Many second-stage ESOP transactions take the ESOP ownership from a minority ownership position to controlling or total ownership. The effect from this debt-related transaction is often a rapid decline in the stock price, which may reduce employee morale. A common way to address this is to provide floor price protection, which contractually prevents the account value of selected employees from declining as a result of a highly leveraged second-stage ESOP transaction. This issue brief, written by a team of expert ESOP practitioners, discusses price protection, its general effects, its impact on valuation, and fiduciary perspectives.
Table of Contents
An Introduction to Floor Price Protection
Robert E. Massengill
Some Effects of a Second-Stage Transaction
Floor Price Protection
Critical Independent Floor Price Protection Design Decisions
The Impact of Price Protection on Valuation
Aziz El-Tahch and Joe Demetrius
Basic Analytical Procedures
Base Scenario: Second-Stage ESOP Transaction, No Price Protection
Analysis with Variable Price Protection
Analysis with Fixed Floor Put
A Fiduciary Perspective on Price Protection
Tracy E. Woolsey
Determining Who Will Be Covered
Determining the Price Protection Stock Price
Determining the Length of Price Protection
From "An Introduction to Floor Price Protection"
In a variation on this theme, some advisors and plan administrators recommend that price protection be done via a two-check payment. The first check is paid by the trust to the participant at the appraised price in the normal distribution process. The second check is paid by the company for any difference between the appraised ESOP price and the protected price. Thus, in total, the participant's price per share is not adversely affected by the second-stage ESOP sale. It is important to note, however, that the second check paid by the company would not be eligible for a rollover. This may or may not be a consideration if the eligible participants are retirees and would not roll over the amounts in any event, which is often the case.
From "The Impact of Price Protection on Valuation"
The dilutive impact of price protection on the unprotected shares as of December 13, 2010, is lower under the fixed floor put plan ($3.171 million) than under the variable price protection plan ($5.114 million). This results from two factors. First, under the fixed floor put plan, the price-protected shares participate in the enterprise value appreciation of the company only to the extent that such appreciation results in an underlying equity value that exceeds $100.00 per share, whereas under the variable price protection plan, the protected shares receive the full benefit of enterprise value appreciation. Stated differently, the Transaction-related debt still has a limited impact on the company's share price under the fixed floor put plan but is completely disregarded under the variable price protection plan. Second, under the fixed floor put plan, the price protection remains in place only until the underlying per share value exceeds $100.00 per share or until the term of the price protection period has expired, whereas under the variable price protection plan, the price protection remains in place until the Transaction-related debt is repaid or the term of the price protection period has expired. In this example, assuming a 5% annual EBITDA growth rate, ABC Company reaches the $100.00 threshold sooner than the Transaction-related debt is repaid.
From "A Fiduciary Perspective on Price Protection"
As noted above, price protection is a very important point to be considered during a second-stage leveraged transaction, and it is also not a simple decision. From a fiduciary perspective, it is very important that a process is followed when determining how price protection will be established and showing that it was, if appropriate, a negotiated part of the transaction. Since price protection is an expense of the company and not the trust, it is important that the company and board sign off on price protection and that it is negotiated during the transaction.