WashingtonTechnology.com
had two ESOP-related articles online this week, and previously posted an article back in June.

American Systems Corp. (Chantilly, VA)

Sweet dreams tells the story of American Systems Corp., a technology provider that recently paid off their ESOP loan and is now a non-leveraged ESOP that plans to grow at 20 percent or more per year:

"Hoover has unveiled an aggressive acquisitions campaign for American Systems, of Chantilly, Va., an employee-owned information technology provider….Having liquidated the debt, American Systems is now in a position to grow significantly, he added, with a long-range financial plan to reach the $650 million to $700 million revenue threshold by 2012.

"Our desire is to move beyond the $650 [million] into the $1 billion, $2 billion, $3 billion range," he said. "We believe that there is a real opportunity for an employee-owned company to be successful. We have to get to the $750 million to $1 billion level in order to compete effectively with the large guys across a broad spectrum of capabilities.""

Paying an ESOP loan too quickly

Employee ownership takes careful management
discusses the importance of not paying down the ESOP loan too quickly:

"Because the employees initially hold a note on the company, ESOPs are required to make annual debt repayments into employee accounts. If you start to pay that note between the company and the ESOP too quickly, you could push too much value into employees' accounts, overcompensating them, he said."

In addition to overcompensating the employees, the employees may form an expectation that that they will continue to receive large contributions in future years, which may be unrealistic to sustain. Proper communication can help minimize this expectation.

Mirror Loans

If you have extra cash flow and would like to make additional loan payments, another option to consider is making payments on the loan between the company and the lender but not on the loan between the ESOP and the company. While the ESOP loan and the lender loan are often "mirror loans" with the same terms and payment schedule, they do not have to be the same (unless specifically provided by the loan provisions). This option will allow for the cash flow to be used to pay down the loan to the lender while providing a consistent contribution to the ESOP.

Future Repurchase Liability

The article also emphasizes the importance of understanding and preparing for the future repurchase liability:

""You've always got to be very cognizant of ... the demographics of your employee base and ... how big this potential repurchase obligation might end up being," he said.

Jackson advises his ESOP clients to understand their repurchase liability because "when you don't monitor it and it sneaks up on you, you have a much more constrained set of options to try to deal with it.""

ESOP Eligibility in an Acquisition

The article also discusses how to address the eligibility of new employees in an acquisition, including operating the acquisition as a "stand-alone subsidiary with its own infrastructure and benefits plan" or contributing new shares on an annual basis, "which shouldn't lower their value, especially if the acquired company is worth more than its purchase price." For more information, check out: Addressing Benefit and Compensation Issues in an M&A Transaction

Government Contracting Rules Depress M&A Market, ESOPs Still a Viable Option

Small businesses on the block should explore ESOPs compares selling a large business to a small one, and discusses how new government contracting rules that require a small-business recertification immediately after acquisition "will depress sales prices for small-business acquisitions that do happen and prevent some of them from occurring altogether." The article proceeds to recommend an ESOP as a viable and over-looked alternative, stressing the tax and psychological benefits:

"An owner selling a company through an ESOP enjoys a tax benefit and also leaves a tax benefit for the company. A shareholder selling shares to an ESOP is permitted to take the gain from the ESOP sale and, as long as he or she reinvests it in an "operating business" within one year, defer tax on the gain. The company's tax benefit comes from its right to deduct from taxable income both principal and interest on the debt incurred in funding the purchase of ESOP shares, which can be repaid in pretax dollars. This is a significant advantage because most corporate debt is not deductible and must be repaid with post-tax dollars.

There may also be a psychological benefit. The exit of a significant stockholder can be disruptive, especially if the person is also a key operating executive. Employee ownership may provide a sense of continuity in which continuing employees find not only potential financial reward but also comfort that the reins of the company are in the hands of fellow employees they already know."