The CEO of an ESOP that had engaged SES for EOSP plan administration services was looking to manage the company’s repurchase obligation. The company asked SES Advisors to evaluate a variety of plan funding options in order to determine the most cash-efficient approach for the company. The project included several considerations, including:
- Impact on current and former employees in the ESOP
- Impact on non-ESOP shareholders
- Volatility of the company’s repurchase obligation
- Finding a solution within the confines of the company’s debt capacity.
SES first evaluated traditional repurchase funding mechanisms: 1) share recycling funded by contributions; 2) share recycling funded by earnings distributions; and 3) share redemption. SES determined that traditional repurchase obligation funding approaches in this ESOP had only minor differences in economic value for the company and ESOP participants. SES then evaluated potential changes in the ESOPs distribution policies. For this company, changes in the distribution policies had relatively modest impacts on the repurchase liability, primarily because the company was expecting little growth in the near term but substantial growth after year three of the study.
SES developed a plan to redeem a block of ESOP stock for the purpose of paying benefits and segregating accounts of terminated participants. In order to ensure that the ESOP continued to hold its present interest in the company, the redeemed shares were immediately sold back to the ESOP Trust in exchange for a promissory note. This exchange is commonly referred to as a re-leverage transaction.
The re-leverage approach had several benefits for ESOP participants and the company. Terminated ESOP participants had their accounts diversified. The newly leveraged shares provided a pool of shares for future participants. The company achieved a reduction in the projected repurchase obligation and greater certainty concerning the repurchase cost over the next five years. The repurchase savings meant that if the company meets its valuation projections, the economic results are improved for all constituents (ESOP participants, new employees and non-ESOP shareholders). The total projected enhancement to company value using this approach was projected to be as much as 20 percent over the next 10 years.