Common Misconceptions

For the majority of its thirty-year history, the ESOP has not generally been regarded as an option for leveraged buyouts. However, since the recent adoption of the S-Corp legislation in 1998, the viability of using ESOPs in leveraged buyouts has changed dramatically. In fact, in many situations, an all-cash leveraged ESOP transaction has pronounced structural and competitive advantages over a traditionally structured all-cash leveraged buyout. As the financial community becomes aware of these advantages, leveraged ESOP buyouts are becoming ever more prevalent. One of the major hurdles to wide adoption is the re-education of the general financial community concerning the misconceptions and unknown advantages of ESOPs and the false perception that they are unwieldy. Examples of some misconceptions and relevant clarifications are listed below

1. Investors can lose control.
Clarification: Investors and/or shareholders and executives can maintain full control over corporate governance after completing an ESOP buyout. For example, in going private transactions, an ESOP buyout usually results in no material change to a company’s board of directors or management. Even when an ESOP trust owns 100% of the common stock of a company, investors can effectively control their investment and the company’s board of directors through investment covenants and other control provisions. Regardless of how much equity the ESOP owns, the ESOP trustee does not assume board level control; the trustee typically maintains the right to approve board members. Moving forward, the board must simply treat the ESOP as fairly as it would treat any other stakeholder or minority shareholder.

2. You must disclose sensitive financial data to employees.
Clarification: There is no requirement to disclose corporate financial data, capital structure, or executive compensation. You need to disclose only specific information regarding the ESOP, such as the value of each employee's account, or the number of shares each employee beneficially owns. The exceptions are for major divestitures or change of control transactions, which require shareholder approval and substantial disclosure, just as would be normally required for any other form of corporate ownership. Such approval and disclosure is not necessary for most investor related recapitalizations. Intrepid Equity Group, however, subscribes to the principal of Open Book Management, as implemented by The Great Game of Business, as the best tool with which to capture the full potential of an ESOP and management and employee ownership.

3. Investing in an ESOP dilutes an investor’s upside.
Clarification: While investing in an ESOP transaction provides a sharing of the upside with employees, investors do not loose upside potential in a properly structured transaction.

4. ESOPs deter an Exit strategy.
Clarification: ESOPS can be bought out, terminated, or converted to a profit sharing plan. As a practical matter, since it is often much more efficient to keep an ESOP in place than to buy it out, most investor exits from ESOP companies traditionally occur through recapitalizations.

5. Employees aren't interested in ESOPs.
Clarification: Quite the contrary - once properly enlightened and motivated employees understand the benefits of an ESOP (and, potentially, Open Book Management) and the fact that they have no personal liability, productivity increases dramatically. Studies show that ESOP companies are more profitable and experience growth rates that exceed those of none ESOP companies, with one-eighth the failure rate.

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