Business ownership exit planning strategies continues to be an active conversation between our Cedar Rapids Bank & Trust commercial bankers and clients. A prevalent ownership succession strategy is the Employee Stock Ownership Plan (ESOP).
An ESOP is a formal employee retirement benefit plan that is set up by a company as an ownership transition tool, allowing employees to purchase ownership shares. Governed by the Employee Retirement Income Security Act of 1974 (ERISA), ESOPs fall under federal law that regulates most private retirement and health plans.
If you’re considering an ESOP as part of your succession plan, it is important to work with a commercial banking partner that understands the intricacies of ESOPs. These transactions can significantly impact a company’s financial statements, cash flows, and pre-transaction bank covenants. Having a financial partner who understands the nuances of these transactions helps ensure you’re prepared for the financial shifts that come with this structure.
Understanding the Financial Impact
A banking partner knowledgeable in ESOP financing can help you navigate the specific financial changes an ESOP will bring. For example, a leveraged ESOP can significantly increase your company’s balance sheet leverage (debt to tangible equity) ratio. This results from increased senior and seller debt, along with a decrease in tangible net worth due to the accounting treatment of a company’s internal ESOP loan.
Discussing these elements with your banking partner is essential for ensuring the long-term success of your ESOP transition. Other financial factors to consider include:
- Required debt principal payments
- Temporary working capital needs
- Capital expenditures
- Future stock repurchase obligations
- Non-cash expense items specific to an ESOP owned business
At Cedar Rapids Bank & Trust, we understand the intricacies of ESOPs and have years of experience helping local employee-owned businesses manage these transitions. Our team is here to guide you through the process, helping you address these financial considerations with confidence.
David Stoltenberg is Senior Vice President, Commercial & Industrial Manager at Cedar Rapids Bank & Trust. His direct line is (319) 743-7105.
