EP9 - Tin Cup - ESOPs - The Road Less Travelled

In this episode, I discuss the tension of making these choices around ESOP - but not just the path of an ESOP.  This episode is to discuss some general ideas around what shareholders face when making decisions towards how they go about the transition of their business.

Transcript

[0:10] Hey everybody thanks for joining us today we're so excited that you're here it's the ESOP guy podcast journey to an ESOP and Beyond season 5 so if you're new to the podcast thanks for joining and this is just briefly this is a podcast designed as a resource. 
 To help folks understand Employee Stock ownership plans not at a PhD level. 
 
 [0:32] Not even at a master's level but really at a fundamental level, and what we try to do is break down these Concepts these thoughts these things that happen and people are like I'm so confused and really get to the heart of those things and 1 of the things I'll kind of start off with today is just if there are things that are on your mind please go to our website at journey to an ESOP calm um if you're thinking about it and it's complicated for you it's probably complicated for somebody else and that's our goal is to make it uncomplicated okay let's start off with this today um as we think about the new topic that we're going to get into. 
 
 [1:23] Plop if you've ever golfed that's terrible terrible terrible terrible none of that thing not none of it. 
 He nutted it he nutted it so what the heck okay so we're going to get into this this is going to be fun today because there's just a combination of things that that I think are so much. 
 
 [1:43] Fun to talk about that are so important as we start thinking about it the first thing as we go into this I wanted to kind of bridge in this idea of. 
 The way that we go about some of the things that we go about doing in the ESOP world um are not as straightforward in a sense in that in that um it may not be if you start thinking about the Employee Stock ownership plan as an option and this is really speaking specifically to the people that are kind of on the fence like as an ESOP the right thing for you. 
 And as we're going to talk about the topic today is really going to be about um the the. 
 Way to go about your approach to the succession and exit but at the same time we're talking about is the road. 
 Less Traveled. 
 
 [2:35] And there's there's really going to be a focal point around your the way that you've structured your business as we get into the topic itself but I wanted to say this. 
 In all credit due to Robert Frost I shall be telling this with a sigh. 
 
 [2:55] Somewhere ages and ages hence 2 roads diverged in a wood and I. 
 
 [3:02] I took the 1 Less Traveled by and that has made all the difference. 
 Totally Robert Frost and as we as we think about that I've only read like the last stanza of the of the poem so just. 
 Go back and look at it if you've never heard that poem before but it's it's kind of simple in the sense of hey there's a lot of things to think about when it comes to your ESOP the. 
 
 [3:27] Area I wanted to cover today and I I kind of start off with this idea that The Road Less Traveled is this idea that. 
 You know a lot of ways people think about this is how you're supposed to do it now let me go back a little bit in 2023 because I think it's important. 
 And I haven't kind of stepped in and talked about some of these things over the last year just because it's I wanted to really I really focus on you know of course the topics and the interviews but the first thing is is if you haven't watched any YouTube videos of mine. 
 On ESOP the ESOP Guy where I interview people um and you do watch them what 1 thing I will point out is that I have been um I grew my hair out last year in 2023 and and it was kind of fun my wife was like Hey I you've been cutting it really short for your whole life and your career. 
 Um just grow it out so I did I grew it out got really long and then I went through this phase where I actually um. 
 
 [4:34] Over the last month or so I started getting it cut now the problem is is I I went to a person to cut my hair and I spent a lot of money on that haircut and I can I basically just assumed that hey I was going to be um a great haircut because I was spending a lot of money on it and I'm not going to say how much I spent but it was a lot more than I ever spent my entire life and I'm like all right so it's got to be a good haircut right. 
 
 [4:59] Well it wasn't a good haircut and so the person who cut my hair she said hey come back if you don't like it and I did I came back a second time and guess what the second haircut was not good. 
 And so. 
 Finally I mean after I just kind of like was I was like whatever I'm a guy I just I don't care it's just hair I kind of finally decided after I got these these you know my. 
 Kids were just kind of you know all over me like yeah it's the the funniest haircut you've ever had so I finally got it cut again so the third time and now I paid now I paid a new person to do it and it was way less money right and now I like it alright so so 1 of the things I wanted to kind of say about that it just made me think about what people are spending on ESOP transactions and and I got to tell you like there is a sense that you know you you're paying you're getting something that you should get out of a deal where you're spending a lot of money but the truth is for an ESOP transaction that you're there because most ESOP transactions are done by Investment Banking firms and they're charging you a success fee you're probably way overpaying for that ESOP just just as we I say that because collectively. 
 Experientially I've seen that happen over and over and over again not only that. 
 
 [6:17] They it's not just a bad haircut it's their other ramifications of. 
 Of that going down the road like you might be putting the company in in Jeopardy because you're you're not balancing out do they really know what they're doing well the the main thing is is you can always check out if they really know what they're doing. 
 Um I my advice is to get get multiple opinions on the sell side advisors and don't always just go with the 1 your friend did because if you know if they're spending a bunch of money at the end of the day it may make sense for them. 
 But it it may not make sense if you find that you have somebody that's less costly. 
 That can deliver do some due diligence do some homework I've had people. 
 
 [7:09] Of course get client references and um you certainly need to take your time to to hire the right people so that's kind of a quick overview of um just the the The Road Less Traveled The Road Less Traveled today that we're going to talk about is going to be um around the way you structure your business and specific to the valuation um and feasibility and then very specifically we're going to get into the idea of how you build your business around the customer base and that's going to be very definitive and very specific and I think it's also something that. 
 All right I want to talk about just because I've seen this happen over the last couple weeks with some clients and how some clients have done an enormously phenomenal exciting job of building a client acceptance process in their business and it has led to an extremely well Diversified customer base that's led to a very high level of of value in terms of the value of their revenue. 
 
 [8:15] Visa V the value of their cash flows going forward and so I felt like it was such a specific topic that would be super helpful and it falls in to this to this idea of. 
 You know it's not always obvious that this is the road you should take right because it's a little bit you know when you think about customer. 
 You know Revenue it's a little bit counterintuitive sometimes to to say hey no this is the direction we're going to go when it comes to building our Revenue models and I think it really warrants and I that a topic and a discussion as we get into it so that's what we're going to cover today I'm not. 
 
 [8:52] I mean I noticed it man you put a hell of a little gust from the gods cost me make. 
 But not now now I'm playing it from right here now give me a ball. 
 
 [9:14] Porsche Jimmy I don't believe this he can go up use the Drop Zone make par force a playoff with Jacobson and get out of here. 
 
 [9:25] Music. 
 
 [9:39] Kaplan. 
 Okay his second shot doesn't go in all right Tin Cup it's so classic right we're just dealing with this classic tension of doing something that is just. 
 
 [9:54] Doesn't make any sense for people around you and and I'm and I'm really excited to talk to these things because I didn't think I mean I've got we've got stuff to talk about when it comes to even people walking through an ESOP transaction and everybody's like you're crazy I have a client who they're um Investment Banking broker who is doing trying to do a big strategic deals like you. 
 Esops are complicated is too expensive and all that so so keeping that in mind as we as we segue into the concept of. 
 We are dealing with some high-level things that are really important so let's just talk through first off the the valuation itself and why is that the case well. 
 What happens in in when you're looking at the revenue structure of a company in valuation. 
 
 [10:50] There needs to be an assessment around the recurring whether it's recurring or non-recurring Revenue the some of that has to do just usually with concentration issues those kind of things with just normal specific company risk um and of course if you if you just think about this common with common sense if the company has Revenue that's highly concentrated then you're going to have um a problem you're going to have risk related to that business that's going to be difficult to um max let's just say maximize the value of the business for the shareholder so as we think about this from a shareholder value point of view um revenue is a big deal now the client acceptance process or customer acceptance process when we talk about you know first off what is that as we as we think about it. 
 
 [11:39] It's a company that. 
 If we think about the companies building up your your years and years and years of of how they go about you know building out their revenue model. 
 There are products there are services but ultimately those are going to go to a customer that they have in mind and it usually for me it's like just asking some questions around you know who's your Target customer you know and how how do you guys provide within that Target customer base a value proposition that is Meaningful. 
 
 [12:11] And helpful to build out like just very looking at bullet points of of the idea of of you know the repeatability that um the sense of of a deep Long tenure relationship also you know do they do they look at all of those things and if of course profitability right so part of the customer um acceptance process. 
 If if everything is is correct I mean it should prove out that that is a profitable customer now we think about profitability of course we're thinking of Financial profitability and that will of course segue into cash flow because net income plus depreciation plus interest expense plus whatever other add backs there are is going to eventually get to like an adjusted ebit number which we're going to use as our definitional cash flow number normalize cash flow. 
 
 [13:07] The buyer in an ESOP transaction is buying the cash flow. 
 The normalized economic benefit Stream So talking through all those things so of course if we are are aligned well in terms or we are. 
 
 [13:23] Providing customers that are profitable financially that's going to lead to more value now there's another level of profitability that I think is super important and I think I don't think it gets talked about um. 
 In terms of because we do kind of I think Finance people. 
 And when we talk about valuation we always kind of think a lot more about the the net income and cash flow kind of thing so what I'm talking about is another layer of profitability how profitable is that customer relationship to the Strategic direction of the company. 
 So things like does it work if my company is really, niching itself or niching itself I I don't even know honestly who. 
 Comes up with the way we pronounce words like this but either way are we specializing in something that delivers a strategic value in a long-term business plan strategic plan so. 
 If you're an expert let's just say in, you know helping retail or health care or construction companies or whatever industry if you're an expert at that right you're you're you're niching into that you're you're becoming like the go-to and the more you become the go-to it's kind of like the whole Medical Practice thing the more the highest. 
 
 [14:43] Paid person in a medical practices is going to be somebody that is is specializing say in neurosurgery or some special type of surgery that only 5 people in the whole world can do your your it's just supply and demand right it's economics 101 go back to. 
 Go back to college and look at like the Supply right so in a company's profitability um or or customer acceptance process, we always care about financial profitability but we also care about does this. 
 Fit well within the Strategic plan of the company now that might also kind of. 
 
 [15:20] Illuminate and Enlighten you to start thinking a little bit different about your company it may be that your company is is very well-run. 
 And has a lot of different customers but strategically they've never really kind of carved into a target market and niched into something to become more and more profitable and less and less like you're not what you're doing is you're really kind of moving away from what I would call the Shark Tank, and you're moving more into the uh the world of hey we really this also now that's going to benefit of course the the shareholders but I also want to talk a little bit about. 
 
 [16:11] The company itself and as we think about the customer acceptance process we also are dealing with in in pre-op planning the long-term sustainability of the company and 1 of the things that has to be continually looked at by the key leaders of the company and then sometimes this is the Visionary sometimes this is you know a leadership group but is is the the mix of customers that we have this sustainable are there Trends related to that customer group maybe we niched really well their company years ago into um a an an industry that was going to suffer some major changes because of you know just thinking legislatively or maybe maybe it was just use like International could be a good example and a lot of the international work was in the specific to a country that now is under. 
 Sanctions with the United States so let's just say that was Russia and you guys and the company was like yeah we we've built our whole business model around being very very specialized in in importing Russian or exporting to Russia or whatever having this International Exchange with Russia but now you know. 
 All kinds of political things have happened and that is becoming either in Jeopardy or already starting to kind of go away so the Visionary has to start thinking about the company and sustainability model of of what is the mix of that. 
 
 [17:41] Not only is the the mix important when it comes to the trends related to some of those specific areas they might have carved into. 
 But it might also be important for them to think about um the scalability and the growth of the company maybe they've reached some some some ceilings on some of the the different areas that you maybe geographically but also specialized in those areas so there's a lot of things to think about when I when I say the word sustainability in ESOP. 
 
 [18:10] The it's a big big. 
 Discussion like that's a key word when you're thinking about esops because what we are trying to do is plan a long-term venture. 
 If you're planning a a a simply an ESOP transaction then I believe you're you're not being big picture enough because an ESOP transaction is really the beginning. 
 
 [18:34] For the employees for the key people it's the beginning you know that that kind of creates it we want it to be a long-term opportunity so another part of this is the idea that you would have um. 
 The value that you're creating in terms of your customer acceptance process um and I mentioned this a little bit but is is not only from a the perspective of profitability um but to align well. 
 With the existing resources the company has and that in some cases let's just say that we have you know the classic, resources a company brings to the table is is labor and people, in whatever however you would Define that my employee base right so what is it that they bring to the table what is it that the company's resources maybe they have um a high level of of capital. 
 Assets that they're using to manage through Revenue with different kind of customers how do we Leverage. 
 And align those resources in the market as we think about the client acceptance process so on a higher level. 
 
 [19:41] Um I'm going to get into a little bit more of the how to behind this but I'm what I'm right now is just kind of walking through really the why of of why a customer acceptance process I'm kind of calling it both things um let's just call it cap right now cap. 
 Be something that we just created on the fly but the idea of like how do I create this process. 
 Really really well and um and why why are the reasons why we're doing it so if I'm aligning my resources really well with the customers that we're going to reach and the more I can optimize that alignment then guess what I'm going to actually accomplish way more and you're going to have um I believe I'm a business strategy standpoint you're going to have a 1 plus 1 equals 4 equation because you're going to end up doing a lot of other things not just creating profitability and sustainability you're going to create a high impact company with employees that love doing what they do. 
 
 [20:38] Because there's nothing worse I think well there's a lot of things that could be worse than this but just. 
 Mean a humor me for a second if you have a company that's trying to go to market. 
 Doesn't have the resources to P the people that are employed there don't have the talent or maybe not the. 
 The talent but they don't have the skill set to deliver on those services so they don't they're trying all these different new things that that aren't working. 
 There's nothing more miserable for an employee of that company to have to be. 
 Going to work every day thinking I do not know how I'm going to do my my job and that's avoidable because we're as we think about this. 
 Um it's going to be avoidable because we're thinking strategically about this you know a process itself is really delivering. 
 And and executing on a strategy. 
 In my opinion that's kind of what happens is like strategic thinkers get around and like all right this is the way we need to go let's create a process and then that process is kind of repeating itself around the idea of what we're trying to accomplish. 
 
 [21:39] The next thing here is that and I I think final thing as we start thinking about the way the reason why we want this. 
 Cap this customer acceptance process is because it maximizes customer value there's nothing worse than being a customer of a company. 
 
 [21:57] And you're always you're at that place where you kind of you're on that fence if somebody ever asked you the question as a survey you know how would you rank your experience and you're coming back saying over and over again cash nobody ever calls me you know nobody ever actually asked my you know what we're looking for in terms of value or you know there's. 
 The the I'm a C I'm a customer of a company that they they just don't know really what I need and I'm probably going to leave and get if somebody else comes on to shows up on my front door probably just going to go ahead and move my business kind of thing so we don't want that to happen right so 1 of the things about. 
 The customer acceptance process is you can't be all things to all people and the more you try to do that the more your other customers are going to suffer and if those customers don't fit within your target market, framework you're actually going to be better off and this is where I'm using the gulf metaphor and the Robert Frost poem and this this idea of the haircut it's like you got to do sometimes what doesn't intuitively seem right and that means as we talk about the next part of this is to align your your company well with your customers, but it made me mean that you have to do something counterintuitive which is hey I'm going to have to start um having my customers go to other companies and not be my customers anymore. 
 
 [23:18] I remember like in business that has been such a difficult thing not only for our company you know years and years and years ago it isn't as much now but. 
 
 [23:29] It certainly was before and I've seen it with other companies too that we represent and that the management group isn't looking at. 
 Um they're looking at this from a fear perspective and the fear perspective says I can't lose that Revenue. 
 
 [23:45] You know the department heads like I can't lose that Revenue that revenue is so important to my budget and my people if I lose the revenue I'm going to lose my employees and all of those things start to stir around but you know just like anything it takes a little bit of Courage. 
 
 [24:01] It takes a little bit of a process and it takes a little bit of a strategy I think to walk through those things which is what we're going to get into you know in a in. 
 You know next as we go through this because I think it's it's going to be such a valuable thing to start to integrate if you're not already, doing this in your business and that's and that's really why I'm talking about it because it is absolutely an ESOP valuation topic and issue if you're in that place where you're just planting your ESOP and you're a few years out or you're right in the middle of starting your ESOP process I'm going to just say I think this is something that needs to be on the table in your thought in your thinking and if it's not been there then I really want to challenge you to be be thinking about that you know what's crazy Jimmy if he doesn't finish the hole with this ball. 
 Turn in a card he's disqualified oh my god oh dear Lord please oh dear lord. 
 
 [24:53] Music. 
 
 [25:30] What sits on the green it's rolling it's in the hole. 
 Here the Applause. 
 Ah as we think about what we're going to go into now is just as we talked through this idea of client, customer acceptance processes and really the the the success behind it is what we're going to talk about but getting into that as far as what action steps do you take like do you. 
 As we talk about The Road Less Traveled what sort of things and the reason I say that like I keep saying that over and over again is that. 
 
 [26:13] A lot of times this is not something that people really do. 
 
 [26:18] Because it's it's it's just not part of what they've thought through and there's a little bit of a anxiety when it comes to um Turning Away business because that's really what we're getting at you know in in the bottom line and then it could mean. 
 For some companies that you're not all Turning Away business coming in you might be turning away existing business that you already have. 
 So there's really 4 main things I want to cover here and the first is. 
 Do the work to take a stab at your profitability reports by customer and I think that's really difficult sometimes depending on what your accounting software. 
 Um whatever your systems are that kind of create um what I'm looking for is a report that helps me take every single customer relationship and assign some level of profitability to it which means you're going to likely have to burden the the companies um that that customer with certain costs and that could be. 
 Some direct cost but I would also recommend all-in um overhead cost as well so. 
 That may be something you need to get to get help with but in in the end when you can actually see a reliable consistent report. 
 
 [27:34] By customer profitability and I would also recommend that that be done um over the you know a trend I mean it might be that um over the last 5 years that customer the value of that customer is going down or the the um. 
 
 [27:51] The next 5 years I mean or whatever you have projected to do business with that customer it could be um that they're more profitable less profitable but the bottom line is you want to know what is their profitability and that's going to be important and then look at your bottom profitability and when you're looking at 1 of the 1 of the keys to this right now and the last couple years has been you know if you're if it if the work that you're doing for a customer. 
 
 [28:21] Requires a an an a lot of like time staff production time, and you're trying to do everything and be everything to all people and you can't hire new people or at least can't get um you know from an efficiency standpoint. 
 People that could be cost-effective to your organization um and profitable to the whole scheme of things this will give you the ability to not have as much pressure on your existing people so um once you know who those people are those customers are you can go through a calling process and the calling process would be, um do they are they a good fit for the company and do we want to keep going forward on that so that's going to be the first thing is build some some reports. 
 
 [29:04] Um as you start doing that I would also recommend that you revisit the Strategic vision of the company. 
 And this is kind of coming back to the idea is in the alignment of your vision. 
 With the existing customer base and then the future customer base so we're going to want to continue to to re-evaluate the um the. 
 Alignment of the customers that you have your target market customer and the vision of where the company is going as we start thinking about the actual process of calling clients which just really means um. 
 Either letting them go right like that process however that works um helping them find a new home if that's the case or whatever however you do that but in the end the effective action is to is to have them not be part of your company's Revenue in the future which again is counterintuitive in some some cases so. 
 Connected back to the vision and then the other piece of it I think that's important as you think about you know having solid reports this doesn't need to be um a 1-time event in fact I believe it needs to be an ongoing, process so what you're going to be doing out of these first 2 steps is you're you're not just going to create the reports for 1 event you're going to create those to be updated on an annual basis and. 
 
 [30:31] Maybe maybe it's an annual process I think maybe it's a couple maybe it's every couple years it depends on on how deep you go with it and then I think testing out part of the process needs to be you know testing out whether you know how that really worked you might start small keep building on that process as we go but we do want to take the process of of of the reporting and then the connection and alignment of vision and write a business process around this if you're not doing it that is going to be something that your leadership team would follow every single year as part of the way they you go about doing business. 
 
 [31:13] That's going to give you the ability to not only um. 
 Be more effective at this type of of process and and ultimately what we're what we're getting back to is building a stronger valuation and building a stronger model for your ESOP so that's the point that we we keep wanting to make because these will become sustainable strong sustainable companies when they have processes like this for companies because these are really truly best practices as we think about those. 
 1 1 so the final thing that you that this is going to do I think for the company is it's going to give the company the ability to communicate. 
 Um execute and. 
 Hold accountable your organization to continue to grow and improve in areas that um for some people might not be um. 
 
 [32:07] You know for some companies this may not be you know a huge dramatic shift for others I think it is a dramatic shift in what they're doing so kind of depends on where you are but, if if it's not the communicate if it's not the customer acceptance process or the client acceptance process then there is there is something in this whole whole part of it in terms of aligning. 
 
 [32:27] Your company as in a continuous Improvement, towards the ongoing Improvement of of of better and better customers with the resources you as a company have to provide so e either way I think that that moves you forward and that's not like I said 1 a 1-time event it's going to be this ongoing effort as a as a. 
 Ongoing business process that I have seen not only in my own company. 
 But across the country with a lot of companies that that are very focused on um Improvement, whether that be for the sake purely for the sake of increasing their valuation um but I think it's bigger than that I think it's for the sake of improving the company's cash flow. 
 To support um the leveraged buyout under an ESOP so that it's more sustainable as time goes on and if you're already as an ESOP right if you already done become an ESOP this is still something that you should be practicing as the company grows and improves so all of that's important thank you guys for listening today I hope you have a wonderful rest of your day wherever you find yourself thank you and we will see you on the next step on this journey to anyone.