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The ESOP Company Board Handbook
by Neil Brozen, Stephen P. Magowan, Loren Rodgers, Scott Rodrick, Corey Rosen, John D. Schlichte, James G. Steiker, Cecil Ursprung, Michael Wade, and Nancy Wiefek
This is provided as a PDF, with no shipping charges. It also is available in a print version (for which shipping charges apply).
$25.00 for NCEO members; $35.00 for nonmembers
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When the first edition was released in 2009, it was an instant bestseller. The second edition builds on the strengths of the first edition, adding three new chapters on the role of the board in selling an ESOP company, what boards should know about the Department of Labor and ESOPs, and the results of the NCEO's 2016 ESOP company corporate governance survey. The second edition also replaces the former chapter 2 (Reflections of ESOP Board Members) with a new, updated chapter on the same topic, and updates the chapter on D&O and fiduciary insurance as well as the chapter on ESOP basics. Also added in the second edition are three new appendices that provide a sample letter with a company acquisition policy, questions to ask potential acquirers, and a letter to a potential acquirer.
Format: PDF, 160 pages
Dimensions: 6 x 9 inches
Edition: 2nd (October 2016)
Status: Available for electronic delivery
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1. Governing the ESOP Company: Fiduciary Issues and Practical Solutions for Boards of Directors in ESOP Companies
2. Reflections of an ESOP Company Board Member
3. The Role of the Board in ESOP Companies
4. What Boards Should Know About the Department of Labor and ESOPs
5. The Role of the Board in Selling an ESOP Company
6. Directors, Officers, and Fiduciary Liability Insurance for ESOP Companies
7. The 2016 ESOP Corporate Governance Survey
8. ESOP Basics for Board Members
Appendix 1: Sample Company Acquisition Policy
Appendix 2: Sample Questions to Ask Potential Acquirers
Appendix 3: Key ESOP Issues: Informational Letter to a Potential Acquirer
About the Authors
About the NCEO
Customized ESOP Board Training
From Chapter 1, "Governing the ESOP Company: Fiduciary Issues and Practical Solutions for Boards of Directors in ESOP Companies"As noted above, the concept of the duty of care is not immutable; that is to say, it is not a principle that applies uniformly to all factual situations. Thus a board member of a bank has a different kind of duty of care than a board member of a firm that makes office furniture. A board member's duty of care is also different whenever there is an ESOP shareholder.
I come to this conclusion in several ways. First, general negligence theory is founded on the concept that if a fiduciary breaches a duty to a person to whom the fiduciary owed a duty (let's say a duty of care), then the fiduciary is liable for the harm caused by his or her breach. Also, under general negligence rules, if a fiduciary knows that this person has a particular trait that makes it possible that he or she can be harmed more easily or in a different way, then the fiduciary's duty is enhanced to take into account the special trait.
Second, in any corporation, common sense tells us that the board of directors must be responsive to the needs of significant shareholders. If an ESOP owns, say, a 25% or larger equity stake and has provided the method through which the corporation's founder has had a liquidity event, then it seems logical that the board should be paying special attention to that ESOP's needs.
There are two useful corollaries that come to mind here. First, when a private equity firm provides a liquidity event for an owner, the private equity firm frequently obtains significant if not majority control over the board, and the business is largely run to meet the investment return expectations of the private equity investor, e.g., the need for a second liquidity event in X years.
The second corollary relates to the doctrine of "reasonable expectations." Under this doctrine, a minority shareholder's reasonable expectations that formed when it invested in the corporation are to be protected from improper or abusive exercises of majority control. Thus, although a majority shareholder may by virtue of his or her majority position have the power to do what he or she wants with the corporation, his or her actions are limited by a fiduciary relationship to the minority shareholder, and the scope of that relationship is measured by the reasonable expectations of the minority shareholder. Thus, the director's (and majority shareholders') duty to the ESOP would specifically relate to the ESOP's expectation when it invested in the company, for example, in connection with a leveraged ESOP transaction.
Here is where things get interesting. In the many cases where individual plaintiffs have alleged frustration of reasonable expectations, it is virtually impossible to have any true objective basis for determining these expectations. This is not true in the ESOP setting because in the ESOP setting we have the valuation report prepared for the ESOP trustee, which is nearly always based in significant part on the projections of future financial growth of the business. So, if the ESOP trustee is basing its purchase on those forecasted financials, it is reasonable to say that the ESOP—as a shareholder—at least has a reasonable expectation that the company will take steps to meet those forecasts. So, if the board takes actions that lower the projected earnings, for example by making bonuses to executives, the board will be violating a duty of care owed to the ESOP shareholder.
Here, however, we run into a problem arising from the received wisdom of how ESOP purchase transactions are conducted.
As a general rule, a professional (i.e., bank) trustee does not share any analyses performed for it by its appraiser in the ESOP purchase transaction. Realizing this is not without controversy, is it completely against the interests of the ESOP participants for the directors to understand how the ESOP trustee arrived at a "yes" answer to the transaction after the fact within the context of making certain the directors and the ESOP are on the same page concerning the ESOP's expectations? If a person is a director of a corporation that has an ESOP as a shareholder, I think it is necessarily obvious that the director needs to understand how that shareholder is different and needs to understand what that shareholder's expectations were when it became a shareholder.
From Chapter 5, "The Role of the Board in Selling an ESOP Company"I strongly encourage ESOP company boards to adopt a written policy for responding to unsolicited offers, including a description of the process of what should happen if an unsolicited offer is received. This policy should include a statement that a "sale of the company is not deemed to be in the best interests of the shareholders at this time," if in fact this is true. However, this policy sets forth a strategy for a response if the offer is deemed to be serious. In certain states, the policy may also discuss concerns about community, employment, or other value-based issues. This strategy includes identifying the prospective acquirer, initial price, terms, financial capacity to complete the transaction, and other relevant items. A serious acquirer should be willing to provide most of the information requested.
There are circumstances in which an offer that is less than the most recent appraised value should be considered. This situation may exist when the long-term prospects of a company change after the appraisal is completed. The company may be in jeopardy because of technology changes in the industry it serves, lack of access to capital, inability to secure successor management, etc. For instance, the board should consider a sale at a lower price than the most recently established fair market value if the primary product of the company becomes obsolete when a competitor introduces a better product at a lower price. An acquiring company might value the assets of the ESOP company more highly if it can repurpose them within its own product and marketing capacity.
A potential acquirer is unlikely to provide its price until it has sufficient data to determine the price. Therefore, it will request financial information to allow it to provide a preliminary price. I recommend providing very limited high-level data until you are satisfied that their other responses indicate that the potential acquirer is seriously interested and has the financial capability to complete the transaction. The limited financial data would include revenue, gross profit, and "adjusted or normalized" EBITDA for the current and prior several years. No information should be provided until the potential acquirer signs a confidentiality and nondisclosure agreement. It is never appropriate to provide the potential acquirer with any valuation reports.