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How to Choose Employee Ownership Consultants

Shakespeare may have promised that "the first thing we do, let's kill all the lawyers" (King Henry VI, Part 2), but in setting up an ESOP, equity compensation plan, or other employee ownership plan, first you will hire them. And, depending on the type of plan, you will hire valuation consultants (appraisers), plan administrators, and possibly others as well. This assemblage of expertise will not come cheap, but these experts will save you the hassle, time, and unwarranted risk of trying to figure this out yourself.

Contents
  1. Overview
  2. Gauging Someone's Qualifications
  3. Choosing a Lawyer or Plan Design Expert
  4. Choosing an Appraiser
  5. Choosing an Administrator
  6. Other Parties

1. Overview

Where to Find Experts

Our Service Provider Directory lists hundreds of NCEO members who provider services in this field. (NCEO members also have access to our ESOP Lender Directory in the members-only area of our site.) Although these are all NCEO members, we do not vouch for their qualifications or approaches. For that you need to probe further, as described below.

Who You Need for ESOPs

When setting up an employee stock ownership plan (ESOP), you need at a minimum:

Other parties are frequently hired as well:

This may seem like a lot. However, if you are using an ESOP to buy out an owner, many of these same people would be needed if you chose some route other than an ESOP, plus you might need a business broker, who would charge a percentage of the transaction.

Be sure to read our article on Red Flags in ESOP Transactions, which provides a list of key issues to watch out for and ways to avoid them.

Who You Need for Equity Compensation Plans

The guidelines for stock option plans, stock purchase plans, and the like are not as strict as for ESOPs, but you will still need qualified people:

With a broad-based equity plan, some companies understand the technical issues sufficiently enough to effectively design, implement, and administer their stock option plan mostly in-house. In fact, many companies have had equity plans for executives in place for a long time and are, therefore, familiar with the operation of the plan. Although setting up and maintaining a plan does not necessarily require the same degree of technical assistance as an ESOP, the advice of experienced, knowledgeable professionals is often necessary and desirable to design a plan that maximizes benefits and best meets corporate objectives. Most commonly, assistance is needed in designing, administering, and communicating a stock option plan.

Outside the U.S.

The above comments apply to U.S. plans. If you are setting up a plan outside the U.S., then the very type of plan you have will depend on what is possible in that country; for example, the U.S. ESOP is largely unique to the U.S. However, stock options, for example, are more alike from country to country.

A multinational corporation wishing to set up a stock plan or plans covering employees in multiple countries must be careful to comply with the host of tax and regulatory issues that will arise; working with experienced legal counsel is crucial here.

Interview Several Firms and Check References

In picking a professional advisor, we recommend that you interview several different firms, checking references for each, before hiring one.

Don't Limit Yourself to Local Firms

Remember that you need not hire someone in your state, let alone your city. This is a specialized field, and it is common to hire firms located hundreds of miles away, especially if you are not in a major metropolitan area (New York, Chicago, Dallas, Los Angeles, San Francisco, etc.). What matters is hiring an expert. It is not at all like hiring a local personal injury attorney after you get in a car accident, or hiring a local CPA to keep your books in order.

2. Gauging Someone's Qualifications

Once you have gotten over the natural instinct to find a way to do it for less money and with less complexity, it is time to get down to the serious business of finding the right team to set up your plan. There are some general considerations to keep in mind for everyone:

Some Key Indicators to Look For

Insist on demonstrated experience and expertise. First, it will save you money down the road. It makes no sense to hire inexperienced people and pay them to learn how to set up an employee ownership plan. Second, you will be much more likely to avoid the much larger cost of a bungled plan. Your experts should be members of one or more of the relevant professional organizations, such as ours (the National Center for Employee Ownership), the ESOP Association, and the National Association of Stock Plan Professionals. They should be willing to give you lists of clients (many more people claim experience than have it). It is a plus if they have written or spoken on the subject in various professional forums; that likely means an outside source has reviewed their qualifications and their professional reputation.

Interview more than one person for each area of needed expertise and find people who are not just qualified but whose philosophy toward the employee ownership plan matches yours. You don't need to argue with a lawyer about why you want, or don't want, employees to have full pass-through voting, for instance, or with your options plan design expert over whether you should give options to part-timers, or with your valuation consultant about why you want to be cautious about giving the ESOP too much credit (or not enough) for the impact of the put option on value, or your options consultant about whether the options value formula should be on the conservative side, or with your administrator about why you want reports sent in a computer-readable format or just on paper.

In the case of an ESOP, ask for recommendations from ESOP trustees: Ask ESOP providers to provide recommendations from institutional trustees (unless, of course, you are interviewing trustees; in that case, ask for recommendations from other service providers they work with). At least two references should be provided. These trustees work closely with ESOP experts and may be able to provide useful feedback.

Question pricing structures that are unusually low or high. Some consultants will give low initial estimates to get the contract, but costs escalate later on. Check with references to see how much prior clients actually paid rather than relying solely on the estimates of the providers. If proposed transaction fees are unusually high, get a detailed explanation of why the fees are so much higher than those for other reputable providers.

Look for Red Flags

If in Doubt, Call Us at the NCEO If You Are a Member

We cannot make specific endorsements, but if you are an NCEO member (if not, you can join here) we can tell you whether someone is a member and for how long, and, if we know it, any specifics about areas of specialization. Our main phone number is 510-208-1300.

3. Choosing a Lawyer or Plan Design Expert

In most cases, the attorney will draft your plan documents, keep you apprised of changes in the law that require plan amendments, provide legal advice about plan design and operation, and coordinate the transaction (you can, however, also choose a financial advisor to coordinate matters). A company creating an ESOP should always use a law firm for plan drafting, etc.; a company creating a broad-based equity option plan might use a specialist in designing these plans who is not an attorney, but have an attorney review the plan. (For simplicity, we will assume here you are using a law firm, but if not, you can make a mental substitution for "plan design expert.")

The most important initial task of the law firm will be to draft plan documents. This should be a participative process. Most attorneys will have a standard plan they will apply to your situation, so writing the document is itself not time-consuming. Instead, time will be spent working with you to establish the attributes of the plan, such as allocation, vesting, voting, distribution, equity award exercise, and governance rules. The more you know in advance about these issues, the more the plan will conform to what you really want and the less expensive the attorney's fee will be.

ESOP Issues

Equity Compensation Issues

4. Choosing an Appraiser

If your company is closely held, and for some purposes even if it is public, you should have an appraisal to determine the share value. Outside appraisals are required for ESOPs and sensible for equity compensation plans. This may be the most complex and important part of your task in putting a team together.

Note that in the ESOP context, the appraiser is hired by and reports to the trustee of the plan, not the seller or the board, although the seller or company may hire an appraiser for a preliminary valuation when evaluating the feasibility of an ESOP. Thus, if an ESOP transaction is in question, the recommendations directed to "you" below about hiring an appraiser are addressed to the ESOP trustee, and in particular an internal trustee (i.e., a company employee or committee) as opposed to an external trustee whose business it is to know these matters.

First, you want to make sure the appraiser is independent, a requirement of the law for ESOPs and desirable for broad stock option plans. There is no "bright line" definition of this term. At a minimum, the appraiser should have no other business relationship with your company. Clearly, your company's CPA is not independent, nor is your CFO. But what if your CPA is a member of a major accounting firm that has a separate appraisal division? Or your appraiser is a member of a brokerage firm that also has a lending division making you an ESOP loan or is handling the sale of exercised stock options in a broad stock option plan? Most people think that large firms like these can create sufficient separation between the units to provide independence, but you should have a compelling reason for taking this approach when there are lots of truly independent appraisers available. Some legal consultants also have affiliated appraisers who are technically not part of their firm but who get referrals from them. This is not clearly improper, but our advice at the NCEO is that it is a risk that is not worth taking and that it creates a clear conflict of interest. The point of having an independent appraisal is to avoid putting the appraiser in a situation where he or she knows that coming up with an acceptable price will win business for a related firm.

Second, you want to check qualifications, as outlined above. Appraisers have particular professional designations granted by either the American Society of Appraisers or Institute of Business Appraisers. Various designations offered by these groups indicate professionals have reviewed materials and taken tests to demonstrate their competence. You should ask if an appraiser has any such designations and what they entail. Industry-specific expertise is generally not an issue. Appraisers all have access to various databases indicating the relevant ratios and other information that are used to make appraisals for particular business areas. ESOP-specific or options-specific expertise is another matter, since both plans raise special valuation issues. In order to become familiar with these issues, appraisers should have participated extensively in professional organizations.

Third, you want to evaluate the cost of an appraisal. Fees will vary widely. In part, the variation is a function of the size and reputation of the firm. In a larger firm, your appraisal will be reviewed by one or more other people. Some firms also have proprietary databases tracking such things as how much closely held business have sold for in various industries. Naturally, you will pay more for this additional infrastructure and time. Will this result in a better or different number than using a smaller firm? There are costs and benefits either way.

Finally, you should find an appraiser whose approach is one that fits your definition of what is in the best interests of the plan. This is a complex issue. The general methods used to assess the value of a company overall do not vary dramatically from one qualified appraiser to another, but some appraisers are more aggressive in their assumptions than others. More important, the philosophy about ESOP-specific or options-specific issues varies widely.

ESOP Issues

Equity Compensation Issues

5. Choosing an Administrator

ESOP Issues

Here the task in selecting a service provider is relatively simple. Find an administrator with a good reputation, demonstrated expertise, and acceptable fees. The administrator will keep all the records, make sure forms are filed with the government, work with you to make sure participants get the information and distributions they need, and help integrate your plan into other plans you may have. The administrator should also be capable of helping you assess your repurchase obligation and plot strategies to deal with it. An accomplished administrator should also be a participant in the plan design phase, helping you to structure the plan so that you can actually live with it. It is advisable that your administrator be able to administer all your retirement plans. ESOP plan administration firms can do this, but many firms that focus on 401(k) or other plans may not have the right skills and systems for ESOPs.

Equity Compensation Issues

6. Other Parties

Aside from the necessary parties such as attorneys, there are other experts you may need or want, such as feasibility study experts, investment bankers, and organizational development experts.

Ownership Culture Consultants

To help create an ownership culture, you may want to hire people to help you with plan communications and employee participation structures. There is a growing number of people with specific organizational development experience in employee ownership companies, although people from conventional management consulting organizations may be able to provide useful advice as well. The key to hiring these people is to avoid those with a prepackaged program or those who will come in and impose programs from above. The best ownership culture consultants work with you and an employee team to help the company's employee owners develop and implement their own programs. The consultants serve as coaches and advisors. There is something very unsettling to employees to be told their company will now become more participative by having a participation structure imposed on them by an outsider.

Financial Advisors and Trustees for ESOPs

Equity Compensation Issues

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