Generally, the idea of selling is not a priority for the senior management team or board of directors ("board") at a successful ESOP-owned company. Indeed, when an ESOP is created, the typical expectation is that the ESOP will remain in place indefinitely and the employee-owners will continue to benefit over time as their ESOP accounts accumulate company shares.
Still, there are cases when ESOP-owned companies are sold. Typically, if an ESOP-owned company is contemplating a sale of the business, it is not usually because the company is proactively seeking a buyer. Rather, most successful ESOP companies that are considering a sale have received an unsolicited purchase offer from a private equity firm or a competitor in the same or a similar industry.
That said, there may be circumstances that result in an ESOP-owned company affirmatively seeking out a potential buyer. In those cases where the company wishes to be sold, the board typically hires an investment banking firm to actively solicit bids and to assist with negotiations with interested buyers.
In any event, whether dealing with a solicited or unsolicited offer, the company’s board should be prepared to review and respond to the offer. This is true since the board not only has a responsibility to protect the assets of the company but also should ensure that the shareholders receive the highest return on their investment. As a result, some boards choose to establish a committee to review purchase offers. If no such committee is formed, the full board will need to formulate a plan to respond.
More often than not, if the management team and/or the board have a negative reaction after considering a bona fide offer, the possibility of a sale will likely end at that point. On the other hand, if they are interested in exploring the possibility of a sale further, the company and the potential buyer usually exchange confidentiality agreements - also known as non-disclosure agreements - and will then customarily share cursory information about their businesses in order to gain a better understanding of each other. This could include, for example, summary operational and financial information. Under no circumstances should the company provide a potential buyer a copy of the annual ESOP valuation.
At that point, if the board and senior management remain interested in moving forward with a possible sale, they should involve the ESOP trustee in the sale discussions and negotiations. The board and the trustee also need to determine if, in order to satisfy their fiduciary responsibilities, a broader sales and marketing process would be advisable and whether it is feasible that a higher sales price may be achieved.
Regardless, in most cases, should the board determine that it wishes to pursue a bona fide purchase offer, the board is tasked with negotiating the terms of the offer. However, the board and the ESOP trustee (and its advisors) should communicate early and often in the negotiation process. This is because, even though the board may take the lead in the negotiations, the ESOP trustee has the final say in approving the deal on behalf of the ESOP.
Ultimately, there may be a number of possible reasons an ESOP company decides to sell - including circumstances that are unique to the company. However, we have found that some of the more common reasons an ESOP-owned company’s board elects to sell include the following:
At the same time, there are a number of reasons that an ESOP-owned company’s board may decide against selling, including the following:
Notably, after considering the pros and cons related to a sale, the board may decide to accept a purchase offer. However, before a sale can be finalized, the trustee has to vote the ESOP stock either in favor of or against the deal. In addition, depending on the type of sale, the vote may need to be passed through to the ESOP participants.
There are two basic types of sales: a purchase of assets and a purchase of stock. With a purchase of assets, the buyer receives the company’s assets and may or may not take on the company’s liabilities. In comparison, if the buyer purchases the company’s stock, they take on the liabilities as well as the assets.
Although the plan document will have more specific directions, in general, if the buyer proposes a purchase of stock, the trustee can decide whether or not to move forward without input from the participants. However, if the buyer wishes to purchase the company’s assets, the vote is typically required to be passed through to the plan participants who will need to cast a ballot in favor of or against a sale of the company’s assets.
In that case, the company will need to provide participants with a descriptive memorandum outlining detailed financial information, what will happen if the sale takes place, when the sale will take place, and how much money participants are expected to receive as a result of the sale. Participants will be given a date by which their vote must be cast. The votes will then be tallied by the plan administrator or a law firm, and the results will be provided to the trustee. The possibility of a participant vote should be raised early in the process because it adds time to the closing schedule that non-ESOP investment bankers and acquirers may not anticipate.
Notably, since the trustee’s ultimate responsibility is to act in the best interest of the ESOP, if the trustee determines that the outcome of the participants’ vote is not actually in the ESOP’s best interest, the trustee can theoretically supersede the participant vote if the trustee believes it would be a breach of their fiduciary duty to follow the participants’ vote. However, this is extremely rare.
If a sale ultimately takes place, in most cases, the ESOP will be terminated. However, before the ESOP can be completely terminated, all participants - including those who are no longer employees of the company - will need to be paid. In our estimation, on average, it takes about two years to conclude the operations of an ESOP, and participants are often not paid in-full for a year or more after the sale transaction closes. As a result, the trustee will remain in place until all of the ESOP termination activities are complete.
During that time, the company will be involved in several activities, such as completing the necessary paperwork for the IRS; working with the plan administrator to allocate participant shares; and demonstrating that all participant distributions have been made. If there are participants that cannot be located, the company must also show that it made a good faith effort to find those people.
In the end, although there are several issues and special considerations in the sale of an ESOP-owned company that are not typically present in traditional M&A transactions, a company properly prepared for sale by an investment bank with ESOP expertise can move forward successfully and can benefit both the company and the ESOP participants.
Anthony Dolan is a Managing Director at Prairie Capital Advisors, Inc. He can be contacted at 630.413.5587 or by email: firstname.lastname@example.org.
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