The Zero to 100% ESOP Seems Daunting Is There an alternative? Midwest ESOP Conference Minneapolis, MN / September 10, 2015
Introduction Alternative Structures for New ESOPs Partial S Corp. ESOP 100% S Corp. ESOP Transactions Involving C Corps. 2
Partially Owned S Corp. ESOP Requirement for single class of stock Impact of tax distribution made to non ESOP shareholders Enhanced flexibility Benefit levels Length of internal loan Payoff of external loan Future transactions 3
100% S Corp. ESOP Long term goal of many companies Great tax and cash accumulation benefits Other considerations as discussed in case study and financing update 4
C Corp. Transactions Consideration of Section 1042 treatment Consideration of remaining C or converting to S after transaction Built in Gains Future Sec. 1042 treatment 5
Who Are We? Founded by Steve Silver in 1983 in Texas He sold imported furniture and other products in flea markets Grown to $140M in 2014. Second largest casual dining and occasional producer in the US. Focused, low cost importer and distributor 220 employees, 500,000 square feet distribution center 4 Asia offices, 63 people on the ground Company converted to a majority-owned ESOP in 2011 Company awarded prestigious NCEO Excellence in Ownership Award for innovative business processes and is ranked as a top ESOP 6
Results 2014 Price Per Share 7
How Do We Do It? 8
SIP Teams What is a SIP Team? Cross functional team of people All have a stake in a strategic issue Purpose of SIP Team? Establish direction and focus for a strategic issue Align people Motivate Create better buy in Develop leadership bench strength SIP Examples Establish internal QC standards and a real-time Asia/US QC reporting system Result: Reduced quality-related returns by 30% Create internal credit and collection s group Result: Reduced expenses over $400K Establish off-site insurance captive Create ecommerce business unit that does <$20MM Develop a supply chain finance program 9
Top Five Reasons to Do A Partial ESOP Transaction 1. Allows for a broader choice of financing options. 2. Cost of capital is less than a 100% transaction. The more leverage, the more it will cost you. 3. Provides flexibility determining how to structure 2 nd Tranche. 4. Allows you more operating flexibility after using an ESOP as an effective change management tool Goldilocks and the Three Bears Approach 5. Allows you to test the resilience of your senior leadership team and your ESOP team. 10
OCC Guidelines Top 100 financial institutions in the U.S. Leverage Lending Total Debt > 4.0x EBITDA Full amortization of debt: 50% of Senior over 5 years 50% of Total debt over 7 years Additional scrutiny FDIC as well Seller Subordinated Debt = (or not) Equity 11
Impact of the Valuation Multiple 5.0x Multiple 10.0x Multiple EBITDA $5.0MM $5.0MM Total Debt $25.0MM $50.0MM Senior Mezzanine or PE Seller Existing Qualified Plan Secure senior financing Represents the sellers cash at closing Subordinated to the senior lender Private equity structured equity Subordinated to the senior lender Small cash pay interest and warrants Rollover of account balances Substitute benefits Senior 2x to 3x EBITDA Mezzanine or PE 0.5x 1.0x EBITDA Private Equity Seller Transfer from 401(k) Valuation Multiple 5.0x Twice as much Debt Valuation Multiple 10.0x 12
Disadvantages of the 100% S ESOP Compelling tax savings in the 100% S ESOP Risk adjusted impact of tax savings Reduced financial flexibility Business cycle planning 10 years of EBITDA in a 10x multiple company Growth funding may need to be delayed Impact of ESOP repurchase obligations Restructuring costs are high Sellers subordinated debt tax risks Regulatory risks DOL Meaningful benefit to the employees Design of the internal loan 13
Design of the Internal ESOP Loan Important ratio Redemption transactions Valuation multiple Staged purchases Manage the repurchases Plan design flexibility Delay 5, pay 5 Delay during the ESOP loan 5 year installments Recognition of past service Contribution limits Payments on the Internal ESOP Loan PAYROLL (Eligible) 5.0x Multiple 10.0x Multiple EBITDA $5.0MM $5.0MM Payroll Estimate $10.0MM $10.0MM Internal ESOP Loan $25.0MM $50.0MM Term of Internal Loan 10 years 20 years Benefit Percentage 25.0% 25.0% 14
Contact Information David Corbin Steve Silver Company 888 400 8113 ext. 1230 dcorbin@ssilver.com Kim Abello Wells Fargo & Company 312 630 2487 kim.abello@wellsfargo.com Dave Horvath Crowe Horwath LLP 630 586 5117 david.horvath@crowehorwath.com 15