
As companies evaluate whether to become an employee-owned organization (ESOP), it’s critical to align with trusted experts in banking, legal, accounting and valuations, and lean on professionals like the Minnesota Center for Employee Ownership (MNCEO). While many banks offer financing to employee-owned companies, partnering with a business bank with extensive ESOP experience provides tremendous value. Owners and trusted advisers should review items like motivation, finances, culture, legacy, community impact, tax and bank issues.
Seller financial considerations
Companies with stable revenue streams and earnings can be successfully employee owned. If the owner wants to share their financial success and jobs with the community, it can also be part of their legacy. Sellers should ask:
- What are my future personal goals?
- What are my goals for the business?
- What is my comfort level with risk?
- Can I wait for organization to pay me over time?
- Does an ESOP structure fit my retirement needs?
Cultural considerations
An employee-owned company flourishes when decision making moves from “me” to “we” culture. Important companywide questions include:
- Will an ESOP structure resonate with the employees?
- Will the team members embrace a culture shift?
- Are there enough employees to grow the business?
- Does current leadership have the expertise to take on more responsibility?
- Will key hires need to be made for this transition?
- How does succession planning fit into the long-term growth of the organization?
Tax considerations
An ESOP board values good fiduciary responsibility. A company valuation decreases with volatility and decreased profitability. Good CPAs are a cornerstone in an ESOP because they:
- Bolster an annual ESOP valuation.
- Evaluate tax options for the owners/sellers.
- Create relationships with the owners’ other financial services and wealth managers.
- Review and audit special projects, including any future acquisitions.
- Assist with capital expenditure plans for efficient financing.
- Provides analysis on long-term equipment financing options, like True Leases, allowing cash flow improvement and a lower interest rate because of deprecation taken by the Equipment Finance company.
Finally, loaning to an ESOP is important to banks because it helps maintain relationships within the community, provides additional future lending opportunities and keeps jobs local. The bank can work with the advisory team to determine the best structure for each unique business.
Bank considerations
The main thing banks evaluate is the credit worthiness of the company, which includes:
- Strong historical financial statements, internal systems and operating results.
- Financial projections, liquidity levels and consistent earnings.
- Asset values to lend against (receivables, inventory, equipment, real estate).
- Term loan (real estate, equipment, acquisition debt) and revolving loan amounts.
- Cashflow, accounts receivable and payable aging reports.
- Diversification of customer base and sales.
- Vendor relationships.
- Biographies of the key management team.
- Industry information and outlook for the markets served.
Other ESOP items to note
Some ESOPs use Stock Appreciation Rights (SARs) to incentivize employees as a compensation benefit if the company stock price increases or if there is a liquidity event (such as sale of company).
Seller debt is common with ESOP transactions. Seller notes are typically subordinated to any bank debt. This is situation specific, and the repayment plan of seller debt is usually addressed within a bank lending arrangement.
Though the process of considering whether employee ownership is the right fit for a business can feel overwhelming, feel confident in the expertise of the MNCEO and trusted advisers for guidance.
The Minnesota Center for Employee Ownership serves as a free unbiased source for education and resources around all forms of employee ownership. With 52,000 business owners over the age of 55 in Minnesota exiting their business in the next 3-5 years, there is a crisis looming. What will happen to their legacy, employees, community? Business owners will look to their advisors on how best to exit. Contact us for more information on how we can be a resource for you www.mnceo.org, or reach Sue Crockett, executive director of MNCEO, at scrockett@mnceo.org
Mark Paetznick (markp@fidelitybankmn.com) is the vice president of equipment financing and leasing, and Jeff Campbell (jeffc@fidelitybankmn.com) is the senior vice president of commercial banking at Fidelity Bank in Minneapolis.
