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Dealing with the Downturn: Issues and Strategies for ESOP Companies

An NCEO Issue Brief

(Digital Version)

by Corey Rosen, John Miscione, Bill Vogelgesang, Elisabeth Schutz, Bob Gross, and Loren Rodgers

This is one of our archived publications; specialized publications that have been removed from our main publication list and are not being updated, but are are still available for purchase, although sometimes only in digital form.

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This issue brief contains survey results on the impact of the credit crunch on ESOP companies, as well as articles by experts on the state of ESOP financing, how to deal with more difficult credit markets, valuation concerns, and ideas for communication with employees. John Miscione of Duff & Phelps, an investment banking firm, describes what the impact of the credit crisis will be on lending practices in general and for ESOPs in particular. William Vogelgesang of South Franklin Street Partners, a mezzanine loan investment firm with a special interest in ESOPs, and Elisabeth Schutz of Union Bank, a major ESOP lender, provide tips on obtaining credit. Loren Rodgers of the NCEO reports on an October 2008 NCEO survey on the financial impact of the credit crunch on ESOP companies. Bob Gross of Prairie Capital Advisors, an ESOP valuation and financial advisory firm, discusses how the credit crunch and downturn will affect ESOP valuations. Corey Rosen of the NCEO discusses strategies for communicating with employees about down times and, in another section, provides questions and answers about how plans can be changed to deal with down times.

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Publication Details

Format: PDF, 46 pages
Publication date: October 2008
Status: Available for electronic delivery

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Contents

Introduction
The Current Credit Crisis and Its Implications for ESOP Companies
Three Rules of Business Finance
The Economy, The Credit Crunch, and ESOPs
ESOP Valuations and the Effect of the Credit Crisis
Floating Rate Notes: Still a Good Investment?
Communicating with Employee Owners in Tough Times
The Impact of the Credit Crisis on ESOP Companies

Excerpts

From "The Current Credit Crisis and Its Implications for ESOP Companies"

Recently created minority ESOP companies and particularly new 100% ESOP-owned S corporations need to be very cautious in this environment because they are most likely to be the most leveraged and may have the least financial flexibility. Such companies should assess their near-term cash flows and fixed obligations, taking into consideration the impact of the possible worsening of economic conditions. Such companies should make sure they have sufficient cash to meet their obligations and comply with their financial covenants. Management teams should reexamine all types of discretionary spending. In addition, management teams should be in touch with their current bank or bank group. Companies should make sure that their current group of institutions can support them, and companies should inquire how such institutions are managing during the current credit crisis. Companies should be proactive in examining their options. Time is not a friend, given the credit market upheaval and economic uncertainty.

While new ESOPs may face difficulty, this market will provide many options to mature 100% ESOP-owned S corporations that have paid down debt and built up cash reserves. After management teams have assured themselves that they have the liquidity to meet their obligations, they, much like Warren Buffet, will have the opportunity to consider acquisitions and investments on favorable terms. These companies may also be able to provide financial assistance to ESOP companies facing financial challenges. Ultimately, prudent acquisitions at favorable prices can result in substantial value creation for these mature ESOP companies and their shareholders.

From "The Impact of the Credit Crisis on ESOP Companies"

Companies in retail and insurance were more likely to report restrictions on their current access to credit and companies in engineering/architecture/related fields reported the least restrictions. Smaller companies were more likely to report no loss in access to credit. We found no significant differences between S corporations and C corporations, between 100% ESOPs and non-100% ESOPs, or between newer ESOPs and older ESOPs. Companies that are more leveraged are slightly more likely to report restrictions on their access to capital. While 76% of the companies overall report no change in access to long-term credit, that percentage falls somewhat to 66% of companies with currently leveraged ESOPs and 62% of companies with debt:EBITDA ratios greater than 3:1. Results for access to short-term credit are similar.