We find that once an ESOP closes, there is some degree of uncertainty on the next steps. In this episode, we focus on the ESOP closing guide to prepare clients on the correct ways to implement the organizational structure and timeline of a successful ESOP. In other words, we cover how to accomplish a company’s goals in the transition of an ESOP that take specific knowledge of timing and communication.
We find that once an ESOP closes, there is some degree of uncertainty on the next steps. In this episode, we focus on the ESOP closing guide to prepare clients on the correct ways to implement the organizational structure and timeline of a successful ESOP. In other words, we cover how to accomplish a company’s goals in the transition of an ESOP that take specific knowledge of timing and communication.
[0:10] Hey everybody this is the SOP guy we're on a journey to an ESOP and Beyond welcome. To the podcast if you're brand new this is a free resource we've been doing this is our fifth season the whole goal here is to give you a resource that just gives you good information factual information about Employee Stock ownership plans. We can find more about what we do at journey to an ESOP calm and if you've been listening. For a while thank you guys for continuing to listen and excited to share this episode with you.
[0:52] You men able to eat something that far awayI don't know him I never saw him before.
[0:59] So here we have as we start off the episodethis is coming directly from, a movie you may have seen um I watched it over the the long weekend I thought it was just fun to catch up on an old movie quickly Down Under, and so this is a an old movie with Tom Selleck and you may have seen it or may not have seen it in this scene what we're talking about is this this shot that he's going to make with this this rifle so as we what he's doing is he's basically got to Australia he's going to be hired by this really bad guy and we'll see what happens, it have to be a good shot all right.
[1:42] So this guy's driving out his horseFar Far Away out there about there I'll do.
[1:54] He didn't hear that.
[2:11] So here's the scene where he's going to walk up and make the shot so let's just as we stop this real quick and then we'll and then we'll play it in a second let's just say like number 1 the guy wrote his horse out with a bucket and he goes out 782 yards. That in fee is 2346 feet, and um write a little under about a half a mile so that's a pretty long shot right so that's what we're what we're talking about in this episode today we're going to talk about making the long shot you know as it counts and 1 of the things we're going to talk about is related to. Um of course esops and I'll talk about the topic in a second but let's see if he makes it.
[2:49] Music.
[3:39] You quite certain Mr quickly. Why do people interrupt people when they're trying to do things I don't understand it but anyway so here we go.
[3:55] Of course he goes right through this the bucket so that's all great of course he's going to make the shot this is all about the movie. Proving himself to be an expert Marksman and so I don't know how many people can shoot something a half mile off and especially you know in the idea of an old movie. But the point is at the topic today is is making you know the long shot count and the idea here is to. Um think about the ESOP itself and what we're going to get into today. Is how to start off on the right foot so sometimes I mean whether it's something we're working on or something else is working on, the deal the ESOP transaction is eventually going to close and so some of the things we've been highlighting this year is the whole journey to an ESOP and Beyond.
[4:43] And what we're trying to get to is some of the best practices we're seeing. Some of the things that we're we're trying to do and accomplish so that a couple things as we start thinking about this episode it's really going to be about. How do you how do you dig into and what sort of things should you be digging into coming out of closing. And so um I we generically have talked about this in a couple different ways but we're going to just be really um in this episode trying to cover all the bases of things that should be on your mind as you get. Through that and start you know looking to close your transaction either you're working on that now or you've already done it and so this might be a good, a good topic to be thinking about reminding you and this would be more for companies that have finalized their maybe their first year of their ESOP. Um it also could be things that you may have not thought about an existing ESOP world so that'll be kind of our our direction today.
[5:40] So thank you again for listening please go to our website at journey to an ESOP Comm for more information, about the practice about the podcast of course if you have questions please go there if you like this podcast rate it and review it give us a big rating a great rating and share it with a friend I always think that's helpful if you know somebody and that's thinking about doing an ESOP I think this is this is a good resource that they could turn to to learn more about. Um how Employee Stock ownership plans workso let's just talk through as we as we go through that and the reason I was using quickly the first off with quickly Down Under.
[6:17] I would just say that I don't know if anybody's thought about this but that's a weird cowboy named right he's not why he's not you know, um Maverick or something he's he's quickly so. You know it works for the movie I think it's a cool movie but it's not a super like cowboy named that we're probably used to however.
[6:36] That like I love cowboy movies I love western movies and I think he's a good cowboy I think he did he did a good job of of being in that and 1 of the things about Quigley is his character is it's like he does the right thing and that costs him a lot of. Issues right so he's like I'm not doing what this guy the bad guy Marston wants him to do who which is to eliminate the aborigine populations I'm not doing that you know he stands up for people that are are definitely can't defend themselves like and that's how he ends up, with crazy Kora if you watch the movie. So 1 of the elements of that when I think about Employee Stock ownership plans in general is that people want to do like the right thing as they go into the ESOP the the goal here. At least in how I how I have portrayed this and I believe this philosophically and even ethically is that we want we want help everybody win and that includes the company the shareholder the employees the key people everybody involved on that side of things so if we're going to do the right thing by people we're going to have to follow as we think about this all the things that are going to come about and the reason I likethe Quigley Down Under episode that we're looking at is it really does take. A lot of of intentionalityand skill to make what I would say is the long shot the long shot is like how do we aim towards where we're going.
[8:00] Um and if you if you if we break that whole scene down I mean there's a lot of like space in there but the idea is like he's he's setting up the shot right and he's. He kind of has this experience so he's got this already confidence going but you know he he knows the wind direction, he knows like how to you know aim and click and and know where that bullet's going to go and and really when you're aiming a bullet like that you're like looking at it like this long.
[8:29] You know this goal that's going to happen over this period of time that it's going to take to to travel all the way that distance it's pretty unbelievable when you start really thinking about it and so 1 of the things I'm I'm I'm wanting to try to really. Build and Foundation here is that the more preparation you have not just you know I spent a lot of time and all these different seasons talking about preparing for a very good transaction. Part of what I'm talking about today is the continuation of that and the planning that goes in even before you get there from a post ESOP standpoint, so what I'm what I'm going to walk through is what I would say is is just good a good overview of some of the things that are going to come into play. And things that you're going to want to think about when it comes down to um what should you do after the ESOP and so. First thing is is that you know you're you're going to want how do you get all of that information that came through from the closing into the companies. Information B balance sheet income statement the financial information um into the you know the documentation of the of the plan itself into the companies like who needs to be part of that.
[9:48] And then what's what's important because some things have obviously changed right and whether you've done it 100% ESOP or you've done a partial ESOP.
[9:57] You know you're not like you're you're not what you were before right so you have a new. A new shareholder which is the trust that owns the shares which is man managing governed by the trustee. So what what we're doing here is really trying to make sure that categorically we've thought through um all of that so so 1 of the first things is is is just in informally speaking you're going to be presented with the from the ESOP attorney with an with an entire legal binder, of course nowadays that's all digital and in that legal binder there's going to be just a whole bunch of information on what the documentation was to trans for the transaction itself and within that documentation you're going to of course have things like the plan document and the trust document you're going to have the purchase and sale agreement you're going to have the promises and all of the all of the documentation related to the warrants and the SARS and all of the things that are going to be important for you to access so first first things first right the the legal binder itself.
[10:59] As you think about closing the transaction there's a preliminary what I would call preliminary legal binder that happens before the true up now the true up. Happens when your purchase price whichexperientially it's kind of like everybody's purchase price is going to be based on a couple variables first it's going to be the Enterprise value of the transaction and then the other part is going to be the required working capital and when you do your closing what's happening is you're going to estimate the value Equity value at the time of closing based on preliminary datauntil you finalize that data all the way through the month end of what you're closing. So that means that the binder that originally gets put together can be subject to change, if the purchase price goes up or down based on the true up of working capital afterthe closing. So the first thing to do to think about really is the idea that you're going to want to get that information accurate and input into your system correctly so. As we as we do that what I would say is that you're not alone.
[12:08] Um the depending on the structure of the company you might have an existing internal team that is phenomenal when it comes to um accounting and, um documentation and HR and all these other pieces right so so keep in mind I mean everything I'm saying is is always going to be prefaced with this it really kind of depends. On who your existing team is and how you go about this um. Preparation for the long shot preparing right so we're building that that idea of the foundation so we, hear what we're really trying to do is make sure that all the information is put into your system correctly once we get the final legal binder um whether your existing team is internal, or you're looking for some support there there are obviously some CPA firms that are have have the knowledge base um for esops, to help interpret as say you're the CFO or the controller or the primary um, person who's in charge of all that who can help you interpret that data to make sure that all of those entries are booked correctly so 1 of the very first things is is making sure that you've walked through the the change in the cap table.
[13:24] With all of the changes to the equity that are correctly stated, and so understanding what the cap table means includes the um issuance of shares and a lot of times when we're looking at the closing you're going to have a potentially a stock split where we increase the number of shares so that what goes into the trust is actually going to have um a lot more shares in its trust than you might have in the existing cap table that the company goes you know has has existing so there might be that stocks but so understanding the cap table is going to be important making sure that you understand that in terms of its its impact on the the common stock and and the new treasury or the actual um Equity section of of the company, 1 of the the next things is is really recording the Redemption of that stock so in in, obviously in order to purchase the stock there's you know from the shareholder to the company and putting that into the trust there's going to have to be Redemption and that's going to have to be booked um recording any debt that's related out of that so anything that.
[14:34] The company has has incurred so of course if I have senior debt with a bank institution at the time of closing recording that debt correctly if I have for specifically for an S corp if I have. A AAA account which is your your tax basis there generally is a AAA note and a seller note. So the whatever's financed at the time of closing.
[14:58] Um from the bank whatever is left over in the valuation is going to go into the into the Redemption piece for the seller's subordinated debt that's going to get divided between the amount of AAA at the time of closing which again is subject to True up. And then that'll be um whatever is left over from that will be booked as a seller note all of those notes are going to have obviously be booked on the balance sheet.
[15:21] So um the other side of that is going to be recording the sale to the ESOP and so the idea of booking the unearned ESOP shares on the. On the equity section which is a contra Equity account so so again all of that as I go into some of the details are really the helping to book the accounting. Elements of the transaction and um that's going to be really an important element.
[15:47] What happens or could happen if if that doesn't get done correctly at the front end then you may be booking entries after that. That are that are going to be difficult to follow and then you're going to have to have some kind of cleanup process that you're going to have so let's just say that you don't do that correctly in the front end and then you go back through your your annual year-end audit or review, with your CPA firm they're going to have to go back and and make sure that's cleaned up. A couple things that that need to happen within that is you're going to have this um all the amortization schedules need to be, attached to all the documents again those are going to be after the true up but the idea of the amiz schedules is going to give you the information to set up the payments correctly on your system. So that's going to be helpful to start thinking about.
[16:38] Um for as far as setting up the administrative function of actually paying out, you know whether that be the bank bank note plus the interest only component of the seller note making sure all of those are done correctly. I would say it's helpful to go into the closing with the mindset that we or it's going to take a little bit of time. Depending on the advisors you're using.
[17:05] To get the legal binder all squared away so before all that with the true up and all that it's going to take a few months probably sometimes to get all of those set up correctly before you start making all these payments. Um on of course you're going to need to make that payment right away to the bank whatever their terms are but for the seller note payments it may take a little time to get that you know done and caught up correctly so um but it all starts with. You know the thing with accounting right. Which sometimes it's 1 of those areas where you just don't want to but you got to do it the right way at the front end so that you can avoid, you know the misery and again that's those are the kind of the things that happened to make sure that you're aiming correctly down the road here to make sure it's all you know put together correctly, um some of the things that that can come up and 2 is the next step like what happens on taxes so you need to have a pretty good tax plan going into the ESOP transaction. Um depending on what you are as opposed to C or an s or how you're structured at the time of closing. What's happening right after closing and so 1 of the things that does happen is the attorney that does all the documents will get the IRS determination letter um but you do need to I do like, advise people to do some kind of tax planning before the transaction so for instance if I'm an S corporation.
[18:28] Everything up to the point of the closing is going to be the responsibility of the shareholders everything after, that from an income standpoint is going to be the companies um exemption for taxes so understanding how to like plan that is going to be important, um in terms of of building out correctly specifically for the existing prior shareholders that just sold their stock.
[18:52] So 1 of the things about umroles and responsibilities is is I think too it helps to kind of know. Who's doing what when you get down to it and so if you think about like as I said the the ESOP attorney that does all the plan documents is the person, in persons that will provide all the information going forward they're the ones that are responsible to make sure that legal binder has been put together correctly and everything gets gone in there now the sell side advisor. Will be likely doing a lot of the work to help the true up process clean it up do the amp schedules and all that they're going to feed information to the erisa attorney to help make sure that that document was done correctly and everything's in there.
[19:36] Um as this as the company goes into warrants in SARS and and these are going to be synthetic Equity programs that are available in a transaction that get closed, at the time of the transaction the warrant part as we start thinking about what happens those are going to be shares that are going to be issued at the time of closing. In exchange for the for the risk that the seller's taking on their seller note and those warrant Shares are going to be, um part of the forecasted financial statements right they're going to need to be in the ongoing financial statements as well so there's going to need to be a process with your CPA firm whether that be an audit or review to go through um and know that what what the accounting rules are behind booking the um the liability related to the warrants and the SARS so so closing out 1 thing is is that needs to be thought through and the other thing that kind of comes up out of that too is is understanding the projected financial statements going forward, are going to include some of these new things that you haven't had to include before.
[20:43] So let me just say it this way like what I would say is that you're as you're starting to kind of think about your closing if you're in that stage. You know be prepared to to make sure that your providers your third-party, advisors from a CPA or whoever you're using are experienced at of course number 1 ESOP right understanding odisha understanding an ESOP shares all the all those pieces and parts, um secondly that they're they're knowledgeable about the effect on your financial statement.
[21:17] Um sometimes I've seen that happen where we're not the CPA firm but the the firm didn't know, that was going to come and then went through all those things and then they got the financial statements back and the and the companies like oh wow that's that's not what I thought it was going to be so being prepared for that because. Um you're going to be preparing these financial statements for the third parties particularly obviously the senior debt holder the bank, and then also for any other reason right it might be the bonding company it might be you know um other reasons to have it and you're going to want to know how those financial statements are going to look so it may be helpful for you to ask. For maybe your CPA firm to provide you a if they do this kind of work a sample or some type of like. Meeting to go through what the impact of doing the ESOP with all those elements would be and so being prepared for that would be really really helpful.
[22:11] 1 of the things that comes up with closing in the the whole final package of everything is is what happens with first off because we have a retirement plan. Out the ESOP itself is going to be this trust that holds stock and this is going to be a retirement plan. Um we know that we're going to have to have a third party administrator we know they're going to be hired you know at some point either before the closing or after the closing and we know that they are primarily responsible. Of course to to file the the right form so you're going to have the 5,500 that's going to be part of their responsibility um, if you have a situation where the company is large enough then there's also going to be requirement for the audit for the employee Benefit Plan, itself which is going to be part of the new normal and so it's typically around 100 employees or more and so you need to know that that's going to be a requirement as you go into it compliance deadlines are I think are really important if this part so when you're starting to look at you know all the details of setting this up correctly um you're going to want to know when. In what like source of what you're going to have to provide the TPA secondly when all that's going to be required so that you don't miss a deadline for the filing and that can be um expensive to miss because there are penalties and fines related to that.
[23:37] Um now what I'm talking about here again is that when you you're going to have honestly experienced ESOP people around you doing the closing um I'm going to be you know super shocked if they don't know how to advise you on this um but I think it's important to have this condensed idea of things coming out of the closing that you should really be mindful of as you go through the process so that's really what where we're going with all this um and trying to put this in order. Towards what really is somewhat best practices or things to think about. Um as we go forward 1 of the 1 of the key deliverables that I would be wanting to craft is an overall ESOP.
[24:22] First year timeline and then maybe first and second year timeline now. The timeline basically is is coming back to some of the things that are compliance oriented but I would say it's not just compliance oriented it needs to be in my mind it depending on who. Working with to advise you or what you're trying to accomplish you really want to like dig into this timeline idea and say on an all-in you know comprehensive basis. These are everything that we want to accomplish in this first year when it comes down to the ESOP so that could include. Thymulin out a communication strategy and in some rocks there it could be include some educational. Um opportunities that you have you know so you you would start with what I would say is a skeleton timeline of everything that absolutely needs to be done at what date and who's doing it, right so we know that that could include you know internal your team there it could include the um obviously the third party administrator um it could include things like you know just incorporating some of the term sheet language into your timeline so we know that once you come out of the gate you know they're going to have to you're going to have to create a board of directors and that board might need an independent director or multiple independent directors. So you know comprehensively where does that fit on your timeline you know and what date should that board meeting be you know on the calendar and and getting ahead of all of those things so that you're not.
[25:52] Over I think the timeline for me is is so you're not really overwhelmed.
[25:56] And then surprised by something and 1 of the things about this element of what we're talking about that I think is helpful.
[26:04] Is the more overwhelmed your internal team is with all the different responsibilities that can come with an ESOP.
[26:11] That is going tobe obviously anxiety and stress that they're going to have and that's going to communicate through the whole. The whole thing so you want to have this level of confidence so that when you announce the ESOP to your your employees which is all part of that communication which can be put in your timeline. Um that you're kind of starting the clock like people are looking at things and saying okay well what about this what about that right and so if you're if you're muddling through the the all of these things and then, now you're surprised that's going to create a lot of other elements of issues that, you don't really want when you get down to it so um my my advice on the timeline is use your advisors really well, and workshop out all of those things so hopefully as you've partnered well with people they can come to the table and in some cases. Like with the way we do things like we'll do, preliminary timeline will come to the meeting with all that get that populated as we go um and then do workshopping together with other advisors of course the TPA C it could include the trustee and and different parts of your team.
[27:19] So so now as we think about it 1 of the 1 of the easiest things to do and it's really going to be helpful I think for for new team members is it really probably would be helpful to do a comprehensive contact list. So 1 of the things about like this is there's a lot of you know if you're brand new to esops what happens is you're there's a lot of players in the situation so you have you know in the transaction side you're going to have a a sell-side advisor you could have an ESOP attorney on the company side you're going to have a trustee. That trustee is gonna have an independent valuation firm they're going to have that trustee is going to have an attorney um then you going to have the TPA you're going to have of course your own you know independent counsel sometimes you're going to have. Um you're going to have other players too that maybe your CPA firm that have partnered with you along the way um. All of those people you know are going to be important and it's it what I find is like.
[28:18] Having a comprehensive contact list helps your entire team that you're trying to bridge in you know as you start to think about.
[28:27] The closing process 1 of the things we've talked about before is having this ESOP committee and with roles and responsibilities so providing a comprehensive overall, contactless is really helpful for everybody to know kind of who does what right and who so who who they are first but then what function do they have like what should I expect. In my company from the trustee going forward as the as a new person coming into this whole equation. You may know everything about that they may know nothing about that so so part of this is to document that. So that everybody kind of has a good idea um going forward um how to get a hold of these people and making sure that that is part of your whole process.
[29:10] Now some of the things that you want to consider that should have been considered early in the process is like how do you you know educate people on certain things so 1 of the things that I would say in your planning is is. The this whole concept of of education is going to be important for your people so what sort of documentation are you creating at this point to educate your, uh your employees and how does that get rolled out in terms of information and maybe that's through. Um your roll out meeting maybe that's through documentation that you're producing and and hand with handouts all of those things should be you know thought through and Incorporated. Um some of the elements of that could include education on the diversification rules for an ESOP so you may be um wanting everybody to understand like that's a big part of, this retirement plan and and how that could really work um in terms of making sure they understand it.
[30:12] Uh when people like some questions might be in that documentation when people are ready for a distribution how that might work. Um what would be the distribution policy in terms of of making sure that. Um managing all the cash flow related to people potentially leaving the plan down the road, um understanding the implications of what the repurchase liability obligation study is and when it should be due, um I would say most of the term sheets that we negotiate that's going to be pretty clear that it's going to come after the closing um it's not going to be literally right away right because it's not that big of a deal right out of the gate however over a period of time it's going to be it's going to be needed and, some of the things that can come up that I think are important related to that are what happens in the event that the company does does go through a downturn so some of the.
[31:07] Um potential, work here is to kind of prepare for anything that can come about so this is again just some things that you know your advisor would be talking about but in a downturn what would happen if the companies laying off people at what point would we have some repurchase liability issues at what point would we have an IRS issue when we're having certain levels of of contributions, not not being able to be reached because we our payroll goes down below the 25% so so these are kind of the like I would just say I didn't want to get too deep into those topics because we're going to cover some of that stuff but in general just to kind of a good overview of things that coming out of the gate.
[31:51] You want to have kind of documented in I would say some type of of umeverything that you can think of that's important and. I think this could come from you know the advisers but it's something that you also could create on your own um and just getting getting ready for all of those types of things I think they're in my experience there's usually some anxiety from the internal team.
[32:16] Wondering hey what are we supposed to do and when are we supposed to do it so this may be something you're already addressing or already have addressed um but getting that making sure you're prepared to be a super successful ESOP. Um we have to continue to pay attention all you know all of those details and so. Um hopefully as you as you listen to this and you start thinking about your own ESOP and your closing you're really ready to go and um there might be things in there that that we didn't even identify in this checklist that are going to be something that, you know that's there so I didn't want to make sure that we that we try to cover all of those areas but there might be other areas that, that we may have missed but I think the highlights are there for you as you start thinking about it. So with all that thank you again for listening today and um I'm super excited to just continue talking through esops because I think it's so helpful for people. To as they anticipate that or they're in the middle of a transaction or if they've already gone through that to really think through what they're doing so thanks again for listening today and we will see you on the next step on this journey to Nissan.