Masonry Magazine May 1981 Page. 18
ESOP Financing
MAKING IT WORK FOR YOU
By Robert A. Manley
Discussing ESOPs (Employee Stock Ownership Plans) reminds me of the story of the six blind men of Indostan, each of whom had touched and described an elephant. They all approached the beast from different directions and, of course, their conceptions varied greatly. So, if nothing else. I hope I can present you with a balanced view of ESOP financing and how it might be a very powerful tool to help you and your firm solve some very knotty problems.
What is an ESOP? Perhaps one of the best ways to answer is to begin by stating what an ESOP is not.
• It is not a scheme to allow your employees to buy and run your business.
• It does not require that you sell 100% of your company.
• It is not a TRASOP and is not dependent upon the investment tax credit.
The term ESOP is actually a misnomer. Employees who participate in an ESOP do not become legal owners of the sponsoring company's stock. They have a beneficial ownership in the stock held in trust. The voting and political power of the trust is controlled by the existing stockholders through the corporation's board. Only when an employee leaves the company at retirement age may he demand stock, and then most want cash, not stock in a company that no longer employs them.
An owner of a successful firm would never want to install any plan that would give the employees a voice in the everyday management decisions of the company. Only those employees who have a management responsibility should run the business. In other words, it might be very desirable for all employees to have an ownership stake in the company, but it requires a very special talent to manage.
About the Author
Robert A. Manley is president of The Commonwealth Group Incorporated of San Francisco and Director of its ESOP Division. A former electronics engineer turned investment banker, he spent 15 years serving the investment needs of individual and corporate clients. He was the founder of Manley. Cooke & Co., Inc., a New York-based securities dealer. Mr. Manley has spent the last eight years designing and implementing ESOP financing programs for public and private corporations. He was a senior associate at Kelso, Bangert & Company for three years prior to becoming a co-founder of The Commonwealth Group in 1975.
This article is adapted from Mr. Manley's presentation on ESOP financing February 28 during MCAA's 31st International Masonry Conference in Reno, Nevada.
Financing Tool
ESOPs are described in four pieces of major tax legislation and Revenue Ruling 79-122 issued this year by the IRS as a "technique of corporate finance." Just what does that mean? Two of the most important functions of an investment banker in the area of corporate finance is to raise new equity capital, cash, for a corporation and to facilitate the sale of stock of that corporation by creating a market for that stock. This, of course, is done for the public company by the sale of stock to the public and by the organized securities markets.
These are precisely the two functions that an ESOP can perform for the successful closely-held company. Under the proper circumstances, an ESOP company can raise new equity capital as an alternative to continually increasing its debt. The ESOP can become an "in-house" market so that owners may sell 5%, 10%, or perhaps 100% of their ownership interest. And, because the ESOP is funded with pre-tax dollars, it will generate additional cash to re-purchase ownership interests as compared to a normal corporate redemption.
Reasons for ESOP Adoption
In practice, companies have adopted ESOPs to solve some knotty problems that eventually almost every successful private company must face:
1. To allow an owner to gradually sell his interest at fair value while allowing him to maintain control of the company.
2. To repurchase the interest of minority or family stockholders.
3. To "repatriate" dollars lost for company use when they are contributed to a profit sharing plan by converting the profit sharing plan to an ESOP.
4. To increase the equity base of a growing company without bringing in outside investors or relinquishing control.
5. To refinance debt through the ESOP so that the principal, as well as the interest, can be retired with pre-tax earnings.
6. To purchase a subsidiary or division from a selling corporation.