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Leading an ESOP-owned company is similar but different to leading a privately held company. Some of the largest differences are in governance, cash planning, finance, and culture. Here’s my thoughts on each and why any of this matters to leaders of non-ESOPs. /1
Assuming a majority ESOP-owned company, governance is more similar to a publicly traded company. Best practice is a board of directors with qualified outsiders comprising the majority. The CEO is commonly the only internal board member. /2
Board members are fiduciaries, not just advisors. The CEO is appointed by and accountable to the board. Long term strategy, succession planning, and organizational performance are areas on which the board usually focuses. But the board expects the CEO to run the company. /3
Also governance related, ESOPs appoint a trustee to oversee the ESOP Trust, the separate legal entity that owns the shares. The trustee votes the shares on behalf of employees and determines the ESOP share price each year. /4
Cash planning in an ESOP can be extremely different especially when an ESOP owns 100% of an S Corp, which is common. In that case the company has NO federal tax obligation. (You read that correctly!) Tax distributions aren’t necessary, a massive cash flow advantage. /5
However, ESOPs have future cash outlays called Repurchase Obligation (RPO). This is the cash needed in the future to buy back shares as employees leave/retire. A successful ESOP has a big RPO and every few years completes an analysis to estimate future annual cash outlays. /6
Regarding finance, ESOPs need to work with banks that fully understand and appreciate ESOPs. Certain banks view ESOPs very favorably because of the S Corp tax advantage mentioned above and low default rates. Strong ESOPs can borrow at rock bottom rates with the right banks. /7
A bank that understands ESOPs will also make adjustments to covenant calculations. EBITDAE includes an add back of the ESOP benefit contribution expense, since a successful ESOP will have an outsized non-cash retirement contribution expense. /8
Finally, ESOP companies that are run well tend to have strong engagement and ownership cultures. This is awesome but of course many non-ESOP companies achieve this as well, so it isn’t necessarily a differentiator. /9
On the flip side, companies that use the ESOP solely as an owner exit tool and don’t embrace employee ownership risk fostering resentment. If company performance falters as well, a downward spiral can occur, culturally. /10
Takeaways for non-ESOP company leaders? Companies are complex organisms. Fully understanding all your stakeholders and their values, needs, expectations, etc, is critical. Banks aren’t just money. As @BrentBeshore says, money comes with people attached, and people are messy. /11
Leaders need to deeply understand their company’s cash flow drivers, commitments, and projections. Every company has unique cash flow characteristics. Knowing exactly what those are and how to explain them will help you manage others’ expectations and get the best terms. /12
Thank you for reading!
