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10Questions: Buying And Selling ESOP Corporations « Back
August 2012
J. Michael Keeling, President and Chief Staff Officer of The ESOP Association, speaks with Gregory K. Brown, a partner at Katten Muchin Rosenman LLP, about buying and selling ESOP corporations.


Part 1: Buying and selling ESOP corporations

Part 2: Driving performance through ESOPs

Part 3: Exercising fiduciary duties for ESOPs

Keeling: What is motivating ESOP-owned companies to purchase other companies? Where is the money to make these purchases coming from?

Brown: The motivation for ESOP-owned companies to purchase other companies reflects usual corporate motives for making acquisitions, that is, to reach additional markets, add product lines, improve distribution, and so on. In some cases, the ESOP-owned companies are acquiring other ESOP-owned companies, which is an interesting corporate culture match-up. The money for these acquisitions is coming from multiple sources. For ESOP-owned companies that have elected S Corporation status, substantial cash has been accumulated from their federal income tax shield, and that is the primary source. In addition, most acquirers have used senior financing and some have used mezzanine financing. In a few cases, private equity financing has also been used.

Keeling: Are you seeing foreign buyers for ESOP-owned companies? Is there a trend of buyers coming from particular industries?

Brown: We have seen foreign buyers purchasing ESOP-owned companies in the last two years, taking advantage of favourable exchange rates and low interest rates. This has occurred in electrical distribution and technology and technology infrastructure industries.

Keeling: To what extent are private equity funds acquiring ESOP-owned companies?

Brown: We have seen some limited activity here with private equity funds focusing on strong management groups in growth fields.

Keeling: Has there been an increase in private equity funds selling portfolio companies to ESOPs?

Brown: While we have only seen a slight increase in private equity funds selling portfolio companies to ESOPs, the tax motivation for both sides remains intact. For private equity funds with taxable investors, the tax deferred provisions for sales to ESOPs are quite attractive, and for the ESOP company, the tax deduction of principal payments for C corporations and S corporation tax shield are significant deal enhancements.

Keeling: Have you seen special purpose acquisition companies purchasing ESOP-owned companies?

Brown: We have seen two instances of SPACs purchasing ESOP-owned companies thus far in 2012. I am not sure that this represents a trend, but does indicate that SPACs have ESOP-owned companies on their radar screens.

Keeling: Going forward, do you expect to see ESOP-owned companies divest subsidiaries and/or divisions?

Brown: Yes, ESOP-owned companies are just like other companies in this respect. In one case where an ESOP-owned company divested a subsidiary, the buyers were management and an ESOP sponsored by the divested subsidiary.

Keeling: How would you describe valuations of ESOP-owned companies in the current market? Are you seeing a continued disparity between buyer and seller expectations over price?

Brown: While valuations in many industries have substantially recovered from the financial crisis, the recovery has been moderate and appears to be sustainable. That said, we see less disparity between buyer and seller over price expectations and more negotiation over other terms such as escrows.

Keeling: What specific considerations need to be made when structuring transactions that involve an ESOP-owned company as either buyer or seller?

Brown: The number one consideration is that, where the ESOP is the buyer or seller, the ESOP trustee has fiduciary considerations under ERISA to deal with. While the ESOP may borrow money to acquire company stock, it cannot accept a debt instrument from a buyer of the ESOP’s stock. In addition, an ESOP seller of stock is less willing to accept escrows than a non-ESOP seller because of fiduciary concerns.

Keeling: Could you provide an insight into the complications that may arise when addressing issues of control in the deal structure?

Brown: It is permissible for an ESOP to pay a control premium for company stock if, as a result of the transaction, the ESOP owns a majority of the outstanding stock – if it has control – these premiums are normally in the 10-20 percent range. Where the seller is the trustee after the transaction and controls the voting of the ESOP stock, it is difficult to justify a control premium because the same person maintains voting control. On the sale side, a majority ESOP will seek a control premium from the buyer in the 10-20 percent range.
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