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What you should know about financing an ESOP

By Fidelity Bank

December 28, 2021

Forward-thinking business owners want to create a succession plan that preserves their legacy and benefits the organization. Understanding employee stock ownership plans, ESOPs, and how they can impact a business, the employees and a community can be a perfect option for savvy leaders to explore.

What is an ESOP?

With an ESOP, business owners sell all or some of their business shares to a trust that manages the company’s stock. Employees get an ownership stake in the company and the owners get a fair price for their shares. Leaders can develop simple and efficient ESOPs on a tight timeframe. While an ESOP can be intricate, with a little planning, a business can get the right financing to take the next step in creating a legacy. 

ESOPs build business and community stability

An ESOP offers business continuity and stability, and can put an organization in the driver’s seat for recruiting talent. New employees can feel a sense of pride and ownership in the organization, which is a great way to reinforce the culture and instill confidence in retirement benefits. When an organization goes through the ESOP process, the business can preserve jobs, a business legacy and keep the tax base steady.

An ESOP success story: Solution Design Group

Solution Design Group, SDG, a technical services firm, and client of Fidelity Bank, went through an ESOP implementation over six years ago. SDG had an owner ready to retire. The owners explored options, including selling the organization. At the time, SDG worked with a national lender who was uncertain of the ESOP process and wasn’t responsive to inquiries. Their attorney recommended giving Fidelity Bank an opportunity to introduce their ESOP expertise and their understanding of the industry, technology and IT programming. Fidelity explained how they could create a plan for the owners on the SDG’s timeline. Jeff Daniel, CFO of SDG shares the experience:

“We are a professional technology and consulting firm that is an ESOP, which is an ownership structure typically seen in manufacturing. Our ESOP makes us stand out among our peers. We are always educating prospective talent and business peers about our ESOP.
 
“It is key to have an effective communication plan when launching an ESOP to employees. You must have credibility with the employee base because you are asking for trust, selling the concept and benefits with graphs on what could happen as employee owners. We fought messaging from financial advisers who didn’t understand the ESOP model. To reinforce the long-term gains of an ESOP, we brought in a seasoned financial adviser to present during employee meetings and write articles for our employee newsletter. It took two to three years before the whole team was excited.
 
“Now that we are years into an ESOP, we have attended conferences with other business leaders, have steadily reduced our debt and infused the organization with paycheck protection program money. We are looking beyond retirement funding to profit sharing or a dividend program to reach new goals.
 
“Being an ESOP can be complicated, however, it has allowed us to do more around our commitment to the employee experience, customer success and being a good community citizen. We have given back to community organizations and completed more nonprofit projects. We received positive, unplanned publicity by having more engaged employees who give their all to our customers and their communities.”
 
Fidelity Bank, a Minnesota-based business bank, has worked with organizations to ensure a smooth ESOP transition. Todd Williams, President of Fidelity Bank, explains ESOPs, how they help owners and next steps to take.

How has Fidelity Bank built their ESOP expertise?

Over the years, our organization has helped owners, their companies and their communities transition to the next step with an ESOP. At Fidelity Bank, we invested time in developing a deep bench of knowledge and connections with legal teams, tax professionals and appraisers to help us learn how to structure stable ESOP deals. After we established that network, we introduced clients to key ESOP professionals and created a toolkit to help clients take the next step. Generally, we listen to the key management of the business and develop a close relationship, which assists with the ESOP launch.

Many banks are hesitant to finance ESOPs. How do you help owners?

When an owner begins the ESOP process, it can be challenging for leadership. There is a lot of complexity within developing an ESOP. It’s more than just a loan. There are employment laws, purchase liability and other rules, which lenders tend to shy away from because they don’t understand how to work with those ESOP deals. Lenders can help the current owner and future leadership understand the advantage of properly financing the transaction and supporting them with solid advisers to assist with their ESOP journey. Keeping continuity with future leaders is critical, thus bankers should have regular check-in meetings to listen and anticipate financial needs as well as new strategic initiatives. Communication is everything.

How do I get started?

Start early, get educated and reach out to ESOP-related organizations, like MNCEO, and talk to other ESOP business owners, who have made the ESOP journey. These sources can point you to solid ESOP advisers, such as CPAs, legal and professional associates who know about the ESOP process. Most ESOP professionals will ask key questions, such as: 
  • Is there enough talent within your management team to move the business forward?
  • Is this structure a good fit for the business?
If you take the time to research and communicate with others at the beginning, you can set your company up for success with an ESOP solution.

The article was contributed by Fidelity Bank, an independent, privately-owned business and commercial bank providing financial services to small to mid-sized businesses, that is proud to call Minnesota home.  
 
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 advisers on how best to exit.  Contact us for more information on how we can be a resource for you at www.mnceo.org or Sue Crockett, executive director at scrockett@mnceo.org