Is it a Good Deal?
Employee Stock Ownership Plans (ESOPs) present an attractive financing tool and ownership structure for both publicly and privately held businesses.
ESOPs can be very complex. There are many moving parts.
Lawyers, investment bankers, consultants and other advisors love complexity. In fact, professionals often thrive on complexity. Somehow complexity conveys an aura of expertise, and of course, expertise demands high fees.
However, the structuring of an ESOP and the decision-making process undertaken by the various stakeholders (plan sponsors, plan fiduciaries, advisors, etc.) should not overlook very simple questions: “Is this a good deal?” “Do the economics work?”.
In transactions of this nature, there is lots of pressure to “get the deal done.” Pressure by selling shareholders and pressure by the bankers can all be significant. But, it is a fiduciary’s job to ask the simple questions.
In Fish v. GreatBanc, a recent decision by the Seventh Circuit, the Court outlines what amounted to a bad business deal. Although the precise issue decided by the Court focused on the application of the relevant statute of limitations, the underlying business deal was not pretty.
As noted by the Court, and repeated by other bloggers, Steve Rosenberg, What Happens to Company Owners Who Get Overaggressive When Selling out to an ESOP?, outsider advisors to the independent fiduciaries characterized the transaction as “the most aggressive deal structure in the history of ESOPs.”
Wow. When an advisor puts that warning in writing it is best to pay attention. (Remember, it will be part of the record if the deal heads south.)
While many lawyers have commented on the legal issues, I’d like to provide a practical perspective, as an Independent Fiduciary.
At the outset, it is important to note that “aggressive” –taken by itself — is not necessarily a negative or a bad thing.
Many “aggressive” investments may still be prudent. But, in the parlance of modern portfolio theory, an aggressive, or high-risk investment, must be compensated for by a higher rate of return. High risk. High Return.
In addition, the risk of an investment must be assessed in the context of the composition of an entire investment portfolio. High risk investments must be balanced with lower risk investment so that the overall portfolio reflects an appropriate risk level.
ESOPs present a unique challenge when it comes to risk. That is, the company stock held by the ESOP is the sole asset held by the plan (other than some cash).
In the context of Fish, once the deal was characterized as “aggressive”, it was then the fiduciary’s responsibility to dig in. What gives rise to the nature of the aggressive nature of the deal? Are there ways to mitigate the aggressiveness? Can the plan be adequately compensated for the risk inherent in the transaction?
This analysis must be a collaborate effort, undertaken by the fiduciary, the plan sponsor, and the selling shareholders. The analysis is not intended to kill the deal. To the contrary, the analysis is designed to enhance the deal, to afford protections to everyone involved, not the least of whom are the plan participants who must get a fair deal.
ESOPs can be very compelling structures for all stakeholders: owners, plans and plan sponsors. However, it is the fiduciary’s responsibilities to make sure that the risks and rewards are prudently shared.
As an Independent Fiduciary, it is my job to exercise discretion as a “prudent expert”. While prudence includes following various processes and procedures, it also demands me to ask, “Is this a good deal for the plan?” Financial advisors and investment bankers, it is your job to persuade me that, in fact, it is a good deal.