Understanding the Criteria and Tax Advantages of an Employee Stock Ownership Plan

Hi, welcome to ValuationPodcast.com, a podcast and video series about all things related to business and valuation. My name is Melissa Gragg, and I'm a mediator and business valuation expert in St. Louis, Missouri.

In this episode, we speak with Kelly Finnell. He is based in Memphis, Tennessee, and is one of the nation's best ESOP consultants, having spent more than 40 years helping business owners design and execute employee stock ownership plans. Kelly is also the owner of a preeminent ESOP book, "The ESOP Coach", using ESOPs in ownership succession planning in 2010, and his work remains the most comprehensive guide to ESOPs today.

1. What do business owners need to know about ESOPs?
2. What are the primary tax advantages associated with ESOPs?
3. How do ESOPs offer tax advantages compared to other employee benefit plans or ownership structures?
4. What makes a company an ideal candidate for implementing an ESOP?
5. What factors typically drive the adoption of ESOPs within organizations?
6. Do all Employees Need to Participate in an ESOP?
7. In your experience, what common factors lead companies to consider or transition to an ESOP model for their employees?

Melissa Gragg CVA, MAFF
Expert testimony for financial and valuation issues
Bridge Valuation Partners, LLC
melissa@bridgevaluation.com
http://www.BridgeValuation.com
http://www.ValuationPodcast.com
http://www.MediatorPodcast.com
https://www.valuationmediation.com
Cell: (314) 541-8163

Kelly O. Finnell, J.D., CLU, AIF®
CEO, President Executive Financial Services, Inc.
kfin@execfin.com
901-259-7979 3350
Players Club Pkwy, STE 330
Memphis, TN 38125

Melissa (00:00):

Hi, welcome to valuation podcast.com, a podcast and video series about all things related to business and valuation. My name is Melissa Gragg, and I'm a mediator and business valuation expert in St. Louis, Missouri. Today we'll be talking with Kelly Finnell. He is based in Memphis, Tennessee, and is one of the nation's best ESOP consultants, having spent more than 40 years helping business owners design and execute employee stock ownership plans. Kelly is also the owner of a preeminent ESOP book, the ESOP coach, using ESOPs in ownership succession planning in 2010, and his work remains the most comprehensive guide to ESOPs today. Welcome, Kelly. How are you?

Kelly (00:41):

I'm great, Melissa. I hope you are too.

Melissa (00:43):

Oh, this is awesome. So we ha always have a lot of questions about kind of other ti ways that somebody can transfer their business, you know, so, and we get called to do business valuations for like strategic planning. And in that strategic planning, you know, you can do estate planning, you can gift things, you can gift shares, but there's also some ways that if you don't have like next family in line, that you may consider other options if you have employees that could be key players. And this ESOP concept, which is an employee stock ownership plan, has been around for a long time, but has it, you know, like did the pandemic really changed anything? Like, has anything changed or what, what is the landscape in ESOPs right now? If you can give us kind of a, an overview?

Kelly (01:41):

Well, in general, we've seen a pretty significant increase in ESOP activity. And coincidentally it started the first year of the pandemic. I was sitting in my office on March 15th, 2020 thinking this is gonna be a disaster. This is gonna be a repeat. I was thinking at that time of 2008 mm-hmm. <Affirmative>, Lehman Brothers went bankrupt on September 15th, 2008, the great recession began and we, our business was debt for about a year and a half. What we do are leveraged ESOPs. And that leverage usually comes from a combination of bank debt and seller debt. And the market for bank debt had completely dried up for about a year and a half. So I was thinking at the middle of March of 2020 that we were gonna have a repeat event and that our business was going to be way down. And just the opposite of that happened.

Kelly (02:45):

On average, we had done about six ESOP transactions a year up to 2019. And in 2020 we did 10. So the first year of the pandemic, we had done a, we'd closed a couple of transactions before the pandemic began, then our activity was very slow for three months, and the second half of the year was gangbusters. Okay. And it's continued since then. And I think there's several reasons for that. The basic reason is the aging of the baby boomers. Mm-Hmm. <Affirmative>. So the baby boom generation is that group of people that were born between 46 and sixty four, nineteen forty six and 1964. And that group of people, I'm right in the middle of that and we're aging business owners. Baby boomer business owners are thinking about how to cash in on their life's work. And so the pandemic just happened to, to occur as business owners were thinking about those things. And I think that the risk that all of us recognized associated with the pandemic just accelerated that thought process. Mm-Hmm. <affirmative>. And so as we get older, every investment advisor tells us that we should be invested more conservatively because we've got less time to recover from a downturn. And for most business owners, their company is their biggest asset. Right. And so it just makes sense as we age to diversify so that we can mitigate risk like the pandemic and c Ovid 19 and the Great Recession.

Melissa (04:37):

Well, and, and I think that in general, I think business owners that are in that baby boomer space have been highly successful, usually have very, you know, extensive businesses. You could see 25 plus million in revenue, you know, 50 million and and above these types of businesses. And they don't necessarily want to sell. Right. They don't necessarily want to get out of the business, and they don't always know what the options are when they come talking. And, and they, they might not even ask about ESOPs, right. Because they won't understand it. But, and, and what you're talking about in a leveraged buyout, it's really like a business owner coming in and saying you know, I got some employees and, and now we've seen it in like large construction companies where you might have hundreds of employees and you have, you know, 50, a hundred million dollars company that it might not be able to be absorbed very well in the community or things like that.

Melissa (05:45):

Like, you might not have a lot of buyers even for that. But this, this leveraged esop, I think maybe you can explain that a little bit more because I think people would, it, it, it is basically like you're getting bought out and the bank is coming in and buying you out, but the employees are buying it out and it's very structured because everybody has to be protected. But I, we need a more official, you know, like, tell us a little bit more about what a business owner would even need to know about an esop. Just in to, to start with.

Kelly (06:24):

Yeah. The first thing that you need to know is that an ESOP is a form of qualified retirement plan. So it's a first cousin to a 4 0 1 K plan, but there are some things about ESOPs under the law that are different than the rules that apply to 4 0 1 K plans. And as you suggested, result in them being not only a retirement plan for the company's employees, but also a liquidity strategy for the business owner. Mm-Hmm. <affirmative>. And so an esop has three key things that make it different from a 4 0 1 K plan. The first thing is that an ESOP can borrow money. So we're talking about leveraged ESOPs, meaning that there's a loan involved, and in fact, there are almo almost always multiple loans involved. So as a rule of thumb we would expect if we had, for example, a $10 million ESOP transaction, we would expect three to $4 million of bank debt.

Kelly (07:30):

That bank debt, the loan would be made from the bank to the company, and then the company would relend that money to the esop. Hmm. One of the great things about that debt is that it's probably gonna be the first time in the business owner's history that the company has borrowed money without him having to give a personal guarantee on the line. And so, ESOPs are used by business owners to help the separate themselves from the company and offering a personal guarantee would be an anathema to that. And ESOP lenders understand that. So it's one of the rare times a business owner's gonna have the opportunity to have their company borrow money without having to give that personal guarantee. And then in our example of a $10 million transaction with $4 million of bank debt, the rest of the financing would be from the selling shareholder.

Kelly (08:28):

And that would be in the form of a seller note, which is an I O U originally issued by the esop, and then assumed by the company promising to pay the business owner the balance of their proceeds. The $6 million in this example, over time, so it closed, the business owner would receive $4 million of cash. The company over a three to five year period would pay off that bank loan. And while that bank loan was being repaid, the company would pay the selling shareholder interest only on their seller note. Once the bank loan was fully repaid, then either the company would go back to the bank and borrow additional money and use that to buy out the balance on the seller note. Or the company would simply just pay the seller note off over time. And so that could result in the business owner getting all of their money in somewhere between three and about seven or eight years.

Melissa (09:32):

And so that's the, and is that primarily also attached to the fact that there may be like, that the ownership, you know, like they're only buying a part of the ownership at the beginning for the initial amount, or is it all transferring?

Kelly (09:47):

It can happen either way. Okay. But statistics indicate that between 70 to 80% of the ESOP transactions that are done now are 100% sales.

Melissa (10:00):

Okay. Okay. And

Kelly (10:01):

Then the rest of those might be a lesser than a hundred percent sales. So that usually hovers right around that 49 or 51% sale.

Melissa (10:14):

Right. Right. So there'd be a portion, most

Kelly (10:16):

Of them are 100% sales.

Melissa (10:18):

Okay. So, and I think that, you know, some of those things are just important for business owners. I think that was a beautiful recap of kind of the process, because I think it is kind of mystical to people like, oh, you know, the, the government's gonna be involved or the Department of Justice and things like that. But when people are looking at these types of, of strategies, really, because I like your analogy that an ESOP is similar to a 4 0 1 K, so there must be some reasons why people are choosing this process. And you alluded to the fact that there's tax advantages. What are the primary tax advantages associated with ESOPs that would convince a business owner that this is a right move?

Kelly (11:06):

Well, there are tax advantages for the business owner and for their company. So first, for the business owner under section 10 42 of the code, which is a like kind exchange provision, the business owner can sell their stock to an ESOP reinvest in the stocks or bonds of a different US domestic operating company. And that's considered a like kind exchange. I had stock in my company, I sold it, I got cash, and I reinvested that cash in other stocks or bonds. And so those would be very conservative income producing typically US public companies. And so by doing that, the business owner is going to avoid the long-term capital gains tax on that sale. So it's like, you know, most business owners that I talked to have done throughout their career like kind exchanges of real estate. And so I draw that analogy 'cause the concept is identical. I have a piece of property, I sell it, I have a gain, I reinvest the gain in similar property, no tax. I do get a transferred tax basis. Okay. So if I ever sell the reinvestment property, then that's going to trigger the gain. And my basis in the property that I reinvested in will have been that transferred basis. Okay.

Kelly (12:32):

One of the differences is that most of the people that are doing ESOP transactions are mid sixties to mid eighties. And so they're going to reinvest typically in assets that they can hold onto till death. And at that point, their heirs, we'll get a stepped up basis. So it's either a long-term tax deferral or in some cases a complete tax forgiveness.

Melissa (12:57):

Okay. Okay. So

Kelly (12:59):

That's a very powerful tax benefit for the selling shareholder to be able to save that 23.8% federal long-term capital gains tax, plus any state long-term capital gains tax, then there's a big tax advantage for the company. And that is 100% ESOP owned companies operate on a basis no tax at the company level because they're all SS corporations and S-corps don't pay tax. They flow their income through to their shareholder. And as I mentioned earlier, and ESOP is a form of qualified retirement plan like a 4 0 1 k, like a 4 0 1 K plan, it's gonna have a trustee and like the 4 0 1 K trustee, the ESOP trustee is going to be tax exempt. Mm-Hmm. <Affirmative>. So what happens if you have a company that doesn't pay tax and flows its income through to a shareholder that doesn't pay tax? You have public supermarkets mm-hmm. <Affirmative>, which is the largest 100% ESOP owned s corporation in the country, and they compete very well with Kroger because they have this huge pricing advantage. They don't have to distribute 40% of their income to their shareholders so that the shareholders have the cash to pay the tax. There is no tax at Publix or at any of the other 6,000 ESOP owned SS corporations. So huge tax advantages for the shareholder and for the company that sponsors the plan.

Melissa (14:43):

Well, and you know, it's interesting because I've been doing this for, you know, 20 plus years and valuation, and it still surprises me when we talk about things that I should know about. Right. And I think that ESOPs, just so that our listeners understand, like ESOPs are their own their own section, like their own beast. Right. So just because I'm in the field or it seems like I should know about it, like really the professionals and ESOPs are focused on ESOPs. And I think what you were talking about just now were some benefits that we're gonna talk about here, but I need you to like almost re annunciate it because like, this seems like really big things like I didn't even really know. But you know, they also talk, offer these tax advantages compared to the other benefit plans and ownership structures. Is that what you're talking about? Like, that there would be no tag. Like, this is fascinating to me. This is a huge perk. Right.

Kelly (15:50):

Well, and one of the things that you said triggered a thought in my mind when people ask me what are the biggest problems with ESOPs? Yeah.

Kelly (16:01):

My first answer always is lack of knowledge. Yeah. ESOPs are a subspecialty within a subspecialty. Okay. So ERISA is a subspecialty of the tax law and the benefits law. And then ESOPs are a subspecialty of erisa. Okay. So I have clients tell me all the time, I asked my lawyer or my C p A about whether I should consider an an esop, and they said, I don't know anything about ESOPs. Right. and so that, that's the biggest problem with ESOPs is lack of knowledge mm-hmm. <Affirmative>. And so I consider myself in addition to being an ESOP consultant, an ESOP evangelist, spreading the word about all of these great benefits.

Melissa (16:55):

Yeah. Yeah. No, I mean, so, so, but did I hear you right and were you saying that, so if I become an ESOP owner, I'm not gonna have to pay taxes on that either,

Kelly (17:08):

Right. So let me give you a, a, a comparison that will help this come to life a little bit. Okay. At the end of every year for participants in 4 0 1 K plans they get from their non 4 0 1 K investments at 10 99 telling them what the taxable gain was on their investment accounts. Okay. In their 4 0 1 K plan, they don't get a 10 99. Right. And they've never asked themselves why. They just know that that's the rule. The reason they don't get one is they don't own those assets. Those 4 0 1 K assets are owned for their benefit by the 4 0 1 K trustee, which is tax exempt. So 4 0 1 K's a qualified plan, ESOP's a qualified plan, so we've got this tax exempt trustee, and when we flow income through to that tax exempt trustee, obviously there's no tax mm-hmm. <Affirmative> because the trustee doesn't pay tax. And so we end up in a situation where a business owner can operate their company as if it were a church or a synagogue.

Melissa (18:32):

Wow.

Kelly (18:33):

No tax on their income. And so think about what that does. If I'm saving that 40% tax, then I can pay back a five-year bank loan in three years

Melissa (18:47):

Mm-Hmm. <Affirmative> mm-hmm. <Affirmative>,

Kelly (18:49):

Because I've got so much more cash flow. Right. I've got 40% more cash flow than I had without the esop

Melissa (18:57):

Mm-Hmm. <Affirmative>.

Kelly (18:58):

And so the, the, the practical benefits of this tax structure are incredibly powerful and business owners don't know about it.

Melissa (19:10):

Well, and essentially what you're saying is like upon retirement or sale, if you are bought out of the esop, you would then maybe see the gain or the payment of taxes at that time?

Kelly (19:28):

Yes. Okay. The ESOP participants are participants going to pay the tax.

Melissa (19:33):

Okay.

Kelly (19:33):

And so the tax is still going to be due, but the tax has been shifted. Correct.

Melissa (19:39):

So

Kelly (19:39):

The owner didn't pay tax on their sales proceeds, then the company didn't pay tax for let's say 20 years. And so now we've got an employee who's been in the plan for 20 years, the employee's going to take a distribution of their account, now they're retired, they're gonna roll that distribution over to an ira, so no tax when they do that. And then they're gonna take a portion of that money out each year over the next 20 years to support their retirement income. Mm-Hmm. <Affirmative>. So the tax has been shifted from the company to the people who are benefiting from the esop mm-hmm. <Affirmative>, which are the company's participants.

Melissa (20:24):

And if we, you know, blow everybody's mind and it actually skips to the next generation. That's right. You're gonna avoid it all completely <laugh>. Yeah. <Laugh>. Okay. That's fascinating. So that leads into a good question then, because if people start to hear this, like, all of this sounds really amazing, but what, because now I'm thinking, okay, were you an SS Corp or an L L C or partnership or a C Corp to begin with? Because if you were a C corp, that's a big deal if you had the other ones. But like, what makes a company an ideal candidate for implementing an ESOP or, you know, e at least, or, and, and maybe also what would preclude them, you know, like mm-hmm. <Affirmative> from doing that.

Kelly (21:09):

Yep. Well, there are two sets of, of considerations that we look at. The first is the metrics, the numbers. And so as a general rule, in order to be a good candidate for an esop, a company needs to have at least $2 million of adjusted ebitda. So earnings before interest, taxes, depreciation, and amortization. So generally, that is the proxy for the company's free cash flow. Yeah. And so in order to be a good candidate, you need to have that level of cash flow. So I tell people that ESOPs are for small and mid-size companies, they're not appropriate for micro companies.

Melissa (21:53):

Okay.

Kelly (21:53):

And I did say adjusted ebitda. And so we have lots of clients who at the end of the year might have earnings of $500,000, but when you adjust EBITDA for add backs, expenses that are not going to continue after the company is sold, and that's the world you live in doing valuations, you often see a company company have $2 million of add backs. And so now this company has adjusted EBITDA of two and a half million.

Melissa (22:26):

Yeah. Well that's, I can imagine you could also have owner's compensation that could be very, that's

Kelly (22:32):

The big adjustment. Yeah. That's the big adjustment always. And then the other numerical consideration is generally not a hard and fast rule, but generally companies need to have at least 50 employees Okay. To be a candidate. And so when we look at taking this to a more practical level, when we look at the transactions we've done over the last three years, so that would be 23, 22, and 21. During that period of time, we've done 25 transactions. And the smallest one was for a company that had 1.2 million of ebitda. So I said, the general rule is 2 million, but the thing about rules is that they're always exceptions. So that's the smallest one. The biggest one we did was for a company that had 56 million of ebitda, and probably more instructive, the median was a company that had 4 million

Melissa (23:34):

Sure.

Kelly (23:35):

Of ebitda. The smallest company that we did in terms of the number of employees was 24, and the largest was almost 600. The median was 95. Okay. So just under 100 employees,

Melissa (23:49):

Are you, are you seeing any typical industries more likely to Yes. Go into this? Okay. What are some of those industries? Our

Kelly (23:57):

Big industries are engineering. Okay. We've got, we've done over a dozen ESOP transactions for engineering firms, a huge movement now for construction companies mm-hmm. <Affirmative> to do ESOPs manufacturing companies, traditionally have been big users of ESOPs, and then other professional services companies. So an engineering firm is a professional services company. We're also our biggest emerging industry niche is advertising and public relations firms. We've done four of those over the last 18 months mm-hmm. <Affirmative>. And so we're seeing a big push in that industry. And so the common theme is our biggest industry niches are professional services. Mm-Hmm. <Affirmative>. So that can also include architects and, you know, a whole lot of other companies. And so the common denominator among those companies is that culture is the key to their success. And guess what, if you sell to a third party, whether it's private equity or to a strategic buyer, you can be assured that culture's going to change.

Kelly (25:13):

Mm-Hmm. <affirmative>, once somebody has written a check to buy you, they control things. They're gonna tell you nothing's gonna change. But we're adults, and we know that's not the truth. Everything is going to change. And so we see a lot of companies where the business owner during the first meeting will tell me that their employees are the key to their success, and they want to protect those employees, make sure that they have a job after the transaction, they want to reward the people who have gotten them to the point where they could do this transaction and cash in on their life's work. And they wanna maintain company culture for the benefit of their employees and also for their clients. I mean, the clients are gonna be negatively impacted by a change of company culture too. So those are, you know, some of the things that we hear business owners tell us that indicate they're a good candidate for an esop.

Melissa (26:18):

Well, and, and some of the things that you said were interesting because I wonder if it, if it goes towards, you know, like you said, a couple different industries, but some of the things that I see similar in those industries from a valuation standpoint is that you've created a name or a brand. So you either have a name, a brand, a reputation, you know, in construction it becomes very important because you're working with GCs or, you know, a lot of these engineering firms and construction firms are going around the country and like putting up a Chick-fil-A, putting up a Walgreens very quickly. Right. And it's a whole team that comes in, drops in, does that, and leaves. Now that being said, you know, if, if it's because the employees would want to capture that name, brand recognition and kind of continue it on. Right. So what factors, you know, when business owners are coming to you, I would assume that they've already talked to some of their employees, like said, a, is this gonna be a good idea? Or are they just saying, oh, I'm just gonna shove this idea down my employee for like, how, what factors typically drive the adoption of the ESOPs within the organization? Or is it really a top down that like the owner is saying, this is what we're gonna do, get in line? Or is it really the, the owner, the employees pull you in? You know, it's almost,

Kelly (27:52):

It's almost never the employees. Okay. It's almost always top down. But most business owners get a key group of employees involved pretty early in the process. Okay. So the typical process for us would look like our business. Melissa is all over the country. We've got clients in Oregon and clients in South Florida, and every place in between. So fortunately with video conferencing now, we'll usually have a first meeting via video conference, talk to the business owner, maybe their C F O and maybe their lawyer about what ESOP is and how it works. A lot of, a lot of the same things that we've discussed this morning will answer their questions. We'll get some basic information so that we can help them get a sense of whether or not they might be a good candidate. They'll think about that.

Kelly (28:50):

We'll probably have a follow up call where they'll ask additional questions, and then they'll hire us to do a feasibility analysis. So the purpose of that analysis is to answer the four key questions that they have. First question is, if I sell to an esop, what would I expect value to be? What will the ESOP trustee pay for the stock that I'm selling? The second question is financing. So we talked about that a little while ago, and we'll talk to them about how much we think they can borrow from the bank. How much would be in the form of seller notes, and what would the terms of those seller notes look like? Then we're gonna talk to them about their key people. Business owners typically tell us that all of their employees are important to their success, but there's some people who are irreplaceable.

Kelly (29:40):

Hmm. And they wanna do the ESOP for everybody, but they wanna do something on top of the ESOP for those key folks. And that usually comes in the form of stock appreciation rights. Okay. And then the final thing that they wanna know the answer to is corporate governance. How is the business going to be running controlled after they sell? And to preview the answer to that question, not much changes. Mm-Hmm. <Affirmative>. And so we'll do a feasibility analysis. Usually at that point, the business owner will know whether or not this is the right strategy, and oftentimes then they'll get a broader group of employees involved in the discussion. And it's not something that they approach where they say, look, here's what we're gonna do. Take it or leave it. It's usually much more participatory and collegial. And so, you know, this is what we're thinking about. What questions do you have? And does this sound like a good structure for you? Mm-Hmm.

Melissa (30:43):

<Affirmative> Well, and in some capacity, do all of the employees need to participate? You know, is this a, is this a everybody is on board kind of thing. Because I, I think one of the things that I think a business owner would question, or we can even talk about, like the valuation piece. Like in your feasibility study, are you providing like a value? Are you giving them a range of value? Talk a little bit about how that works and how maybe the fiduciary works for the employees, because I think that might just be a little bit of good information to understand that there really are kind of representatives on both sides, if you will. Yeah,

Kelly (31:31):

That's a great point. So we represent the selling shareholders, and we're gonna provide them an estimate of value. I've been doing this for, for 41 years. My lead financial analyst has been with me 16 years. So our estimate of value is gonna be within 10% of the final sales price. Okay. Just know, because we've been doing it that long. So the, the business owner isn't going to have any risk or doubt about how much they're going to get paid, but your point is exactly right. There is a counterparty to this transaction, and every business transaction there's a seller. And so that's the business owner who we represent, and there's a buyer. The buyers essentially are the employees, but they're being represented by the fiduciary that you refer to, who is the ESOP trustee. Mm-Hmm. <Affirmative>. So the trustee is going to have a team with the trustee leading that team.

Kelly (32:31):

They're going to have a valuation advisor that they engage. And the key requirements is that the person be an expert in doing ESOP valuations and that they be independent, meaning that they can never have had a relationship or ever had worked for the company or its owners or its employees. And so that valuation advisor is going to provide the trustee with that range of value that you referenced. And then our job is to negotiate on behalf of the sellers to the very top of that range of value. Mm-Hmm. <Affirmative>. And because of our experience and expertise in doing that, we usually know what the trustee's number is, and we're gonna get the business owner very close to that number. The trustee's also going to have its own legal counsel. So as part of this, we're gonna negotiate, once we've agreed on price and other key terms and a letter of intent, we're going to negotiate a stock purchase agreement and promissory notes and all of those legal documents. And so the company is gonna be represented by ESOP counsel, and the trustees going to have its own counsel, and we're gonna go through a process of negotiating and documenting the transaction terms.

Melissa (33:55):

Well, and, and from a valuation standpoint or from a financial standpoint, there are a lot of rules around ESOPs and regulations. But, and that is why, you know, with electronic communications, that it is imperative, and, and I've been saying this for the entire time that I've been doing valuations. 'cause I I, I've been involved with them on the seller side, on the business side. Right. And the consult on the other side. But, and it was usually not me as the, it was usually big firms that I was involved in, you know, because there is a lot of risk even in being a professional in this field. And so reaching out to somebody or working around the country makes a lot of sense in this space because you want to seek out somebody, you're gonna do an ESOP one time, you know, like, this is gonna be your large exit.

Melissa (34:52):

It's gonna be like if you went to market and sold out, like you really want it to be the a, a very efficient, well done process. So reaching out to somebody who is one of the best in the field, it makes sense in this, you know, it doesn't mean that it, it's gonna cost money to do this in any capacity. Right. So, and, and that is usually absorbed in, you know, in the process, but you really want it to be done correctly because those little mishaps can, can, you know, kind of have an issue. But in your experience, what are some of the factors, you know, even if they understand some of these things, what are some of the factors that would lead them to start considering this transition to an ESOP for their employees? If, if everybody's in their ear saying, no, no, no, sell to the highest bidder, sell to the highest bidder. You know, you, you need an auction style process and some strategic person will come in and, and scoop you up, which I do tell people that they could lie to you and tell you they're gonna do anything, but they, they could do whatever they want after they own the company. What get, what do you think typically, is it just the people or is it even bigger? Is it a legacy kind of thing that they're looking for?

Kelly (36:18):

Yeah, I would say that the, the top things are wanting to protect their employees, maintain company culture maintain the legacy that the company represents for them and their family. I had a business owner tell me one time that there's been a company in this city with their family's name on it for a hundred years, and he wanted to make sure that that was going to continue. So that's the legacy component. Obviously a business owner who's looking to cash in on their life's work. Business owners who care about their employees and who want to get the i r s out of their lives sell tax free, and then operate the company tax free.

Melissa (37:06):

Do you ever see very large family held companies that maybe don't have a great management team in the family? Also do ESOPs because I mean, I I think that this would also protect the fam, you know, like if you had five or 10 cousins, brothers, sisters in the company with those 600 employees. Right. I think that this is still could be a very good option even for a, a, a tight family held company that may not see the next generations have the management skills. Right. Yeah.

Kelly (37:44):

There are a lot of family owned businesses that do ESOPs. And you're exactly right, especially in third generation and beyond families, we see the situation where you might have 10%, 20% of the family members who are involved in active in the company, and then 80% who aren't active in the company, and their interest is contrary to the interest of those that are involved. The people that aren't involved, their interest is to take distributions out of the business. The people that are involved, their interest is not to pay distributions because they wanna reinvest and grow the company. And so an ESOP can be a great solution in that situation to get out those inactive people and sometimes even to provide an opportunity for the active folks to sell mm-hmm. <Affirmative>. So business owners, families generally want everybody to be treated the same, but that can be somewhere between difficult and impossible when you have active and inactive cash is often the solution to that. And an ESOP can give the family cash while ensuring that those active people get to stay involved. Right. And continue to run the business. So you're exactly right.

Melissa (39:12):

Yeah. No, I think, I think this has been a very good discussion for any business owner. Again, you know, like I have probably eight more questions, but I think that this is, this is enough for somebody to say, you know what, I should consider this. And if they think they, they should consider it and they reach out to you. Is this something that you have an initial call and you kind of first fill out the situation? Or is this a process where they fill out something, you know, what is the process to work with you if they decide to reach out to you? Either email you, you know, tell us a little bit about your firm and, and what somebody would, could call you for.

Kelly (39:58):

Yeah, we usually start with a video conference where we discuss what an ESOP is, how it works, where we find out about the company, the owner's goals, and the company's financial position. Those are really the two key things that help the business owner determine, right, what the right strategy is, what are their goals, and what does the company's financial position look like? So yes, we have one or two calls on the front end without any fee to help them explore what an ESOP is, how it works, and give us the opportunity to answer their questions. Mm-Hmm.

Melissa (40:36):

<Affirmative>, because it is, I mean, it is still selling your company, it is still you know, a liquidation event and it's a highly personal kind of situation. Yeah. So, you know, you reach out, talk to, you get some idea of whether it's the right next steps, there are costs involved, obviously and some somewhat significant in all to get all the plans in place, not necessarily the process, but just to convert. Now any other things that you would suggest to anybody if they were considering ESOP or things, you know that are concerning? You know,

Kelly (41:21):

Well, one thing that a lot of our clients do is before we, we talk, or before they move too far along in the strategy, they read my book, which is available on Amazon, called the ESOP Coach. It's the only book on ESOPs that was written in business owner language. All the other ESOP books are written for lawyers and CPAs and valuation advisors and exit planners and commercial and investment bankers. This book is written in plain English. There are lots of charts and diagrams. I think there are seven case studies because I found that business owners relate best to stories. Yeah. And that's what the case studies are. They're all real situations where the client's names have been changed. In any ESOP book, you have to have all the technical material. So that's the second half of the book. And to try to make that as accessible as possible, I did it in a q and a format. And so instead of being a legal treatise, if a business owner has a question about, for example, how does vesting work in a esop, they can go to that question, get the answer, and not have to get bogged down and all the other technicalities that they're probably not interested in. Yeah. So that's always a good first step.

Melissa (42:45):

And it's not a, a, you know, all or nothing, you, the feasibility study is still kind of the first analysis to then you decide after that, do you wanna go forward with the esop? So there, there's some stages in the process and there's some analysis that you provide that I think is probably very significant and helpful for deciding how they're gonna plan their future. And we've given information of how they can reach out to you. Kelly, this has been really helpful. I've, I've done other podcasts on ESOPs and I think I learn something new every time. So I appreciate it. And if people have questions, they can reach out to you directly and discuss some of those things or reach out to your website. Well, I appreciate it. Thanks so much. Thank

Kelly (43:38):

You very much, Melissa.

Melissa (43:40):

All right. Hopefully we'll see you soon, right? Yeah,

Kelly (43:44):

Right.