2021 Could Launch the ‘Decade of The ESOP’

Today’s guest blogger is John Solimine, founding member and Managing Director of Verit Advisors®

To invert the familiar Charles Dickens’ phrase, 2020 was “the worst of times, the best of times.” The result signals the “Decade of the ESOP.”

Blame COVID-19 for the worst of times. The pandemic-induced recession ground financing activity to a halt. Lenders instead spent most of last year’s second quarter monitoring their existing credits and submitting applications for the PPP and EIP programs. These were significant undertakings for the banks and their borrowers. But by that quarter’s end, it became clear these steps had averted the most-feared pain.

With lenders’ worst doubts unrealized, the capital markets by midyear had reopened for private and family-owned companies, as we noted in a blog post last July. Even we were surprised when the second half set deal volume records. Once lenders were past the first-half challenges of the COVID-triggered recession, they found their portfolios had stabilized and they were, if anything, over-reserved for loan losses. By yearend, they were making new loans, producing the best of times for debt capital market participants – and setting the seeds for a record year in 2021 and beyond.

We have “great expectations” for 2021 and the years ahead for ESOPs

PROMOTED

The private company credit market is proving an attractive place to seek capital because it has an unprecedented overhang of capital. But private companies often overlook it to their detriment. Both banks and nontraditional lenders are chasing a finite number of M&A opportunities, not just for ESOPs but also for recapitalizations and growth financings. For potential sellers, having lenders with healthy loan portfolios and a keen desire to pursue financial opportunities is a boon.

This interest in getting deals done is showing up in improved valuations. Multiples of cash flow and EBITDA have improved steadily each month and in February, they reached the levels achieved immediately before the pandemic. This is true for transactions of all sizes and debt structures.

The abundance of sellers signals that COVID was a wakeup call to entrepreneurs about the need to diversify their holdings. Having withstood the Great Recession a dozen years ago, many took the pandemic recession as an encouragement to take some chips off the table, think seriously about their succession plans, or both.

Growth in the number of prospective sellers is the driving factor that has aligned to produce a potential-record setting environment for ESOPs. At Verit, we are finding that inquiries about forming ESOPs have tripled in recent months. We also are experiencing a shorter overall timeframe for completing a transaction than the historical average, signaling an urgency by more owners to close a deal in half the normal time.

With that background, we detect two interesting trends already in 2021. The first is interest in owners in partial ESOPs, typically to the 30% level to take advantage of attractive tax benefits under the IRS Section 1042 “rollover” provisions. The second: Situations where a seller went to the end of a traditional M&A process, including receiving a strong offer (in one case, a letter of intent), but pivoted at the 11th hour to an ESOP. This embrace of the ESOP structure after going well down the M&A path signals two insights.

· The private and family business sellers didn’t know that an ESOP was a compelling alternative at the outset for selling their business at fair value while enabling it to remain independent.

· They were unaware that ESOPs also possesses the ability to create retirement wealth for employees, support senior leadership recruiting and enable the owners to remain involved in the business, if they so choose.

We’re gratified that sellers and their advisors are increasingly aware of the ESOP alternative, and that interest in employee ownership is becoming mainstream. As an example, we point to the recent article about Peter Stavros, co-head of private equity for the Americas for successful buyout firm KKR in The Wall Street Journal. He has long championed the benefits of employee ownership for both workers and business owners

We’re also encouraged by the members of the new Administration familiar with the benefits of employee ownership. They include Jared Bernstein, chief economist and economic adviser to then-Vice President Joe Biden. Now a member of the White House Council of Economic Advisors, he has been a long-time advocate for employee ownership. His 2021 study asks why there aren’t more ESOPs and considers how to address potential barriers to ESOP creation.

The combination of factors favoring ESOP formation, the greater awareness of their benefits and an environment encouraging their use may combine to make the 2020s the “Decade of the ESOP.” As a data-driven consultancy, these signs explain why we, borrowing again from Mr. Dickens, have “great expectations” for 2021 and the years ahead.

I am Founder & CEO of Verit Advisors, a middle market investment banking firm. I have nearly three decades experience with Employee Stock Ownership Plans, and have

 

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