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Innovative ESOP Transaction Structures

An NCEO Issue Brief

by Peter Abrahamson, Gregory K. Brown, Neal Hawkins, Matthew J. Hricko, Patrick Kane, Robert Ruszkowski, Stan Slabas, and Domingo P. Such III

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The employee stock ownership plan (ESOP) is a very flexible financial and employee benefit vehicle. Almost all discussion of ESOPs, however, focuses on a small number of typical transaction structures, such as using a leveraged ESOP financed by a bank or seller note to buy the owner's shares or using the ESOP as an employee benefit plan funded by company contributions of shares. While these structures account for over 90% of all ESOP transactions, there are many innovative ideas for how to use these plans. This issue brief describes a variety of innovative transaction structures for ESOPs, ranging from using profit sharing funds to having the ESOP co-invest with private equity.

Publication Details

Format: Perfect-bound book, 28 pages
Dimensions: 8.5 x 11 inches
Edition: 1st (February 2014)
Status: Available for electronic delivery



Two Innovative Transaction Structures for ESOP Companies
Structure A: Use of Profit Sharing or 401(k) Funds
Structure B: Use of the ESOP for an Acquisition

Alternative Forms of Capital
Types of Alternative Capital
Providers of Capital
The Use of Alternative Forms of Capital in ESOP Transactions
Case Study: ABC Manufacturing Company

ESOP Internal Loan Stretch-Out Transactions
Stretch-Out Rationale
Department of Labor Stretch-Out Guidelines
Event Protection
Dividend Make-Whole Protection
Other Typical Stretch-Out Inducements
Valuation Impact of a Stretch-Out Transaction
Stretch-Out Transactions as Part of Corporate Transactions

The Tender Offer Process
Overview of Tender Offers
Tender Offer Preparation and Execution
Required Disclosures in Tender Offers

Private Equity and ESOPs: A Creative Combination
Co-Investment Scenario
Exit Scenario

About the Authors


From "ESOP Internal Loan Stretch-Out Transactions"

Event protection is a common design element in stretch-out transactions and is generally always incorporated into a stretch-out agreement. Event protection provides that in the event of a major corporate transaction or event, such as a sale, merger, recapitalization, or termination of the ESOP plan, the original terms of the internal loan are to dictate the use of suspense shares to repay the internal loan. The purpose of event protection is to provide that the ESOP trust and the plan participants will not be harmed or worse off should a major event occur after the internal loan is refinanced and before the final maturity of the new internal loan.

For example, the ABC ESOP has 1,200,000 shares, 800,000 of which are allocated and 400,000 of which are unallocated. The outstanding balance of the existing internal loan is approximately $5 million. The terms of the internal loan dictate that ABC will release 80,000 shares per year and that over the next five years all of the unallocated shares will be allocated according to the terms of the existing internal loan. Event protection would dictate that this original release schedule would be in effect for purposes of calculating the suspense shares that could be used to repay the outstanding balance of the new internal loan in place after a stretch-out transaction. After five years, none of the shares in the suspense account for the ABC ESOP could be used to repay the new internal loan because the original loan would have fully released the shares. Rather, all suspense shares would be allocated to participant accounts with the internal loan forgiven by the company and/or satisfied by additional contributions or dividends.

From "Private Equity and ESOPs: A Creative Combination"

Using an ESOP structure as an investment vehicle is not the only way PE financial sponsors can use ESOPs. Another alternative is for a PE firm to exit an existing portfolio company investment by selling the company to an ESOP in a leveraged transaction. In situations where a portfolio company may not have the necessary attributes to go public or be sold to a strategic buyer, the ESOP exit strategy may be the best alternative. In addition, an ESOP exit strategy is available if the PE financial sponsor is only seeking partial liquidity, since ESOPs can be structured to purchase a minority block of shares. As a buyer of company stock, an ESOP is permitted to pay up to full fair market value, which is generally interpreted to be what a financial buyer would pay for the stock in a hypothetical, arm's-length transaction between a willing buyer and a willing seller. Therefore, the total consideration paid by an ESOP can typically be as competitive as that offered by other financial buyers. Furthermore, if the investors in the PE group are individuals, partnerships, or certain kinds of trusts, the total consideration can be more competitive on an after-tax basis if the sellers elect the Section 1042 tax deferral.