With over 120 panels at each NCEO annual conference, there are lots of great insights about employee ownership. This issue brief compiles a selection of great ideas from a wide variety of panels on governance, finance, trustee issues, plan operations, acquisitions, plan design, communications, and culture at the NCEO's 2015 annual conference in Denver, CO. The materials are drawn directly from the presentations, other than minor editorial changes to provide context or ensure flow. The goal here is not to present a summary of basic ESOP issues, but rather to look at best practices in dealing with often challenging matters. For instance, two presentations look at financing covenants, one focused on sellers and one on banks.
Table of Contents
Selecting and Training Board Members
Counting Employee Votes Properly in Pass-Through Situations
Pros and Cons of ESOP Financing Alternatives
Using an LLC Drop-Down Entity to Facilitate Equity Investment in a 100% ESOP
Covenants in Seller-Financed Transactions
Working with Banks After the Closing in ESOP Transactions
Trustee and Fiduciary Issues
Reviewing the Appraisal Report
ESOP Administrative Committees: Are We Responsible for That?
Open-Book Management Tips: Using Employee Huddles
Individual Development Plans at Web Industries
ESOP Communications at RealityWorks
Should You Have an Investment Policy for Non-ESOP Assets?
DOL and IRS Plan Audits
Don't Do That: Key Problems to Avoid in ESOPs
Employee Ownership in Multinational Companies
Releveraging Your ESOP
Terminating or Freezing Your ESOP
Valuation Support Checklist
Qualifying as a Certified Business Enterprise
About the Editor
About the NCEO
From "Working with Banks After the Closing in ESOP Transactions"
Banks often impose financial covenants when they make loans to ESOPs or to ESOP companies for other purposes. These can include requirements for fixed charge coverage, debt service coverage, senior leverage, and total leverage. If the covenants are beached, companies need to work with banks to avoid the loans being called.
To maintain a good relationship with the bank, set the original covenant levels and definitions carefully, so they are realistic. Test, test and retest the ratios before you sign. Make sure the covenant compliance certificate is clear and accurately reflects the formulas. After the closing, run projections of covenant compliance on a regular basis. If a breach is projected, discuss this with the bank in advance so that a waiver or amendment can be negotiated.
From "Don't Do That: Key Problems to Avoid in ESOPs"
Fiduciaries can rely on expert advice only if the experts are really experts. For instance, has your appraiser done ESOP valuations before? Have the appraiser's valuations been challenged and, if so, what was the resolution? Has your attorney worked in this field? Has the attorney ever been involved in litigation or unfavorable audits and, if so, what was the resolution?
Investigations can include a number of steps. First, make sure the professionals do not have criminal backgrounds or name changes. Companies that have used these professionals can be contacted. Membership in ESOP professional organizations at least indicates an interest in keeping up to date.
On an ongoing basis, if the work seems poorly developed (such as material errors in an appraisal), a review of the advisors is called for, and possibly a change.
From "Releveraging Your ESOP"
In recent years, many mature ESOPs have considered releveraging their plan, either to help manage their repurchase obligation by buying shares at a time when borrowing costs are very low and stock prices are strong, to acquire shares to new employees, or both. There are a variety of issues in structuring a plan.
Traditional repurchase approaches can create problems in mature ESOPs. The lack of new shares being bought by the plan can create a have and have-not problem. Repurchase obligations increase steadily over time, especially if the company's stock price is growing quickly. Companies that rely on making tax-deductible cash contributions to the plan to fund repurchase (this would not apply to 100% ESOP-owned S corporations) exceed deduction limits. The employee benefit now becomes based on what is needed to buy back shares, not company performance.
From "Valuation Support Checklist"
If it is determined that any of the metrics listed on the prior page should be disregarded in assessing the reasonableness of the projections, document in writing both the calculations of the metric (unless calculation is impossible) and the basis for the conclusion that the metric should be disregarded. Explain in writing the bases for concluding that the comparable companies are actually comparable to the company being valued, including on the basis of size, customer concentration (if such information is publicly available), and volatility of earnings. If a guideline public company analysis is performed, explain in writing any discounts applied to the multiples selected, and if no discount this applied to any given multiple, explain in significant detail the reasons.