Armando (0:00 – 0:35)
Hello founder, you’ve built a successful business and now it’s time to think about that once-in-a-lifetime exit from your business. You’ve come to the right place. Here you will hear business exit professionals involved in the buying and selling of companies talk about what you should know before you exit.
If you’ve never sold a business before, this podcast can be super helpful to you. I’m Armando, host of the founder’s guidepost. Enjoy.
If you like this information, please subscribe and share. Hi, Armando Roman with the founder’s guidepost here today with Abran Villegas of Lazear Capital. Abran, how are you?
Abran (0:36 – 0:50)
Great, Armando. This is the highlight of my month easily. So thank you so much for having me on your podcast.
Thanks for the great content that you provide out there as well. It’s great for business owners. It’s great for providers like me.
So well done. It’s such an honor to be here.
Armando (0:50 – 1:34)
Thank you. Thank you. Our whole goal with these podcasts is to help a business owner who’s had that company say 30 or so years, never sold, never exited a company before, but now he or she is realizing it’s time to start thinking about that.
And they just don’t know what they don’t know. And what we want to be able to do is bring experts like you who work in a very narrow space where you are certainly an option that they need to think about and need to be aware of. It may or may not be a good fit for them, but they owe it to themselves and their family to really understand what is available.
And so today what we’ll talk about is an ESOP, an Employee Stock Ownership Plan. And in general, Abran, what is an ESOP?
Abran (1:35 – 2:06)
Yeah, good question. So an ESOP, similar to a 401k plan, is a plan where workers own stock in the company that they work for. It just so happens that instead of owning Apple stock or Microsoft stock, you own the stock of your company.
So it’s a really unique way to exit a business, but with some incredible benefits, both for the owner and for the buyers, who in this case are the employees.
Armando (2:07 – 2:50)
Okay. I looked at ESOP today, just a little homework. And one of the things I looked up when I was on Google, the IRS website came up about ESOP.
So I thought, I want to see what that says. And it was interesting to me that IRS website is organized under headers, then subheaders, et cetera. Well, ESOP was under the header of retirement plan.
And that caught me a little bit off guard that it was categorized in the same grouping as 401ks, defined benefit plans, proprietary plans. Those are all retirement plans in the eyes of the IRS. And that’s where an ESOP was also included.
Abran (2:51 – 3:30)
Yeah. And that goes to the heart of why the government really supports ESOPs. Back in 1974, there were folks in Congress that realized social security may not be enough for people to retire on.
And today, in fact, the average retirement plan for baby boomers is about 60, 65,000 plus. For the broader population, it’s 32,000. So not enough to retire on by itself.
And I think Congress realizes that, both Democrats and Republicans. And so this is an incredible way to provide a retirement plan to a lot of folks that may not have it or certainly may not have enough to retire on.
Armando (3:30 – 3:48)
Yeah. And it sounds like it’s a real interesting concept. So how does an ESOP work?
You mentioned that the employees buy the company. If they’re working for the company, they’re not going to have big pots of money to just dig in their pocket and buy it. How does that work then?
Abran (3:48 – 4:45)
Yeah, that’s a great question. So it costs nothing for the employees. So just want to reiterate that the employees don’t have to put a dollar into the retirement plan.
So they’re getting this essentially for just their sweat equity. So just what they’re putting into the company. So the way it works, I like to use an analogy of a home that you’re selling.
Let’s say you’re selling your home to your employees. Well, day one, when you sell that home, you’re using 100% debt to finance that. So let’s say your home is worth a million dollars.
You finance it with a component. Some of it’s a carryback debt, some of it’s bank debt. But as that home grows in value, so as time goes on, your home is hopefully becoming more valuable.
And as you pay the debt down, that equity that’s available is then distributed to the employees. So I think that’s a good way to look at what an ESOP essentially is.
Armando (4:46 – 5:46)
Okay. So as Arizona has become hot for people, for new companies to move into the Arizona marketplace, the easiest way for them, of course, is to buy an existing company, which has been happening a lot here in Arizona. And if there’s a company out there here in Arizona who is getting these phone calls from private equity and from others who want to buy them out, before they accept that offer, if they know nothing about an ESOP and they just want to understand why would they consider this.
And let’s say the company, for example, is worth $30 million. That’s what they think the company is worth. If they were to walk down that path to look at an ESOP with you and explore that, what would they really be doing?
And I guess really, let me shorten that cycle just a little bit here. I guess in the end, what do they do? They’re going to sell the company to the employees somehow, some way.
They’re going to realize a price for the company based on an appraisal.
Abran (5:47 – 8:26)
Yeah, it’s absolutely, they sell to an ESOP similar to they would to third party in terms of the values. So the value should be a market value that’s paid by the employees, by the ESOP to purchase the company. I think the real, well, a couple of really good things for business owners, one large one is their ability to sell tax-free.
Meaning that if they’re selling their company for 30 million to company X out of Los Angeles, they’re going to have to pay at least the 20% capital gains. So that’s million off of the top of your sale price. And then the state of Arizona has a 2.75 or 2.85% depending on what tax bracket you’re on. So that’s an additional 3%. And then there’s some Medicare taxes. So at the end of the day in Arizona, you could pay up to 25 cents on every dollar that you sell your company for to a third party.
So in your example of a $30 million company, 25% of that sale price is going to go towards taxes. Wow. $7.5 million. $7.5 million. Yeah. Thanks for doing the math there.
So $7.5 million is going day one to taxes. So a lot of people think, well, I’m selling my company for 30 million. I can live on that for the rest of my life.
And absolutely that could be the case. But when you sell to a third party, you can’t forget that $7.5 million in taxes that comes off of the top. So on an ESOP, you have the ability to sell tax-free.
I’m very passionate about keeping businesses here in Arizona to help sustain our economy. A lot of the private equity groups, a lot of the companies that are buying, doing these roll-ups are out of state. So you got them out of Illinois, California, New York, Delaware, wherever these funds are based.
So you end up losing, we help grow these companies here locally, and then you lose them as a headquarters. So we want to try to, I’m passionate about trying to keep businesses based here in Arizona. And so you’re able to do that as an ESOP owner.
The other big one is that they’re also able to maintain their legacy. So in that $30 million example, they probably started the company on their own at some point. We’re working the widgets, working long nights, weekends, as a business owner, Armando, that you’ve got to keep the lights on, you’re always involved with the business operations.
So over time you build a culture and that’s your, a lot of people call it their second, third, or fourth child, a lot of them sometimes their only child. And so it’s a way for them to maintain that culture that worked so hard to build over time.
Armando (8:27 – 9:51)
Okay. So when you mentioned the tax recomponent, which is enormous, you know, 25% of 30 million, seven and a half million dollars, that’s a lot of money. And yes, they could certainly take the 30 mil, subtract taxes out and what’s left over.
It’s still a lot of money. They could certainly live very well the rest of their life and be perfectly happy. But one thing that we try to help our founders, our business founders understand is that when there is more in that pot, then they can be more generous with their family, more generous with the community, maybe help their alma mater.
You know, people often have something that tugs at their heart for causes they want to support one way or another. And if they can keep more money in their pocket going through that sale, or maybe during that sale, give money directly to the charity and get a tax benefit for it, then it just meets a lot of different objectives that the family who owns that company really is trying to get to. So the owner, let’s say that he or she sells that company for 30 million to an ESOP, how does that really roll out?
Just kind of over time, they say, yeah, I want to do this a year, two year, three year, five years. What does that really look like for them going forward? Are they out on day one?
Are they staying there in the company? What’s happening with the owner of the business?
Abran (9:51 – 10:52)
Yeah, that’s a really good question and a great benefit, I think, for the seller. So it’s really on their own terms. The short answer is it’s on their own terms.
If they have a company that runs on its own, they already might have a president in place, maybe they’re just the chairperson, or they have a CFO that’s really strong. They can continue to run it as they’re currently running it, or they can stay on as long as they want to continue to draw a salary, to continue to accrue benefits. So it’s really up to the seller on how and when they want to exit.
The way you’re paid out is usually over a three to five year period, depending on the cash flow of the company. A lot of business owners like to stay on for that three to five year period, but they can stay on indefinitely. As long as the trustee and the company continues to perform well, it really is up to them how they exit.
Armando (10:53 – 10:58)
So it sounds like it has some flexibility there to it.
Abran (10:58 – 11:42)
Yeah, and there was a statistic. I recently did my certified exit planning associate class, and one of the statistics that came out was that 75% of business owners deeply regret selling their business. I know you’re in the exception, Armando, when you sold it.
But a lot of business owners lose their identity, lose their sense of purpose. You can only go on the golf course so many times a year. You can only travel so much.
And at the end of the day, I think a lot of business owners miss the connection that they have with their employees, with their legacy, with what they built. And so this allows them to exit how they like.
Armando (11:43 – 11:54)
Yeah. And if they were to sell to a private equity firm or some other buyer, they might be out on day one or maybe out six months, 12 months later, and they don’t have a key to get back in.
Abran (11:55 – 13:50)
I think private equity is really important as a liquidity event and as a way to exit a business. I’m not trying to disparage what they’re doing. And if an owner is ready to leave and just wants to hand over the keys, private equity is a great exit.
But I will say what surprised me the most in talking to business owners isn’t that they’re most interested in the tax deduction or interested in protecting their legacy. They’re actually really concerned about their employees. Your $30 million company, maybe they’ve been around for 20 years.
Some of those employees might have started on day one and a lot of ways they feel like family or even closer than family to some of these business owners. And they want to find a way to reward them and to help them in any way they can. And that part’s really exciting.
Again, if you go the private equity or roll-up route, a lot of times it’s the office people that go first because there are some redundancies. If there are some office people at the private equity group or at the roll-up and then a lot of the rank and file employees that help get you to where you’re at as a business owner today, they may or may not lose their jobs. And that can be, I think that’s another thing that contributes to those people that deeply regret selling their business because you have no control over that.
So with an ESOP, it’s a way to reward them. A lot of times I think when you sell your company, business owners approach it as a zero-sum game, meaning if I lose something, then the private equity groups gain something or vice versa. And in an ESOP, the way it’s set up, everyone is able to benefit from it.
I’ve drunk the Kool-Aid completely, Armando, so sorry if I get really animated.
Armando (13:50 – 14:36)
No, no, no, no. I’m glad. I’ve worked with qualified plans, mostly defined benefit plans, 401Ks, profiteering plans for over 30 years.
I think they’re fantastic. They’re not for everyone. There are limitations.
There are some areas about those that are not good, but in the right situation, there’s literally nothing better. And it sounds like with an ESOP in the right situation, it can be a really flexible, fantastic tool. Let me ask you then about the employees.
The company goes through an ESOP and the employees are there before the ESOP starts. After the ESOP, now that it’s in place or transitioning into place, what happens differently to the employees or what do they see differently as they go forward?
Abran (14:37 – 17:12)
Yeah, so I think there’s some benefits there too. I don’t know if you, when you went through your sale, Armando, if you had to have, you have management meetings, you have the investment bankers that come in. There are a lot of suits that are in the office, kind of picking apart your baby a lot of times, unless it’s just a private sale and something not as intense as that.
But there begins to be water cooler talk about what’s happening to the company. Am I going to keep my job? Is this going to be sold?
And so you see a lull in productivity or the rumors begin to fly. If it gets out that you’re considering an ESOP, that’s not necessarily a bad rumor to have out there. So it’s good on the front end for the employees, in my mind.
Post ESOP, not a lot changes, to be honest. You continue to have the owner that acts as a CEO, or maybe they’re turning something over to their president. And in fact, if you look at the statistics, so tomorrow I’m a business owner and instead of an employee, you’re going to act differently as an owner versus an employee.
And we have an example, we had an electrical contractor that had over $600,000 in overtime pre ESOP. Post ESOP, that went down to zero. And a lot of it was, there was a lot of peer pressure saying, hey, I’m an owner now, get your job done.
And a lot of it was just self-imposed as well, too, that, hey, let’s increase our productivity here because we’re all owners and it benefits all of us. So I think that’s over time, it’s the change in attitude from an employee to an owner. And you feel it when you go into some of these businesses that they treat their investment a little differently than if they were just collecting a salary.
A big benefit, side benefit. It’s also a great recruitment tool, especially for contractors. So there’s a lot of competition for workers right now.
And that might, may not always be the case, but right now, one way to distinguish yourself is to be an ESOP. So not only are we going to offer you great benefits and a living wage, but here’s this additional benefit that you will be an owner in this company that you come into work for. And I think it makes a huge difference.
So retention’s better, recruitment’s easier, productivity is higher. There’s usually a 4% to 6% bump in revenue. And so it’s, again, yeah, I’m drinking the Kool-Aid, but it is a win-win situation for the business.
Armando (17:13 – 17:40)
So then I’m thinking about what I saw earlier with IRS having this categorized under retirement plans. And for the employees, if they’re looking at this as their retirement plan, they’re getting some value in the business every year, they get a statement of what that value is, and they can see, just like seeing their 401k statement, seeing what that looks like, what are they really seeing?
Abran (17:40 – 19:02)
Yeah. Well, I know you provide some 401k plans and some other retirement services. So what happens is on an annual basis, the company gets a valuation from a third party.
So they’ll come in and say, we think your business is worth 30 million this year. And then depending on how much you’re vested in your stock, you’ll get an annual statement that will say, here’s your value of the stock and shares that you own. And then there’s also a website similar to if you would sign on to your 401k to see what your balance is, you can sign on and see what your balance is, see what your vesting schedule is.
And then depending on the value of the company, what you expect the value of the company to be, you can also look out four or five, six years down the road to see where your investment will be. And this can be life-changing. I have an uncle and an aunt and a brother-in-law who are all part of an ESOP, and it really did, it was life-changing.
And we forget, I think the professionals in my space forget about, we chase the business owner and there are some incredible benefits for them, but we forget about the huge benefits to these employees that are able to buy homes or send their children to college or retire comfortably on something more than just social security. And it’s powerful.
Armando (19:04 – 19:35)
Wow. So the statements that the employees get and the portal they can log in to see the value, there’s an annual outside independent third-party appraisal on the business to establish a value or a range of value. Five years after this company’s become an ESOP, employee has seen that value change over time, hopefully increasing over time.
And at some point that employee is going to retire, how do they get the value that they see on that statement?
Abran (19:36 – 20:06)
So a couple of ways they could either, if they’re changing jobs and are not retiring, they have the ability to roll that over into an IRA or a Roth IRA. They can roll it into their other, their new 401k plan if it will accept it. So there’s no tax consequences if they’re just changing jobs.
If they decide to retire, they can roll that again into either a 401k or an IRA, and then begin to draw income as they would any other 401k.
Armando (20:06 – 20:14)
Okay. And it sounds like it functions to the employees just like a 401k. Absolutely.
Or similar anyway.
Abran (20:15 – 20:27)
And they do. That’s where the IRS does get their taxes is once you do begin to draw on the 401k or on the retirement plan is when you pay ordinary income taxes on that withdrawal.
Armando (20:28 – 20:53)
Okay. So then a question of Ron, are there certain types of businesses or industries where the ESOP is just, there’s just no question. It is the best thing.
And anybody in that space or anyone who has the certain company profile, they really should be at least looking at this before they make any kind of decision to sell or exit their business.
Abran (20:54 – 23:14)
Yeah. Well, I’d say everyone. I’m one of those guys.
What’s the question? But there are a couple of industries that I think this works particularly well in, and contractors are one of them. And the reason being is that you could sell your subcontractor or contractor business to a third party.
And right now you’d probably get three, maximum five times EBITDA for the value of your business. But we can get five or higher multiple when you’re selling to an ESOP and then also the ability to sell tax-free. So you get a double benefit of a higher value and a lower tax burden.
And the reason being is just, if you think about a contractor, a lot of their business is driven by the founder or whoever the CEO is, or the top level employees that are there. If you sell to a third party, you lose that knowledge, you lose that CEO potentially. And so in an ESOP, we think that there’s a lot of value to retaining the existing management staff.
And so you’re able to get a higher value there. So contractors come to mind, I think also senior living facilities. So you sell your company to the ESOP, but you can also sell the real estate that is used in the operations to the ESOP as well.
And there are ways to also sell that potentially tax-free, avoiding capital gains and avoiding depreciation recapture. And so that’s a huge thing for assisted living facilities. A lot of times they’re sold for the value of the real estate, and then they’re maybe getting one or two times EBITDA for the value of the business.
Well, we also are able to give them a fair value for the business, closer to the four or five times range. Again, because you’re keeping the same staff in place, there’s no knowledge transfer that’s required. So you’re able to look at a potentially higher value.
And so that combined with the real estate tax avoidance on some of the depreciation recapture and the capital gains, it can be a really huge benefit on the assisted living side.
Armando (23:15 – 24:22)
Okay. And let me just recap that a little bit so that I’ll make sure I’m clear. I want to just repeat that.
So in an example, you used an example of construction and senior living, and you also talked about multiples and EBITDA. So when a company sells, often they’re looking at EBITDA, which in layman’s terms might be called profit with some adjustments, but the profit of business, and then that profit gets taken times the number three, the number four, number five, and that’s the multiple. And then that becomes the value of the business.
And that fluctuates up and down the multiple and depends on industries also. But I think what you said is that in some industries, because of the way things work, rather than being tied to a value in that multiple or that multiple driving the value, that the appraisal, if it stays as an ESOP, because it stays intact before and after the sale, more of that value is retained in the business. And therefore you can sell that at a higher price, a higher valuation.
Abran (24:22 – 24:44)
Yep. That’s very well said. And yeah, thanks for the clarification on EBITDA.
I think as investment bankers, we like to use fancy terms to make ourselves. EBITDA is just another way, like you said, to talk about profit. But yes, we find that you can get a higher value for something because you’re keeping the management and the company intact.
Armando (24:45 – 25:01)
Okay. And so those are a couple of industries. What about the company?
Just describe that company and how many employees, is there a mid-level management team? Is there a board, advisory board? What does that company look like?
Abran (25:02 – 26:13)
Yeah. So there’s some IRS and department of labor guidelines that no group of, and I think it’s, don’t quote me on this, but I think it’s five employees can own more than 25% of the company. So usually the minimum number of employees is 15 to 20.
Just so you don’t bump up against that rule. 20 plus employees. We do have a minimum EBITDA that kind of changes depending on the company.
And that could be two to 3 million in EBITDA. But we do have some options for companies smaller than that as well too, in the form of co-ops and other employee ownership options, if they’re smaller than 2 million. And the 2 million isn’t really arbitrary.
It really is in order to gain the maximum benefit. I mean, you do have to have, you usually have to get reviewed statements. You’re having to hire a third party appraiser on an annual basis.
You have to have a third party trustee. And so that it makes more sense at the 2 million mark with those additional fixed costs that you can’t avoid.
[Speaker 3] (26:14 – 26:14)
Okay.
Abran (26:14 – 27:04)
In terms of the management of the company, that’s really up to the trustee who represents the employees in a sale and then the current ownership. So the seller, and they’ll usually decide to keep the seller on as the CEO or whatever his or her, whatever they’re wanting to do on a post ESOP basis. And then they do bring on a board.
And usually that consists of the CEO, maybe the president. And then the trustee will bring on a third person with, from a recommendation of the CEO. And sometimes it’s a five-person board and sometimes it’s a three-person board, but that’s really up to the CEO and the trustee and how they run the board.
But the trustee is not in the business of running the company. I mean, that really just still remains in the hands of the management.
Armando (27:05 – 28:02)
Okay. So it sounds like if the founder has a good solid management team and they’re really running his or her business, then maybe the owner pops in during the week or logs in to see how the metrics are on the company. That could be a really good situation for them to consider an ESOP.
Owner is already almost an absentee owner anyway. The people who are running the day-to-day operations, they know what they’re doing. The company is producing and functioning the way it’s supposed to.
And it could look literally exactly the same way after they become an ESOP. The difference is the employees are now getting this new account every year where they’re building some value in that for their own retirement. And the owner has then somehow, someway over the years gotten a tax-free payout on the full sale value or appraised value of that business.
Abran (28:02 – 28:31)
Yes, absolutely. That is absolutely well said. And you don’t need to be discouraged if you don’t have that bench strength in place when you close.
The ESOP is also a great way to attract new leadership as well to sort of bring on a president or to bring on a CFO if you have a controller. So it’s a way to recruit as well if you don’t have those positions well-staffed when you close. So we’ve seen them both ways.
Armando (28:32 – 29:17)
Okay. And then the company, once it goes through that, let’s say it’s worth 30 million when it gets appraised, goes through an ESOP, and now the owner has his or her 30 million tax-free, and now the company is going forward, the company values will go up and down over time. Industries sometimes change and sometimes federal regulations come out that just destroy some businesses and open up a window for others to flourish.
That company going forward that was worth $30 million on day one of the ESOP, ideally, what should that value be looking like going forward, again, to make this, for it to make sense and work out?
Abran (29:19 – 30:57)
Yeah. Well, I remember you getting, in that house example that I used, you’re getting value in two different ways. One is paying down debt, and then you own the house free and clear, the $30 million house.
The other way is that your $30 million house increases in value. And it really depends on the industry. Again, you’re going to gain a bump in productivity and a bump in revenue just by virtue of being an ESOP.
That happens a lot. So I don’t know if there’s a magic number, but if there’s a 3% to 5% growth rate, depending on your salary, you’re going to be creating a lot of millionaires by the time you hit year 15 or year 10, depending on how much is allocated and how much is made. So, 3% to 5% is a healthy growth rate.
And you may gain that just by virtue of being an ESOP. Another thing I wanted to mention, if you do sell as an S-Corp, the company becomes tax-free. So not only does the owner have an ability to sell tax-free, but over time the ESOP has an ability to be tax-free.
And that generates a whole lot of additional cash as well. And so what you see a lot of ESOPs doing is potentially selling down the road, but a lot of them also are in the acquisition realm. So maybe in your example, they’re acquiring maybe some of those businesses that are a little more ahead of the curve or the new businesses that are being created.
They become a target for some of these ESOPs that become rich in cash because they’re conserving cash by not paying taxes.
Armando (30:59 – 31:28)
Huh. So an S-Corp has additional advantages when they go through an ESOP. They do.
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Abran (31:29 – 32:01)
So they have the ability to be tax-free day one. If you sell as a C-Corp, then you have to have five tax periods. You have to wait five tax periods until you switch to an S-Corp.
But again, during those five years, if you are a C-Corp, any of the ESOP contributions that you’re making are also tax write-offs as well. So it’s a very efficient, even if you are a C-Corp, it’s a very efficient way to sell.
Armando (32:02 – 32:34)
And so for an owner who’s wondering if this is for, say for her business, and she calls you up and says, Hey, I’ve run, I’ve got this company and I want to be out in three to five years. Can you help me? And you say, yes.
What happens after that? What do you do? How did those meetings go?
What are the conversations? What are the steps and timeframe? Not in five hours, but in like two minutes, maybe if you could walk through that little bit.
Abran (32:34 – 34:40)
No, the first thing I tell her is to call Armando, help you get ready to be sold. So just like any other business, when you’re looking at an exit price, if you have better controls in place, if you have good financial reporting, if you have a good C-level staff, those all increase your multiple and the value of your business. So the first thing I’d say is probably, let’s take a look at where you’re at.
Let’s take a look at your financial reporting. Are you getting a review or an audit? Would you consider doing that?
So if you’ve got a few years out, I think it’s really important to align yourself with someone like your group, Armando, in all sincerity. And that’s how you get the best multiple of value, regardless of what we use as your exit strategy. So I think spending time understanding the business and maybe looking to see where there are some gaps and then bringing in experts like you to help them work through those gaps and to maximize their value down the road.
Maybe after a couple of years, we’ll put together a complementary feasibility analysis. And this is like a $35,000 to $40,000 piece of work that includes a value range, a suggestion on what the structure should look like. Also, we’ll show the owner what her employees are going to get over time based on the projections.
60-page analysis of their business and recommendations that we make. And then once we get into the weeds of it, it’s usually a three to six-month process, depending on how motivated the seller is to get the ESOP in place. Okay.
Just like any other business, I mean, I think it’s, you’re not going to get a special multiple. You still have to do the work to have the controls in place, to have a well-run organization that maximizes value.
Armando (34:41 – 34:57)
Okay. So after the feasibility study, you do that. And then you go through that with her and walk through what that really means.
And then at that point, if the answer is yes, let’s go ahead and do this. And three to six months later, you’ve got that going then?
Abran (34:58 – 35:38)
That’s correct. And we don’t, our compensation at Lazier is fully on a success fee basis. So, we get paid once the house sells, if you will.
So, we make our commission and any fees, including ours, also get paid by the buyer, which in this case are the employees. Okay. Including the purchase price.
And so, from that perspective, it’s also a good deal for the seller that they’re not, obviously you’ve got some legal fees and accounting fees that you have up front, but those really can get rolled into the final sale price, the sales price to the employees.
Armando (35:39 – 36:05)
Okay. And you mentioned about, you mentioned showing her the, what the employees would have, say in five years or somewhere down the road. Are you showing her then as the business owner, a schedule where she can see that my front office gal, Amy, who’s been with me for 20 years, then if she sticks with being in the five or 10, she can see what that number would look like for Amy?
Abran (36:06 – 36:29)
Yes. That’s absolutely what we show them. And obviously the big caveat there, that’s based on the projections that the owner has provided to us.
So, that assumes that the projections are met, but we just closed the transaction that $50,000 employee today, if they stuck with this company would be, would have a retirement account of close to a million dollars after 15 years.
[Speaker 3] (36:29 – 36:30)
Wow.
Abran (36:30 – 36:40)
That’s a, you know, it’s a blue collar is the wrong word for it, but this is kind of a rank and file employee, right? I was in a year, they’d be at a million.
[Speaker 4] (36:40 – 36:40)
Right.
Abran (36:41 – 36:56)
And as an owner can decide there’s a point system. So, it can be a combination of years of service and then a salary, the salary that you make for the number of shares that are allocated to you, but you do have some say on that.
Armando (36:57 – 37:33)
So, I imagine that when that owner is going through that process and seeing those numbers and seeing the impact it can have for the employees, that could be a very gratifying, a very satisfying path to walk down for them. And I’m thinking to the employees now, employees get nervous when a company is being sold or owner is thinking about stepping out. So, to keep those employees on board, I would think that communication with them is really critical as this is starting to roll forward.
What does that look like for her employees?
Abran (37:34 – 38:35)
Yep. Well, one, they do have that portal that can go on to any time to see what their value is. That’s really up to the company.
We recommend an annual share price party. So, where the whole staff comes together and the previous owner can reveal what the valuation of the company is and then what that means for the share price. I think that’s important.
We also recommend companies will set up an ESOP committee where interested parties can be part of a committee that’s educated on in terms of the financials, the valuation, what the stock price looks like over time. And the way it works, day one, there’s 100% of debt on that house. So, the stock is worth zero.
So, day one, there’s some excitement that you’re now a business owner, but it’s not until years three plus that you really begin to then see that compound value of your ownership in the company.
Armando (38:35 – 38:44)
Okay. So, you kind of bought a house, no money down. The debt and the value are about the same.
Abran (38:45 – 38:47)
Yeah. So, the value is zero day one.
Armando (38:48 – 38:57)
So, that’s why they’ve got to wait a few years to really see some numbers in their account begin to add up for their annual ESOP valuation of that.
Abran (38:58 – 39:10)
Yeah. And hopefully, if they’re a smaller company, they see their individual contributions hopefully reflected in that stock price as well too that gets re-evaluated every year.
Armando (39:10 – 39:43)
Okay. So, then you began talking about the culture of the company that the owner has fostered and built over time, and that culture can remain intact. And you also mentioned that employee retention can be better, employee efficiencies.
You mentioned that example of the 600,000 of overtime that suddenly disappeared the year after the ESOP went in. What other benefits would an owner expect to see from the ongoing operations of that business that we haven’t touched on yet?
Abran (39:43 – 40:02)
Yeah. So, just a couple of statistics, employee owners, median household net worth is 92% higher. Median job tenure is 53% higher.
And then on average, income from wages of employee owners are actually 33% higher.
[Speaker 3] (40:03 – 40:03)
Wow.
Abran (40:04 – 40:28)
Because you have more cash to maybe pay higher wages. And then employee owners are four times less likely to be laid off during the recession. Again, just because if you’re an owner, you treat your company a little bit differently than you would a non-owner or just an employee.
So, those are some intangible benefits for employees.
Armando (40:29 – 40:32)
Wow. One third increase in wages sounds amazing.
Abran (40:34 – 40:39)
Yeah. Everyone should go out and try to get a job at an ESOP, or let’s upgrade some.
[Speaker 3] (40:41 – 40:42)
Wow.
Abran (40:42 – 40:55)
On the company side, ESOP companies are actually 25% more likely to stay in business during economic downturns than comparable non-ESOPs. So, you actually have a stronger company once you’re in ESOP.
Armando (40:56 – 41:33)
So, what about companies sometimes need working capital and financing to buy big expensive equipment? And often the owner puts his or her personal guarantee on that to get that equipment. Going forward, when it comes time for the company for capital investments like that, how does that work then in terms of acquiring financing?
But without that majority owner-founder signing his or her personal name for a guarantee, the company is able to acquire financing to get new capital in that, I imagine.
Abran (41:34 – 42:59)
So, part of what we do up front is to help the company establish a bank relationship. And we go to the incumbent bank first to provide them a working capital line of credit. So, we try to have that up front for the entity.
It’s sort of like, maybe I’ll use a car analogy, selling a car with some gas. You want to be sure that there’s some cash in the company and that they have an available line of credit. So, we’ll help them do that.
But all of the debt is non-recourse to the owner. Because first off, the owners are the employees and it’s not the CEO anymore. And so, there are banks that will lend money just directly to the company with non-recourse to the owner.
So, that’s a big benefit to the owner as well, too, is that they’re not signing a personal guarantee on any of the debt with the company. Now, they do have an owner carryback note, which is different. So, the way that these ESOPs are financed is you do have some traditional bank debt and then the remaining portion is an owner carryback that the owner gets paid from over a three to six-year period, depending on the cash flow of the company.
But they’re also making a very good return on that owner carryback note that they’re keeping in the form of interest, just regular interest paid, and then also warrants or warrants to percentage of the company down the road. So, they’re compensated for that risk that they’re holding.
Armando (43:01 – 43:14)
Well, it sounds like it has a lot of flexibility and certainly should be looked at. Are there situations then where it doesn’t work?
Abran (43:15 – 45:05)
I think a lot of companies that are fast growth or technology companies, maybe they’re getting a 12 times multiple in the market because someone really wants them. Well, that doesn’t really work because it’s hard to show a market valuation of 12 times with an ESOP. I think an owner that just wants to take their money and move off to Yuma or wherever they were going to move to, they need to believe in the cash flow of the company for the next three to five years at a minimum because that’s what’s going to pay them off.
And so, business owners that don’t believe in the future cash flow of the company, not a good exit. And then the other thing is if a company owner wants to get 100% of their cash up front, well, that’s not the case in an ESOP. You’re probably getting 25, 30, maybe 40% of your cash up front.
The rest is paid over a three to five-year period. But anymore, I mean, we’ve our busiest year yet. What we’re finding is that a lot of private equity groups are paying a percentage up front and then the rest is paid out through an earn out.
And what that means is you have to meet certain benchmarks or certain revenue growths or certain margin targets in order to be paid the rest of your money. So, a lot of deals are being structured with that earn out. And so, you’re not getting 100% or maybe if you are, you’re getting a discount.
And then a lot of times, maybe they’re getting 100% up front, but they have a three to five-year contract in place that they have to stay managing the company for the next three to five years if they do get that full payout up front.
Armando (45:06 – 46:08)
Okay. Well, it’s super important that a founder who’s built a very successful business that’s now worth a lot of money, that they explore their options fully before they decide on any option. And whether an ESOP is right for them or not, hopefully, they can at least take a look at it, understand a little more about it and decide whether it makes sense or not.
For those, as you said, whose industries might be questionable, they’re just not sure what the future holds. So, maybe an ESOP isn’t the best thing for them. Maybe they do just that private equity or whatever else might come along that might satisfy their best interest at that time.
But certainly, worth exploring. Anything around that we haven’t talked about yet in this conversation for that founder who’s never sold a company before, had this business now 30 years, and they’re realizing it’s time for them to begin thinking about what that exit will look like for them? Anything we haven’t touched on in this conversation?
Abran (46:09 – 48:10)
I just think I’ve spent my career dealing with business owners. And for the most part, the average net worth is 80 to 90% of a business owner’s net worth is tied up in his or her company. So, it’s their biggest asset in a lot of ways.
With the care that they would their 401k or their retirement plan, they need to be meeting with you on a quarterly basis to talk about the value of their business. So, that’d be my biggest. And I think we as the advisory side of things don’t show enough respect to some of these business owners either.
Or we don’t realize that they were making widgets at 18 and then grown this company to Y. And we ask, well, haven’t you looked at your margins? Or what about that EBITDA?
And why don’t you know about your CAGRs? So, I think it’s incumbent on us to treat business owners with the respect that they deserve for what they’ve built. But I would say to business owners, you don’t have to be the expert on everything.
Just hopefully rely on an advisor like you, Armando, that knows their stuff, that can bring some value. And it’s okay not to know everything. My dad’s a teacher, so I think it’s in my blood.
But I see it as my mission to just educate business owners on what their options are. And then let them decide. These are really intelligent people that have built incredible businesses.
But at least give them the tools and give them the education so that they can then decide on what their exit path is. But I think every business owner should be thinking about an exit path. Again, because 80-90% of your net worth tied up in this business, you need to treat it with some love, not just on the operational side, but from the financial side as well.
Armando (48:11 – 48:44)
Yeah, no, that makes sense. And a question for you, everyone. Sometimes when there are big tax breaks afforded to people that are written within the tax code that people use, the IRS is always seeming to kind of close some of those windows so that there’s less tax benefit for people.
Have there been any changes that you’ve seen coming along the pike that would impact the ability of a company to put an ESOP together and get the benefits?
Abran (48:45 – 49:37)
I’m curious. I know when you went to the IRS website, but they did come out recently just saying that you shouldn’t be abusing these great tax loopholes. And so we tend to approach things really conservatively at Lazier.
The tax code was written to employee ownership, so let’s not abuse it. And so we’re very conservative on the way we structure our transactions. So I just think like anything, any tax code that’s out there is ripe for interpretation and for being taken advantage of.
I’d say if you’re approaching it conservatively with the right partner, there shouldn’t be any issues. But just like any code, you just need to bring in the experts that understand it.
Armando (49:37 – 50:11)
Well, exactly. And this uses a very specific part of the tax code to benefit the owners during a sale and benefit employees after the sale. And it just gets to the point that make sure you get your tax CPA or your tax attorney who really understands the space so that you know what the landscape is, know how to navigate it.
And then when it’s all done, you’re not worried or concerned because you have done it right. You’ve brought in the right people and you can walk away feeling confident that you’ve done the best thing you could at that time was what you knew at that time.
Abran (50:12 – 50:43)
Yeah. And you want to sleep well at night knowing you’ve got the professionals that know their stuff. And on all of our transactions, we have tax attorneys, tax accountants, Lazier Capital, Columbus, Ohio.
We’ve got a big staff there. Most of them are either attorneys, former tax attorneys and former tax accountants. So they know what they’re talking about.
And so I think it’s important if it’s not with us, just make sure that who you’re dealing with has the expertise necessary to avoid any tax issues.
Armando (50:43 – 51:16)
Right. No, I would agree. And I’m glad that you’ve got those folks in-house that can help, that can help with making sure obviously that things are on the right path.
At the same time, owners will often have a go-to lawyer they’ve had for 20 years or a go-to CPA they’ve had for 20 years. And if they want to get some outside validation that this is how it works, then great. They should do that.
They should absolutely do that, especially when it’s a once-in-a-lifetime sale of their business.
Abran (51:17 – 51:44)
Absolutely. No, you know as well as I do, sometimes you have the attorney that helped you form your first LLC and you may have outgrown them as a business owner, but we don’t want to tell a business owner that if we can bring in an expert that understands the space well to complement your existing relationships, that’s what we’ll do. I mean, what you don’t want to do is have someone that doesn’t, has never done an ESOP walking you through the process.
Armando (51:44 – 53:24)
Right. Right. They will get them, there’s the higher potential of them getting themselves in trouble and you in trouble during that same time.
Which we want to avoid. Yeah. So let me do a little bit of a recap here.
ESOP is an employee stock ownership plan where the owner of the business in effect sells that company to the employees. The employees buy it for no money down as you know, like buying a house with no money down. But in over time as the company produces profits on that, then the owner can get the rest of his or her payout maybe over three to five or three to six years and then get paid out.
The owner will get that payout tax-free. It sounds like when they go through that process as well. And as a result of what you’ve seen of ESOPs and how they work, the employees become more efficient.
They have a different feel to their owners now versus just employees and other owners as well. So the productivity goes up, retention stays up. It can make the company even more attractive because it has an ESOP so you can maybe attract better talent when you’ve got to replace people along the way.
And those employees who’ve been there with you building that company along the way, when they stick with the company through that transition, they can see because you’re showing them in your feasibility study, they can see what their accounts might look like based on the owner’s projections of what that company can do going forward. So Amy at the front desk who makes 50,000 years, been there for 20 years, she might be able to have a million dollars in her account in the future just by continuing doing her job now that it’s an ESOP.
Abran (53:25 – 53:29)
That’s exactly right. We need you to work here at Lazier, Armando. That was a really good recap.
Armando (53:30 – 54:08)
Well, you also mentioned the feasibility study. I like what you said. You said you’ll talk with an owner and sometimes you’ll see that maybe they need to get reviewed statements.
Maybe they need to do a little bit more professionalizing the business. Maybe they need to get the articles or bylaws or whatever structured correctly. And they might need a couple or three years to, I hate to say clean up the business, but that in effect is really cleaning up the back office of the business so that when it does come time for them to exit, everything is the way it needs to be to get the highest value when that time comes.
Abran (54:09 – 54:32)
And that’s why I think your outfit, Armando, is so important. And a lot of wealth managers wait until there’s a liquidity event or until the business sells to then call on that business owner, but they need to be meeting with you and working with your firm to help them through that process two to three years before they even consider selling.
Armando (54:32 – 55:23)
Well, right. And they don’t know what they don’t know. And if they’re going through a one-time sale, then they’ve got to make sure they’ve got people on board who can help bring all the people together who need to bring up that maximum value for them.
So, you said that you’ll meet with the company, maybe they’re not ready, maybe it’s two years later. You might meet with them again two years later now that they have reviewed financial statements and other things along the way. And then at that point, you might be able to do a feasibility study for them so they can see what it looks like.
And even up to that point, they’ve still not put in expended any money for Lazir or for you because you’re providing value for them. And once they see it, when they go through it, you’re paid on the success fee. And once that happens, then you’re paid.
And it sounds like it all comes together at that point.
Abran (55:24 – 56:04)
It does. Now, Armando, I’m a big guy and I like to eat. So, I will buy any business owner lunch and breakfast as often and dispense free advice as well.
And I’ve seen it all. Prior to this, I was a commercial banker for 22 years. And so, I can provide help or perspective on debt, on structuring, on the things to look at in terms of financial.
So, I love that piece of what I do and happy to sit down with anybody who is thinking about an exit or just wants to get a second opinion on their business or just have a free lunch. And I’m good with that.
Armando (56:04 – 56:17)
And I do want to recap the profile, for lack of a better term, on what kind of company would make sense. You said maybe 15, 20 employees on the low end, right?
Abran (56:18 – 56:19)
Yeah, at a minimum.
Armando (56:19 – 56:29)
And then you said for profit, they really want to be probably somewhere maybe around 2 million EBITDA, about 2 million profit a year. That’s where the numbers can begin to make sense as well.
Abran (56:29 – 56:45)
Yep. And maybe they’re not there today, but they think they’ll be there in two, three years. It doesn’t need to be today.
I realize it’s a long-term sales process. But that’s the goal.
Armando (56:45 – 57:24)
Yep. Okay. Okay, good.
So, perfect. That sounds fantastic. There’s a lot of good too.
Like I said, we’ve worked a lot, many, many years to qualify plans to find benefit, profit sharing, 401k, that kind of thing. In the right situation, they’re fantastic. In the wrong situation, don’t waste your time.
They just don’t make any sense. And it sounds like in the right situation, an ESOP and having a conversation with you certainly is worthwhile. And I imagine that a business owner can talk with you for 30 minutes to an hour and get a much better sense in that conversation if this is something that they should explore further or not.
Abran (57:25 – 57:53)
Yes. Yep. And I’ll be honest with them up front if that’s an option.
I love the Define Benefit and Qualify Benefit plan for companies that may not want to sell today, but are considering an ESOP for two, three years down the way. It’s a great tax planning tool as well. And I think it’s a great reason to get them in front of you to put these plans together.
So, a lot of times that’s the advice or part of the advice that I’ll give to business owners.
Armando (57:53 – 58:02)
Okay, great. So, Brent, if somebody is listening to this and thinking they really want to talk with you and explore a little bit further, what’s the best way for them to reach you?
Abran (58:03 – 58:13)
I think, check out our website, laziercapital.com. Feel free to reach out to me on my cell phone number. Do we have the ability to add that?
Armando (58:14 – 58:18)
Yeah. And if you just want to say it now, I can jot that down as well.
Abran (58:18 – 58:36)
602-881-9164 is my cell number. 602-881-9164 for a text. My email is av, A as in Abran, V as in Villegas at laziercapital.com.
Armando (58:37 – 59:18)
Okay. L-A-Z-E-A-R capital.com. All right, Aran, that sounds great.
You’ve got a very unique offering for a business owner and an exit for them to consider. I hope that the right ears have heard this conversation and that they will give you a call and ask you more questions if it will make sense for them. Really, really enjoyed this conversation, Evan.
The tax savings of this sound pretty darn phenomenal. Along with all the other benefits, the tax component can be extremely beneficial for a founder as well.
Abran (59:19 – 59:25)
Yeah. No, I appreciate it. I really enjoyed catching up with you, Armando.
And yeah, please feel free to reach out with any questions.
Armando (59:26 – 59:56)
All right. Fantastic. Great.
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