Bragging Rights or Take Home Pay?

One common knock from investment bankers about ESOPs is you can't get the best price using an ESOP. While it may be true that strategic buyers can pay more than financial buyers or PE firms, what matters most is not what you get but what you keep.

A leveraged buyout using an ESOP provides unique tax benefits to sellers, companies and employees. Structured properly, sellers can indefinitely defer their capital gain taxes and create a corporation that is exempt from federal and (most) state income tax. Eliminating the sellers' taxes is obvious enough, but think about the value of having the additional cash flow from not paying taxes to service debt and grow a company...

The objective comparison of an ESOP transaction and a taxable sale should be the after tax proceeds. Clients often ask us to compare the "equivalent" sale price of a tax deferred ESOP sale vs. a third-party taxable transaction to help them decide if a taxable market price can compete.

In one such instance, shareholders wanted to know whether or not to go to market to assure themselves they received the highest price. The analysis we prepared established a sale price equivalency for an ESOP buyout with deferred taxation compared with a taxable third-party sale. PHA estimated the equity value for ESOP purposes to be $45MM (6.3x EBITDA). Using tax and company data, we then derived the required third-party sale price needed to net the same value as the ESOP. As the chart shows, the taxable stock sale equivalent price would have been $60.1MM, or a 8.8x EBITDA multiple. This difference would have been larger if the buyer purchased assets.

The reality was the third-party sale would have had to be 34% more than the 6.3x EBITDA value for internal buyout using an ESOP. While it may also be true that some companies will command such a premium, this analysis illustrates why it is so important to think about what you'll keep versus what you'll get.

AUTHOR:   Robert E. Massengill

POSTED IN:   ESOP