Do I Lose Control Of The Company In An ESOP Transaction?

The sale of the company to a 3rd party usually means giving up control of the company.

But what if you aren’t willing to lose control?

A situation we often encounter is when there are two or more partners, and only one will be exiting. The remaining partners want to stay on and remain in control. For example, we had the pleasure of working with two gentlemen, we’ll call them Dan and Eliot.

Forty years after co-founding the company, Dan and Eliot were in two different places. Dan wanted out. He was not active in the business, and had no children in the business. Eliot was very active. He was the CEO and Chairman of the Board, and his two children were Emily, who was president, and Emma, Executive Vice President. They all intended to stay.

To help everyone get what they wanted, we structured the transaction as follows:

  1. Dan got paid almost all in cash and received a very senior note, meaning he got paid in full before Eliot, Emily and Emma got paid any principal on their debt.
  2. Eliot got paid very little cash and took a medium term note (he got a higher interest rate on his note) and a small amount of warrants (liquidity interests in the future of the company). He won’t get paid any principal until Dan gets paid in full, but will be paid in full before Emily and Emma.
  3. Emily and Emma took a longer term note, at a higher interest rate, and more warrants – so that their success is tied to the success of the company. That way, if the company hits a home run, they will be well paid. If the company goes out of business, they won’t get anything.

By structuring the ESOP this way, we met the needs of three different shareholders: short term, medium term and long term. Also we provided an incentive for the growth of the company that makes it a good investment for a passive investor like an ESOP.

The results:

  1. Dan got out.
  2. Eliot got control the company long enough to see his debt paid off.
  3. Emily and Emma expect to spend the rest of their lives running this company and know they will be in control.

Most people come in thinking that everyone in a sale will get the same deal. Usually, that’s true; you all get the same number of dollars per share of stock. But financing is just as important as the price of share, and that’s the flexibility piece.

When I explain ESOPs, I always emphasize the flexibility. The ESOP is amenable to anything, as long as it is fair and reasonable. Like we did for Dan and Eliot, we can design an ESOP transaction that meets the unique circumstances of every individual client.

Written by Steven B. Greenapple