Episode 1: The Top 10 Questions to Ask Your ESOP Advisor

What should business owners ask before implementing an ESOP?

In this first episode of ESOP Radio, Trevor Gilmore, CEO of Menke, and Ben Spadt, ESOP Investment Banking Consultant at Menke, walk through the top ten questions founders and executives should ask when evaluating employee ownership.

Drawing on decades of experience advising ESOP transactions, the conversation covers feasibility analysis, financing options, valuation considerations, regulatory compliance, governance, succession planning, and the role culture plays in long-term ESOP success.

This episode is designed to help business owners, executives, and advisors understand what a thoughtful ESOP process looks like—and how to assess whether employee ownership is the right strategic path for their company.

ESOP Radio is educational in nature and does not constitute legal, tax, or investment advice.

Learn more:

• ESOP Radio: https://www.menke.com/esop-radio/
• ESOP Boot Camp: https://www.menke.com/esop-boot-camp/
• Confidential feasibility review: https://www.menke.com

Transcript

0:03

Hi, everyone. Welcome to Esop radio. Hello and thanks for joining us. I'm Ben Spadt with the Menke Group. And I'm here with Trevor Gilmore CEO of the Menke Group. And we're going to ask answer a few questions about who is Menke and Associates, the Menke Group and the top ten questions you should ask your ESOP Advisor before you implement an ESOP. Trevor, how many Esop transactions have you advised on in total, say, in the past five years? Yeah. Great question Ben. So I'm making group. Over the past five years we've done in excess of 120 Esop transactions. That's awesome. What's the typical size of these types of transactions? So funny thing about Esop transactions there's no typical size. So we take a look across our client base. Some of these transactions have been for as little as 5 million. Some have been a billion. So kind of a wide spread there in terms of, you know, company size and so on. But when we take a look at industries and this will probably talk about in a second and there are some similarities. Yeah, that's quite a range. Well, and you touched on industries, do you specialize in any particular industry. So lately we've been doing a lot in the AEC space. So AEC I mean architecture, engineering, construction, sometimes you see the CM in consulting. So we do a lot in AEC, with CV, both construction and consulting and then followed by professional services that can encompass consulting as well. And, you know, some manufacturing out there too, but very strong in the AEC and consulting space. That's great. So when you mention those, you know, the AEC type companies, they have a lot of regulations sometimes that are, you know, kind of boxed them in. How do you ensure ongoing compliance with, you know, not only a risks, but IRS guidelines, Department of Labor things like that. Yeah. Great question Ben. So we have a full team of Esop investment bankers, Esop attorneys and Esop administrators who are all credentialed. And since we've been in business now over 51 years, started in 1974, that collective experience over the past 51 years has really given us a deep bench in terms of knowledge and experience with all the transactions and clients we've worked on throughout that time. So, in summary here, it's, you know, both history, you know, the depth that that brings, the experience that that brings in on top of that are very talented, long tenured, professional staff that we have here that keep up with the rules, regulations that change under IRS, under RSA, you know, so on. Yeah, it seems like those are ever changing. That's great. Then it is quite a deep bench to, being there since the beginning. All right. So now let's move on to, you know, the top ten questions you should ask an Esop advisor as you're thinking about a, an estate transaction. And, Trevor, I'll ask these of you and you act on behalf of, you know, if someone were asking an advisor from the Menke Group. All right. Sounds great. Perfect. So what approaches do you use for financing these Esop transactions? Basically, how do the selling shareholders get paid? Yeah. So most of these transactions out there are financed two ways. One is the bank bringing outside third party senior bank to come in and provide financing for the transaction. Another common way is seller financing, which sometimes is referred to as seller notes. Usually our transactions have a combination of the two. Now, on the financing side, you do see trends of private credit funds, you know, coming in and wanting to lend private equity funds and so on. So, overall, the big picture, the key takeaway is if you're going through an Esop transaction, likely have financing options out there above and beyond seller notes. And part of our role is to uncover that and figure out what the best financing package is for you. That's great. And kind of piggybacking on that, this is, you know, question two, how do you evaluate the balance between the liquidity for the sale shareholders and then the long term sustainability of the Esop itself? You know, when you talk about bank financing, yeah, that might get me the most cash or close. But where do we find that balance? Yeah. Great question Pat. And really comes into understanding the cash flows of the company and what the key objectives are for the shareholders. So there's always a fine line there between, you know, maybe leveraging the company up high so that the sellers get max cash it close versus them taking a seller note. So such things come into play if they're doing the 1042 rollover. And I know that's an acronym out there, but that's a strategy where basically you can defer your capital gains. That typically requires more cash inflows. But on top of that, you have to really understand the company's balance sheet as well and understand the debt capacity and what they're comfortable with. Most banks, by and large, are going to come in and probably land somewhere between 2 to 3 times EBITDA on a company with not much debt and strong cash flows. Right? So that kind of protects the company and so on. But again, you have to really understand the ratios, cash flows of the company in the balance sheet and what makes the most sense here, you know, so there's no one answer that fits all clients. It's very much client based client specific. So when you're talking about, looking at the financial statements and kind of how does determining the sustainability are you, you know, a lot of buzzwords get thrown around like a stress test or feasibility or are we talking something like that. Absolutely. Yeah. So when you take a look at the balance sheet and the projected cash flows of the company, you always want to stress test that and factor in okay is is base case. You know, what does it look like if the revenue mix changes profitability projects backlog changes and so on. So you always want to stress test that. And on top of that, the bankers who are taking a look at these deals and are running their own models, they're going to be doing the same thing as well to really understand, okay, how does that fit into our risk profile, risk appetite to get comfortable with that. So it's an iterative process. And it you know, it starts off with sound financial understanding of the company and also the key goals and objectives. You know, the company and the seller shareholders. Absolutely. Absolutely. And then kind of piggybacking on that goals and the company goals and objectives and seller goals and objectives. For the next question, what role should the selling shareholders continue to play alongside the, you know, the new employee owners? Yeah, that's a great question. And it really depends on what if they're selling control into the Esop or not to what their overall retirement or overall succession strategy looks like. So I'll give some examples here. We do a lot of partially start ups. And what I mean by that is less than 50%. And the idea there is get some liquidity for the shareholders. And maybe it's in conjunction with their well timed retirement or overall exit timing from the company. You know, it could be several years out, right. You know, so on other situations we do 100% transactions. And again, we do a lot 100% deals here and often there. It's, you know, more immediate succession and meaning, hey, I built this company. I want to get liquidity, have an awesome management team, an awesome employee base who's ready to take over and let's get me bought out, you know, by way of this Esop. And I'll stick around for the next couple of years to oversee an orderly transition. So yeah, there's no one right answer there. It really comes down to what makes the most sense and what is the overall goals and objectives. You know, for the selling shareholders, for the company, you know, and so on. So we see it across the base, you know, some who don't want to retire, you know, until maybe 10 or 15 years out. But they want to execute this Esop now as one of their strategic plays, you know, get it set up and and really set themselves up and the company for success, you know versus hey, let's do the Esop. And I want to retire tomorrow, which we've seen that play as well. You know the the key thing here is really having a strong company, strong management going to really take the company to that next level and be employee owned, you know, with all the benefits that you get. I mean, so, you know, to really help you get there. Absolutely. That makes sense. And so can you speak a little further about maybe one of those sellers that's 10 or 15 years away from retirement? Can they remain on the board? Can they remain in an executive capacity? What what do you mean when you talk about, still being active with the company? Yeah, yeah. And again, it's okay. What is the intention with the Esop and one recent deal that we worked on earlier this year? The father and the uncle had started the company 40 years ago, and they were both retired. The son, who's now in his mid 40s, is the CEO and president and had us come in and saw an Esop to buy 30% of the company. And the idea there is get liquidity for those initial shareholders and spread ownership amongst all the employees and give them skin of the game because he has a great five, ten year growth plan. And since he's in his mid 40s, you know, his retirement is not, you know, going to be for the next 15 plus years. So Esop provided liquidity and it gave you that platform to really scale the company for that next you know, transfer growth that's going to happen with this company and in a marketplace as well. So a couple of years later, you know you can always sell more to these are very flexible and then possibly go 100% Esop. So that's one example. Other examples are selling 100%. However if the seller retains the seller note and is still, you know, possibly the CEO working on their overall succession, okay, they want to make sure the company is still being well-run. You know, it's paying the seller notes, you know, so on often you'll see them take a board seat. In that case, you know, along with and we'll talk about governance changes as well often independent members and so on. And you know, all the pins from the get go on what the initial board make up of the company is. Some of these companies have small boards, you know, very informal. Others have, you know, very much a formalized board already in place with independent members and so on. And, you know, if you move to 100% Esop transaction, you're going to see a very much a formalized board, you know, as part of the transaction. And we're seeing that in even the minority transactions as well, you know, so it's good for corporate governance, you know, to have that strong board in place. Absolutely. It and it it sounds like there's a lot of moving pieces. So you know, if I were to hire you question for here. If I were to hire you hire minky. What does a typical engagement include as we look at a transaction. Yeah. So we we start off with initial feasibility analysis, take a look at the company, its position, its marketplace, what that value range looks like. What are the key goals and objectives of the existing shareholders and of the company. Once we get to a an overall transaction structure, that makes sense, then we move forward with the overall deal that involves interviewing, aligning up the appropriate trustee candidates and their ability, and so their appraiser or their legal counsel talking to banks, doing a bank shop and overall orchestrating the transaction. So one value that we have above and beyond our 51 years in business is the fact that we have a full investment banking and legal team and TPA administration team in house. That really saves time and money for our clients because, you know, basically one team versus having to hire different parties, you know, who might be on different communication channels, right. And so on, and trying to orchestrate that. So, you have one team that execute the deal and then ongoing, we've been talking a lot about Esop transactions, but also we do that ongoing recordkeeping component and the ongoing advisory, related to that. So we have a lot of clients who have been with us on that side of the business for 40 plus years, you know, on that record keeping side. So we enjoy doing that, doing both the transaction itself and making sure that the company is successful in the future by being their Esop advisor and record keeper. Awesome. So I've got a company I hired Trevor to, Mankey to, to sell to my employees. And we've, you know, concluded the transaction. Everybody's happy. The esops in place. Question five is, you know, how do you or do you handle employee communication and that, you know, kind of cultural integration around employee ownership? Do you, do you stick around or are you gone after that point? Yeah. So employee communications is part of all of our engagements. So we have a team that comes out, works with the company on the employee roll out. I've done several. That was really fun to do because, you know, the minute the leaders of the company inform everyone, hey, we went Esop instead of being acquired, you know, by a third party, you know, whatever the case is, there's a lot of excitement in the room. So the challenge that all these companies have is to keep that excitement going long term is that it can be complex. There's a lot of education, you know, so on. So to solve for that, you know, we do the initial communication rollout, but we have an online dashboard called Satcom that all of our clients have access to, including their employees. So they can go on there and watch videos about these, calculate the retirement projected benefit, get the results statements and so on. So, you know, we've really found and that communication is ongoing, you know, not just one point of, you know, time and assets. But it's good stuff. And once employees understand it, which can take time, usually I say after three plus years of being in the Esop, you start getting these statements that start becoming material in value and when that happens, that's usually when any disengaged employees start becoming really engaged with the whole use of home concept, as when they see those statements that have a real value. Yeah. Yeah. You're absolutely right. You know, they've got a stake in the operations of the company now. And, three years in, I start to see some real money in an Esop balance. And that's that's pretty motivating. You're right. So we're moving forward. And when we're doing good things with this Esop. Question six what are there any emerging trends or regulatory changes in the Esop world that, as this, selling shareholder need to be aware of? Yeah. Good question. So, you know, a lot of the regulatory issues lately, I've kind of been centered around valuation. You know, Esops for the most part are we're talking about private companies, right. And, the trustee hires an independent appraiser, you know, who values a company, right. And there's a negotiation on price and terms, just like any other business M&A transaction. So a lot of the concern is on that, of course, is the fact that Esop cannot pay more than fair market value. Of course, we all know valuation is art and science and it's a range. It's not just one simple number, you know, five times profit or whatever. Right. You know, it's it's always a range. So, you know, we see that. And then on top of that, you know, plan operation, you want to have a strong team making sure that the plan remains compliant with the research. With IRS rules. There's things out there like foreign IP. This is an acronym for S Corp. You know, and so on that you have to remain compliant with and then on top of that, in terms of trends, one thing we're noticing is the trend for actually younger sellers lately who are very much, intent on creating a solid succession strategy well ahead of time versus, you know, waiting till their much later in their career and they might not have any other options, you know, so we're seeing that and that's interesting. That's fun because it's very strategic. You know, it's fun to work with planners who are thinking ten, 15 years down the road, what do they want to be doing where they want their company to be out, and so on. And also the idea of, hey, when you give employees skin in the game, they're ideally going to work smarter, harder, etc. you know, and have that positive outcome, you know, and we see that in these data out there as a lot of Esop millionaires, you know, that retire with, you know, healthy account balances, and other trends too. You know, we're seeing private equity, wealth being more interested in the Esop space. You know, whether it's putting them at Esop. Then we have we've seen that, you know, or they come in to buy an Esop, company and maybe retain the Esop, just owns a smaller stake or maybe Co-invest alongside. So, you know, we're seeing some of that out there. And then, you know, this renewed interest as well, I think nationwide, you know, with this idea of the Esop, you know, and since it's been in place now 51 plus years, you kind of go through these up and downs on its popularity. And I think we're, back on that upswing, you know, based on what we're seeing out there. Right. And when so many ways to create an Esop fund, any, they all look the same. Different companies have esops. Question seven what separates thriving Esop companies from those that struggle or ultimately win down? I think the biggest thing and I know this is a total cliche, is culture. You know, some companies that just have that culture where and Esop just makes tons of sense. Number two is the overall strength of the company. You know? And by that I mean what is their moat, you know, what is their competitive advantage. How are they going to stay positive cash flow well into the future. You know, often comes down to your your people and culture, you know, so, it's often that culture is is very important. And I you know, you alluded to this a little bit earlier, but so is succession planning. And, you know, the next line of, of executives, of frontline workers, that sort of thing. Question eight how do you recommend managing succession planning once an Esop is in place? Once we've got, you know, the employees on the company will say 100% for this example. Yeah. So yeah, that's definitely a board matter. Is overall C-suite succession. You know, so you want to understand okay, what is the runway we have with our existing C-suite? Is there a successor identified? If not, there's a board need to focus on finding that successor. You know, and that involves, you know, very honest, open and frank conversations between the C-suite and the board so that everyone's aligned. That makes sense. So alignment in the Esop, or not in the use of sorry, alignment as regards to succession planning and as it, as the future holds, how do you guide companies on board structure and corporate governance after an Esop? Question nine yeah. How do you guide companies on board structure and governance after an ISO? Great question Ben. And no two companies are the same. So you have to start off with we're and they have now what is their board structure like. And from there you have to iterate and say okay where should it be for any sort. Of course this is part of the negotiation. And, you know, is that it comes in and buys control. There's definitely going to be board changes. You know, you're going to professionalize the board, probably have more independent members on the board, more committees. Right. You know, and so on. So there's no right answer there in terms of what our initial approaches we always have to start where they're at today, meet them where they are and see, okay, what is possible because you want a very effective board. You want a high performing board, but you also don't want to be too overly bureaucratic. You know, right where you're having, you know, too many meetings and so on. Right? So, you know, in my opinion, the board's one of the main roles of the board is to make sure the company's performance, supporting the CEO, the C-suite, you know, so on. And and that would be an effective board. You know, the company is firing on all cylinders and the board is helping to make that happen. You know, so you start off there, see where they're at and see where they need to be. Absolutely. And you've talked a lot about culture and, implementing an Esop about once they've got skin in the game, the employees have skin of the game, that sort of thing. And question ten is going to kind of sound silly because you might be biased, but I'll explain in a little bit. What's your philosophy on employee ownership culture? And, you know, basically, am I hiring you to just get me to a transaction and get me paid? And then I'm, you know, riding off into the sunset, going and playing golf, whatever I do when I'm retired, or are you more concerned with Esops as a whole, the Esop industry as a whole, that sort of, niche in retirement plans? So, yeah. What is your philosophy on ownership culture, employee ownership culture? Yeah. So employee ownership culture. Yeah. Good question here. So when you think of employee ownership culture, it's more, hey, do I think like an owner, do I act like an owner? And do I care like an owner? That is ownership culture, in my opinion. It's hard to teach. It's hard to adapt. Some companies have it, some don't. Hiring us to do an Esop, you know, an install one is not going to change the culture. You know, changes people's pay. And, you know, they get this from retirement benefit accruing. And, you know, maybe some of the salary shareholders get a cash out, right. You know, so on, you know, and get liquidity there. But the ownership culture part, you know, that can be hard to change. You know, companies can hire consultants and so on. You know, to try to work on it. Can you work and change culture? Absolutely. You know, we'll do it. No. What will as you turn at the top. Right. So how the board treats culture, how the C-suite does, how the management treats it. And then on top of that, all the employees. Right. And, you know, there's strategies out there, open book management, you know, there's all these different plays out there. IOS entrepreneur operating system. He does another one we see a lot of our clients do and so on. So there's ways to, you know, try to get everyone adapting to that culture and everyone on the same page, you know. But, just in summary, culture is a lot of things, but ownership culture, my mind is, you know, does everyone at this company think like an owner? And by that, I mean, do they care about the company? Do they care about it's, you know, the future? And do they think about it the same way they would think about, hey, I own a house. I'm going to maintain that. Right? Versus, you know, maybe renting a house because the best analogy is no one rents, or sorry, no one washes a rental car. Right. You know, that's the same thing, you know, are you have a hired hand versus an engaged employee with an ownership mindset. Perfect. That's a perfect question to end on. Perfect answer to end on. Thanks, Trevor, for your time today. Why don't you let everybody know the best way to find you or get Ahold of someone at manky? Yeah. Thanks, man. And yeah, great talking. You can reach out to me both via email, website nike.com, LinkedIn Trevor Gilmore. If you find me, you know, I'm the one that works at Nike. There's a few of us on there. So yeah, great talking and thanks again. Great questions. Yes, there is something. Yep. I hope everyone learns something. Have a good day. Thank you very much. Take care. Take care.