EP4 - Interview with Pete Schuler

In this episode, Jason sits down with Pete Schuler, Senior Vice President and Head of Consulting at Blue Ridge, who brings more than 30 years of experience in the ESOP industry. As a trusted advisor on ESOP transactions and compliance, Pete has worked across all stages of the ESOP lifecycle and offers a deep, practical perspective on what makes these transactions successful. Jason and Pete dive into the key “R’s” of an ESOP transaction, unpacking critical considerations around plan design, compliance, and transaction readiness. Drawing on Pete’s extensive experience advising companies, working alongside investment banks, and leading complex ESOP projects, this conversation provides valuable insights for business owners and advisors navigating ESOP planning and execution.

Transcript

[0:09] All right.

[0:11] Welcome everybody back to the journey to an ESOP and Beyond podcast where we seek to make all things related to Employee Stock ownership plans both accessible and understandable. I'm your host Jason Miller and today I have with me Pete Schuler and uh is going to be talking with us about all the RS and you'll learn what those RS are and related to uh an an ESOP transaction and what you need to keep top of mind and when we're just going to have a conversation about those and so uh Pete if you wouldn't mind taking a minute to introduce yourself to the audience and then we can pick up straight away.

[0:49] Sure thing yeah thank you Jason uh my name is Pete Schuler uh currently a senior vice president head of Consulting at Blue Ridge Associates. Um I have 30 years in the ESOP space mostly on the administr almost exclusively on the administration side, a few years at Grant Thorton and then moved over to Crow and ran that group for 22 years was the managing partner in that group my last few years there. Um and then transition the group uh to Blue Ridge and and thrilled to be with Blue Ridge and thrilled to be here talking about the RS awesomethey I, I have to I have to ask this P um otherwise my my children would never forgive me so uh the what what's a pirate's favorite letter of the alphabet.

[1:43] Okay that is a dad joke so it's appropriate that you're telling it it it is but you're right and you said it the right way because of all again all those RS that that were about to pick up on I. If we we frame it um for kind of how. Owners and Founders today should be thinking about the future sustainability of the Esau and really. I believe that's where all of these different terms and then their functions come from is the effort to maintain that sustainability, and then to comply and then to strategize around making the the ESOP or retaining its solvency. Uh well into the future into a future that we might not be around for or can't see into. Because of this opaque barrier of what is the world going to look like after an ESOP transaction right right, so with with that let let's start at the beginning around what are some considerations that should be built into into plan design in the phasing of or the phase of plan design leading up to an ESOP transaction that would be really helpful uh for those later years of of ESOP maturity well into the future.

[2:54] Yeah yeah sure thing first of all I love to see ESOP um documents that have a lot of flexibility in the document itself. Uh in other words they say we can pay in up to 5 install we can also pay lump sum uh we can pay um you know at at we we can make people wait if up to 5 years if there is if their balance is over X but not that we have to wait that long.

[3:20] Um and th those are ideal because then they can work with their TPA like Blue Ridge. Um and come up with what's right in any given year as long as everybody within that year is treated in a non-discriminatory manner.

[3:33] Um what often happens is you will see language put in that really tries to limit distributions as much as possible. In the first part of an esops life when the company itself is still leveraged not talking about ESOP leverage but talking about leverage between the company and the bank and the company and selling shareholders the idea being we want to hold on to our cash so we can pay that debt the reality is is that your distributions in the first several years of the ESOP are very smallum there's going to be very few allocations there's going to be, um depression on the the company value because of the debt on the company's books and maybe you didn't count vesting service before the effective date of the ESOP so people aren't going to be vested for a while. And you don't wouldn't want to take somebody who has a hundred dollar vested account balance and wait you want to pay those out. Even when they get to be a thousand bucks if you're still in the middle and the price is going to be up a lot you probably still want to pay those out so what we found out is you want to pay people as quickly as possible while maintaining good while maintaining company cash flow for what you need to use it for and I think that includes the beginning of the ESOP um so I also wouldn't want to see any Bank coins covenants and we usually don't that just strictly uh don't allow any distributions from the ESOP uh until the until their debt is paid off uh it just doesn't make sense for anybody.

[4:57] Um so yeah in general you want to pay people quickly you want to pay probably pay on lump sum initially um but you do want to have the flexibility for when those balances start growing hey we can wait a period of time or we can pay installments or a combination of the 2 um and usually there's some threshold. So anything over 10,000 bucks and that 10,000 could be 7,000 for some companies because that's the that's the amount you can force people out at could be 100,000 I have clients whose threshold is 100,000 or 500,000 they will pay lump sum under 500 take it over to installments before 500 after 500,000 so um that varies and and every company I think comes to a nice balance. Where they're getting people paid out as quickly as possible because you want the ESOP benefit to be real to the participants, and your former participants will talk to your current participants so that's important uh and you want to of course protect company cash.

[5:54] So that you can continue to operate and grow and do everything a company needs to do.

[6:00] You mentioned a lot of really great stuff in in in that Pete and I'm I'm hearing flexibility.

[6:07] Has a premium in plan design uh that that should be 1 of the priorities in order to to develop and and design around the other thing that you mentioned is that this first years after the ESOP uh is is initially formed that the overlay of the the vesting schedule the number of shares that are unallocated and held in suspense the term of the inside note. All of those are really they really create minimal repurchase obligation in those early years to to Really worry about. Um and maybe for some of our first-time listeners um talk about what repurchase obligation is I think the way that we normally frame it for our clients is. That's honoring the promise of the retirement plan to the participants um but it it carries with it its own kind of definition and connotations and and everything else.

[7:06] Yeah so in a in a nutshell you hit it repurchase obligation is the legal responsibility of the plan sponsor. Uh of the ESOP to fund a distribution specifically to buy back shares that are that are being distributed that's kind of how it's worded. Um but it really obviously as you know and we'll talk about the different RS 1 of them is redeem which is buying back the shares 1 of them is recycling which is paying cash distributions. And um it it boils down to funding the the distribution uh the company has to fund the distribution. Uh that is the repurchase obligation and then there's usually we see the word study behind that that is a an analysis that is done um by third-party administrators not all of them do it not all of them have the tools to do it uh we do uh the big the bigger ones I would say do or have access to to places that do that.

[7:56] And it's an analysis over typically a 20-year period that says hey here's when here's the years that you're going to have to come up with the money here's how much you're gonna have to come up with each year and here's the reasons death disability retirement termination diversification breaks it out kind of like that very involved study a lot of work done on the company side coming up with the variables that go into that the turnover rates by different in different groups of employees within the company obviously your factory people are going to have a different turnover rate than the sea Suite, um so you're going to have different groups and you're going to put them into the study differently uh that that to the the growth of the stock value how quickly your Workforce is going to grow what kind of raises you're going to give all that goes into the study so that the company can have an idea. Of where the do when and where the dollars are going to be. Uh that they're going to need to come up with I always say it's very good at recognizing Peaks and balances everything else is an a very much an estimate.

[8:57] 1 of the questions that we often get around this is what's the good uh rule of thumb or best practice related to when should the the company get their first repurchase repurchase obligation study done how frequentlyum and then why would they need to get it done more than once.

[9:18] Yeah yeah definitely need to get it done more than once because everything changes um the companies available cash changes the the value changes the number of employees they have changes all of that changes um typically there's um if there's Bank financing involved there's often a a covenant that says in row study will be done.

[9:37] Uh within after the 30 South allocation or perhaps after the fourth somewhere around there and I think that's a good time it still gives the company plenty of time. To because you don't want to do a study and find out you have a cash need the next year you need some time to plan for that. So um having it done the third or fourth year still gives a good 5 years before you're going to have really significant distributions. Uh and and to get that first study and see what those distributions are going to be. Um typically we say every 3 years after that uh just to reflect the change in the company the change in the company value uh the change in the number of employees the more people have moved towards retirement all of that type of stuff uh if there are big changes in that 3-year period maybe you do uh so let's say you've you've had um massive stock price growth much more than you anticipated in your first study um then you you may want to do it in 1 or 2 years and then add 3 years after that it's not like you still need to hit that original 3-year period uh if a company wanted to and they were comfortable and things were pretty stable I think you could go 5 years and be being um okay with it I think it's just important that companies think about it that they Factor it into their cash flow needs.

[10:51] And and the only time I've ever seen an issue with with repurchase obligations is when companies don't plan for it if it's planned for it there should not be issues.

[11:00] So this is a a very valuable cash flow tool for management. To balance that obligation uh against the corporate objectives and correct we always like to saythat companies objectives have to come first so that there is a company that's generating cash to be able to pay all all the people that needs to um and the the more insight that you can Garner uh from tools like this uh the better off management is going to be able to Pivot with the data that comes in from from such a absolutely absolutely 1 of the things um that I I think it makes a lot of sense for us to to kind of reiterate or Express is an ESOP transaction is a stock transactionso the stock is being sold into the the ESOP Trust and because it is stock it operates on its own market so to speak yeah uh and that's the the valuation gets set every year it doesn't get set every minute between you know 9:30 and 4 pm Eastern but once a year.

[12:10] And because of that stock like behavior and all of the elements that go into the the valuation um that's why it's really important for those distribution policies that you talked about earlier to consider. Where's the company on its growth trajectory what are those future values what are we kind of projecting out how does you know that that's going to go into the repurchase obligation study to figure out how how do we put dollars on thisI don't want listeners to think the the stock is out out there on on the east on the market and then it it's gonna be growing or or not uh depending on right so the company but generally up for well-performing companies absolutely, be explicit around the impact that that could have on that distribution policy uh with with that that in mind on growing from whatever it is today pick a number ten dollars to in 5 years a hundred dollars.

[13:07] Yeah absolutely certainly something to think about um I I think and and we'll kind of go back to the new ESOP where the value is very low I think flexibility is important there. Um I think that you want to and be able to pay people out uh when their balances are small and pay them out quickly.

[13:24] But I do think that you're going to probably have tears where you will want to remain I think within those tears and maybe it's a 5-year tear or 10-year tear something like that you want the company to have pretty stable distribution Provisions that's mostly for an employee Communications um issue the law is very um lenient towards ESOP distributions Congress recognized that um these are privately held companies that are funding these payouts and they need they have many claims on cash uh they have to pay the utilities they have payroll they want to grow Etc um and so they need flexibility in paying out those distributions so you don't have the same type of anti- cutback rules you do for other Provisions you can change the provisions but from an employee Communications perspective you want people to know what's coming up when they leave. Does that mean it's always going to be you know lump sum under 10,000 and 5 installments over 10,000 know it doesn't. Um it's probably going to change over time and the repurchase obligation is going to inform that. Um so when we run a study we will run it initially base case with what they're using right now what their Provisions are right now. Um but then we'll also look at other things changing to other things because, you might see that you know in year 5 you're going to have some really large just starting with some larger distributions.

[14:45] Typically it's actually year 10 um I just didn't think of that when I said the prior sentence because you have diversification kicking in you have a lot of people hitting retirement age your stock price is almost always at full value in year 10, um so you have that going on and and so that that's kind of the time when you're going to come up with your first semi-permanent. Uh distribution provisions and then you're right as the company continues to grow you may continue to. Have um uh longer distrib longer I have we have a client. Who who is an Inc they're always on the top 5 I think it's the NCO that has a list of. What richest ESOP so I forget what they call it but essentially the largest average account balance so total value in the ESOP divided by number of participants.

[15:33] Incredibly successful company. Um they actually have a provision of for 8 installments because everybody's over you know everybody who would affects is over that threshold where you can pay up to um tenants Tom so they certainly didn't have that when they were a smaller company before they had acquired everything in sight because of the Fantastic tax advantage of being a 100% escort Bop and being very well run both of those are needed. Um so um that's kind of just as the company grows you're going to change your ESOP Provisions to reflect that you are eventually going to probably start paying out higher uh lump sums, you are going to start paying out your distributions faster I know a lot I would say most of our companies don't have much of a waiting period.

[16:19] That 5 year waiting period that you can wait to pay out uh termine non not death disability retirement but other types of termination people tend to not like that because the participant, can take can take a long time to get them their money we certainly see it it's not uncommon I'm just saying we see a lot of companies that would prefer to handle the cash flow through installments as opposed to a waiting period. Um so those are the types of things your your distributions are generally going to grow understanding that if you have a downturn there may be a need to kind of pull that back a little bit um so that you're not paying out distributions as quickly and that's fine you can do that, um but that that seems to be the trajectory is faster payments or larger uh threshold for installments things like that.

[17:04] I'm also Hearing in what you're saying Pete that while uh you know being flexible and having foresight into the plan at the beginning you can alsouh the planet itself is flexible, in the future to adjust to what's needed or what's correct.

[17:23] Correct yes and even if the plane is hardwired and sometimes it is um those Provisions because again the ESOP law surrounding uh distributions is is flexible a lot itself is flexible so you can amend even if the plan document says you are going to pay 5 installments for anything over ten thousand dollars you can change that to you are going to pay 5 installments for anything over fifty thousand dollars you can amend the plan it's just easier if you have a distribution policy which is a document it's considered part of the of the ESOP plan document but it is um drafted by the company um and it can be changed just easier than than it than you could change uh the plane itself you have to amend the plane itself to change it. Got it I think this would be a great time to uh talk about account segregation mhm um if you could share with the listeners what what is account segregation and what purpose does it serve and in light of this conversation.

[18:24] Yeah so segregation um which is often referred to as conversion um I see it referred to as reshuffling as well although I don't agree with that that like the IRS definition of reshuffling, is essentially when. Um buying and selling shares uh and and not ending up with each participant having the same percentage of stock and cash so that's rebalancing when you, when you basically balance the plan in each year and so that everybody has 10% cash and 90% stock because that's what the plan has overall so reshuffling is defined by the IRS to be any selling of shares between active and terminated people that don't end up with those equal percentages so it could be in other words what we call recycling um which you know is we'll talk about that later I can it's easy to start building the onion and going off in different directions um but segregation conversion um again often called reshuffling is when you're getting the shares out of terminated participant accounts and into active participant accounts.

[19:23] Sometimes it is done before the terminated participants are eligible um to take a distribution um sometimes it is done only when they're offered a distribution and they don't take it. Uh be and typically it's because the company in either case it's because the company wants to lock in the stock price. And I think it's important to know because most ESOP companies think ahead of time that they can somehow magically freeze the price of the stock in people's accounts when those people terminate you cannot uh it's just like having a share of Apple stock in your 401K plan you are not freezing that just because you left the company that Apple stock is going to continue to fluctuate every minute to your point before about public markets uh same with ESOP stock it's going to continue to fluctuate annually. Um because it is in the participants account so to lock in someone's value you need to segregate you need to put cash in the ESOP.

[20:17] Which um the way the way that works mechanically typically the cache is contributed or put in by the company as a dividend or escorp income distribution into the ESOP that money is allocated and though then the people with that money buy the shares from the people who are terminated they don't have an option they're not they're not electing to buy those shares its part of our record keeping function that's recycling essentially when people's cash in the ESOP is used to buy terminated participant shares um and that's that is um recycling can be done to fund distributions it can also be done to fund segregation so segregation is when cash is turned in I'm sorry stock is turned into cash within the ESOP in part terminate participant accounts but not paid out in that same year it's held within the ESOP it then has to be invested, um the IRS generally doesn't want it to see it invested in money markets so how to be a little bit something more than that um and the trustee would typically take take care of that investment still nothing crazy it's still going to be very conservative because you don't the biggest goal is to not lose principal it's okay if you make a little bit of interest you don't need to make a ton but you don't want to lose principal um so it's that turning of turn it's basically the conversion of terminated accounts Into Cash um.

[21:31] Again most companies will do it when distributions are are offered and not taken some companies like I said will do it they don't want to change their distribution provisions. But they they want to lock in that stock price in other words they may have a waiting period or they may have installments but they and they want to leave them the same they want to leave that communication the same but in years where they have extra cash if they want to put into the ESOP they may use that to kind of cut off the the growth of the stock and a better way to put it I think is to get that growth into the accounts of active participants and limit the risk of terminated participants because you know they're they're looking forward to taking their money out they certainly don't want less money if the stock price goes down um very true.

[22:15] Yes we're on the same wavelength with that right so the idea of the the stock should be in the hands of the people that are now producing the work correct. And and then the other element going back to the repurchase obligation study and then the the executives managing cash flow uh it's it's basically an ability to uh provide certainty to the obligation, uh correct and proactively manage the their cash position and repurchase obligation in light of those company goals uh without having a runaway share price in the hands of people who no longer work there.

[22:54] Correct correct absolutely absolutely and there's 1 there's always 1 decision point that that companies once they see segregation and as you know esops are new to everybody we work with uh and everything that comes up to them is new so then you'll you'll work through them with with segregation the segregation is done and they'll be like oh what we we just spent this cash why don't we just pay the person now so that's always the second question um why don't we just pay them out um you can have distribution Provisions that say we're going to have installments and or we're gonna have a waiting period for the stock in your account but once you have cash in your account we're going to offer that distribution to you as soon as we can typically you know the year after your account is turned into Cash um and that makes sense unless you are in an industry where people can go to uh another company make the same wages um and very easily do that uh because you typically then some companies will want some delay of gratification for you don't want individuals leaving to get their money and if they know that when they leave you're going to segregate their funds and you're going to get it all in 1 lump sum the year after you leave they may be more inclined to leave the company and go work for somebody else um so so there's just many very as you know many variables uh in anything in the ESOP world to think about.

[24:09] So we've mentioned um Recycling and rebalancing and reshuffling so there's 3 RS right there um let's transition over to uh is is there recycling for recycling sake like not tied to the idea of of segregation um or is it always uh in in parody or or part of that uh that name. It's not so um so let's say that um there's a group of people leaving the ESOP who have a hundred thousand dollars of vested stock they're eligible to get a distributions worth of dollars. In a typical recycling scenario which is very incredibly common for new esops most. Stops for their first 10 years anyway more than that probably but at least any don't think about anything other than recycling there really isn't any reason to. Um they're going to that company is going to deposit as a as an employer contribution typically but it could also go in as a dividend.

[25:07] And I'm just going to say dividend from this point forward realizing that I also mean income distribution if it's an S corporation. Um but they put the money into the ESOP in 1 of the 2 ways that a company can get money into the ESOP dividend or income distribution and they're going to allocate that so let's say it's a contribution we do our work we determine who's eligible they venture to plan they've met the allocation requirements they get a their piece of the hundred thousand dollars they are then going to buy the stock from the people who already left and took a distribution. And that hundred dollars is going to momentarily flow into the accounts of the people who took the distribution and then we reflected that same year as having left the ESOP um uh in the form of a distribution or payout. So that is recycling happens uh both to fund distributions in that manner I just described and also for segregation that we talked about so it's really getting the money into the ESOP allocating it and then having the people to whom it was allocated purchase um the shares of uh people who either took distributions or are terminated and we're just segregated.

[26:11] Very good and then you'd mentioned Redemption earlier as well as an option so uh thinking ahead and you said for the first 10 years like recycle only we're going to get to you know the dreaded relever here in a minute um yeah let's pause and and talk about when Redemption would be appropriate and then what options that that preserves the for the company uh to to reissue at a later date and how that could work for for an ESOP company. Yeah yeah so great question so yes uh Redemption is the this just think the easiest way to think of it is the stock is leaving the ESOP it can really happen in 2 ways um you can pay a stock distribution to the participant.

[26:59] Um in an escort which most esops are there is an automatic put back to the back to the company or the ESOP um so the in other words the participant cannot keep the shares in an S corporation because you want to maintain the 100% S corporation scenario you don't want 1 guy holding 10 shares out there you want all the shares in the ESOP. So you pay the stock distribution and the company or the ESOP immediately buy that stock back the really the only difference is there's a little extra language in the distribution form.

[27:30] That says hey you're receiving a stock distribution by paying this you're recognizing that and you're recognizing you're not getting a stock certificate you're selling it back to the company Etc. They can do the same things with the funds they receive right away roll it over, take a distribution to themselves Etc there is some special tax treatment which is probably a little bit beyond the scope of this discussion but just really quickly. The the cost basis of the stock which we track um is taxed at ordinary income tax rates anything above that is taxed at capital gain rate so there can be. AA advantage to the person receiving the stock distribution uh as long as it's not paid in installments it has to be a lump sum distribution. Um and the um other thing is for S corporations that cost basis gets adjusted every year essentially for the net income of the S corporation per share, and so your difference between the fair market value and the cost basis may not be a significant for S corporations as you think it would be um for corporations which again most esops are not at least not for long um they can hold on to the stock for 2 periods they can hold on to it indefinitely but the company has to buy it back for 2 periods uh it mean you know for a period of time after the initial uh distribution and for the second year a period of time after the second Year's valuation is communicated after that they can hold it indefinitely but they have no Market to sell it to. Um you know they they have no guarantee of a price that they can receive.

[28:55] So those the stock distribution with the company or the ESOP buying it back the company has to assume that responsibility the ESOP can assume that responsibility, uh if it wants to um and the company wants it to um the the the magic of that is you don't need an updated valuation typically. So you're using the last year end value if this if you're paying a stock distribution in 2026 the year you're in, that we're in you're going to use the 1231 2025 stock value to to do that stock distribution and sale back um if you if the company redeems shares from the ESOP directly which is the other way that redemptions work. You have to have an updated valuation as of the date of that transaction. So again if you're nobody's nobody no 1231 client is doing that now let's push forward to June so if a company is redeeming shares from the ESOP. Uh in June of 2026 they cannot use the 1231 2025 value they have to bring in their valuation company to do what we call bring down letter.

[30:00] That says either the 1231 2025 value is the same it's the same now it's the same on June 10th or whatever of 2026 there was no changes or it's now whatever price and that's the price the transaction uh occurs at so the other method if you can use it um just cuts down on on cost because you don't need an updated valuation um you can't. Use the other method if you're trying to fund segregation through. Um a Redemption because the person hasn't elected a distribution therefore can't sell the shares back to the ESOP or to the company because they've never received those shares they've never then in that person's hands first put second um so there's that there's that to consider if that were to be done um you would do a regular updated valuation or bring down letterum the reasons you might do this what we would typically see the reason being.

[30:56] Is there uh you might it's usually going to be a mature ESOP issue you might be at or near your contribution limits. Um you may not want to fund distributions with uh dividends uh and mature ESOP company let's assume that all of the loans are paid off.

[31:15] Uh if you put dividends into the company anybody who's terminated is going to get part of that cash as long as they have shares. And therefore if you're do putting dividends in to do recycling they're going to buy some more shares you don't want terminated people buying more shares you're just going to have to buy those shares back. Uh soon anyway, so 1 way and and dividends I mentioned because that's a way of getting around your contribution limits I shouldn't say getting around it's not illegal or anything but it is a way to get cash into the ESOP and that cash is not subject to the contribution. Um so Redemption is another way to fund distributions or fund segregation um without um, violating contribution limits or perhaps you're targeting a certain benefit level it's not even necessarily the contribution limits you may want a benefit level of.

[32:04] 15% and to fund all of this year's distributions you may be at 24% and you don't want to be that high from a benefit level perspective. So you may redeem enough shares so that you're only putting the 15% in and using that to recycle.

[32:20] I always have an argument for that though that well not an argument I just want companies to know that if you are fully allocated and you're 100% ESOP, you are allocating the value every year. Of the entire value of the companythe benefit level is really what is allocated based on compensation.

[32:39] So it would be the contribution you put in divided by the eligible compensation that's your 15% for example howeveryou you're redeeming shares you're pulling those shares out everybody every other remaining share the price ticks up a little bit because there's fewer shares outstanding so all of the value of the company is being allocated every single year you're just not measuring a part of it based on compensation so just something really great distinction um and I I think it would be helpful to reiterate that contributions are treated differently than distributions. And the the major difference not to say it's the only difference but the major difference is a distribution is a shareholder right the beneficial interest of the shares that are allocated to any participant. Receives its share of a distribution even if they no longer work for the company. Distribution meeting escort escort yes um we're we're a contribution uh is going to the current employee base and so.

[33:44] In a as a an ESOP matures and there's a difference in the number of participants versus the number of active employees then the Nuance between. What is a a dividend or or the escort distribution and the contribution becomes more apparent, um yeah absolutely absolutely and as as you know we we've worked on a fair amount of um transactions together and um I I am always pushing for an ESOP loan that allows. At least in our projections our initial projections that allows the loan to be easily funded with contribution.

[34:21] Sometimes we'll hit something that has a really high value to payroll ratio either it's a union company the union is not participating, or it's a professional services company that doesn't take that many people to drive a lot of value something like that. There are some that even when you set them up you will need dividends to fund a portion of the loan payment and down the road to fund a portion of distributions but ideally you want that. To be funded by contributions because you want the value to go exclusively to active participants typically.

[34:50] And even if they're active you don't necessarily want to allocated on um even if you have no terminated people but you have long-term people in short term people. If you allocate too much based on account balance it's going to you repurchase obligation gets very peaky. And you end up with what they call the Haves and the Have Nots or the haves and have lesses your long-term people are going to keep getting more and more because you're allocating Things based on their account balance.

[35:14] And your new people who are receiving compensation maybe a lot of compensation maybe they're highly compensated Etc but if you're allocating things mostly on account balance they're just not receiving those shares. So most companies will will want to allocate based on compensation or perhaps a service based formula whatever they allocate um but allocate to new people as opposed to terminated people or people that just have been there a long time. Detecting a theme that there are multiple ways um where. By virtue of different choices uh that monies can go to people who are no longer with the company we want to err on the side of making sure that the contributions and the process and strategy around repurchase obligation maintains the Integrity for the people of the plan for the people that are still doing the work. Yeah I agree that shows up in multiple places uh when considering how how to administer the ESOP and how to approach uh the I guess the levers if we want to use that word yeah yeah. Better to to 1 other level that you just start you may may have noticed this too you're starting to see a trend towards people being allowed to get into the ESOP sooner.

[36:28] Um people aren't necessarily doing the 1 year wait enter on July for January 1st and July 1st as much. A part of that it certain helps with employee communication especially if you're using your ESOP to uh to recruit people. Uh because they're not waiting literally 2 and a half to 3 years from date of hire to when they see a statement um so you like a balance you want to make them wait a little bit but not too long the other thing that does though is it spreads your shares across more people. And the more you spread your shares across more people the better your repurchase obligation um it's going to uh make the purchase obligation smoother and it's going to make it generally lower um to spread it across more people um so it kind of has a dual Advantage it's going to help the repurchase obligation and it's going to get your new people more excited about the ESOP and at the end of the day if they're going to be a 2-year person or a 3-year person they're not getting much anyway um I mean the the bottom line of the ESOP is those that are there for a long time. Are going to get really nice balances people that are medium amount of time are still going to get something and it's going to be nice and a lot more than they would have gotten without the ESOP um and then short-term people are going to get very very little so I wouldn't let that very very little drive you know Drive everything.

[37:42] You'd mentioned another term that comes up and uh in the Redemption. Arc and that was uh not to confuse that with the Redemption Arc within a story I'm I'm a writer. Right but back when we were talking about Redemption you mentioned managing to a benefit levelyeah um and then that's another way to approach, how to gate in like Which choice should I make what should we do during this season of of the ESOP how should we be approaching the these these options these levers that we have um talk a little bit about what managing to a benefit level entails um what what that produces for management as a filter. Um and maybe just some best practices around that idea.

[38:27] Yeah absolutely so benefit level is the um allocation that uh it's the the amount people are receiving based on their compensation and as a percentage of their compensation um so if you're and as you know when we do. The pre-transaction compliance testing we measured in 2 wayswe measure it based on the dollar-based contribution um that is going into the ESOP so if the contribution is a hundred thousand dollars a year in your payroll you're eligible payroll is a million bucks a year you've got a 10% benefit level we also measure it based on the fair market value of the shares released, by the that loan payment because that's really the value people are getting. Um in when you start paying distributions again it the it's the same thing the dollar value going in is the the value of the shares that the person is getting uh at at the prior year value of course um and so the um most companies well I'll I'll take 1 Step Back 90 sub companies in the United States have a very low benefit level. Uh most people are getting I want to say 50% of a generous 1 would be 6% match or 8% match so you're getting 4%. Um of of your salary um or of what you're deferring really. Um in well no of your salary uh so very low benefit level definitely single digits usually low to mid single digits uh ESOP companies are going to be higher.

[39:53] They're going to be I would say 8% and up um and that varies by industry uh varies by geography things like that. Um 1 reason to look at benefit levels is if your benefit level is too high it will have the the valuation companies will ding the valuation for that um because you're putting quote unquote too much more more than you need to um into the retirement plan. Um so that's 1 way to think about the other is most companies will want to put in, what they need to put in to attract and retain employees but not too much uh because it can and cash out the door is cash out of the value. Um so you you want to look at it that way um then againyou can be putting money in as dividends or you can be putting in as contributions it's still cash out the door it's still going to impact value. But I think companies like to have both for the valuation reason that it does impact value if you're the benefit level is too high and for communication reason with employees and with future potential employees, you want to manage benefit level to something that's steady and makes sense and that may be very high, and I have clients who are at 25% that is their benefit level they can't go above that um but they're at 25%.

[41:04] Um and and I have some that could be at 25% but they want a 15% benefit level that's what they've always communicated they wanted the employees are used to that they want it to be consistent um distributions are going to vary a lot year to year. Um some years you're going to have very few people taking distributions some some years you're going to have a lot of people so your benefit level could go from 5% to 25% very very easily. Um just depending on who left in his eligible for a distribution and so having some benefit level gives employees something that they can expect. And then then you just figure out what do you do with the rest of the distribution funding. Uh in years where the benefit level would be low because not enough people are taking distributions you may be able to recontribution. In years where it would be 25% you want it to be at 15% you could redeem some of those shares so that consistency that employee communication and evaluation impact I think are why people really like that uh to keep a consistent benefit level.

[42:06] That's our second recurring theme Pete is communicate communicate absolutely absolutely anything that's done in the esops should be communicated inthe downside to an ESOP is everything happens once a year people get statements once a year. Uh it's a big deal once a year I think it's very very important. To have consistent communication throughout the year to keep people um knowledgeable about the ESOP and interested in the ESOP, they're going to go check whenever the market goes up or down dramatically they're going to go check their online to see what their 401k plan did they're going to check to see if their deferral from their bonus or from their paycheck hit they're going to look at all that if the match is put in once a year they'll go check that and see how it does um they're going to just going to look at that a lot they're going to look at the rental retirement planning tools on the on the 401K plan, uh but it is important to keep the ESOP in front of them too because it is just once a year you still have the same tools we have a website we have retirement planning tools on that website but that statement does not change from what it's issued for December 31st 2025 to when it's issued for December 31st 2026very good.

[43:12] Well I've been promising that we're going to get to to relever um and you you made an important distinction earlier we also like to share that so the there's. Outside leverage which is between it's the company's leverage uh whether it's part of the transaction to the shareholders to the bank or just normal operating Capital that's leverage on the company.

[43:36] And then that's distinctly different from a leveraged ESOP which is holding shares in suspenseum and there's an inside note between the trust and the company. Uh and. Not not to confuse anyone any further about that but every time that we can make the distinction we willum because you can have a leveraged ESOP and an unleveraged company and you can have an unlevered or leverage company and unlevered ESOP.

[44:04] Just depending on how how the the circumstances and the facts go so with that when we talk about relever um that that kind of indicates that we are we are re-upping that inside note. Yes let's talk about um why when that happens uh in the life cycle of an ESOP why it happens and what goes into that that decision tree for for a company examining relever.

[44:34] Yeah yeah so relever is typically going to occur for. Um mature esums generally I won't say esops that have paid off their first loan entirely some of these first loans can be you know minimum 20 years usually 40 50 or something like that 30 40 50 years and longer. Um so they may still be in place in the company may still be starting to encounter they may have only halfway pay only half of the shares from the original owner allocated and they may be paying really significant repurchase obligations out. And that's typically when you would see your Leverage come in.

[45:07] Um and I'm thinking of a client we just did a study for is Ben misop for maybe 10 years but they're encountering very large um repurchase obligations um in the 20s and looking at the 30s and and and higher, uh if they don't didn't do something and so um you know we we run the repurchase obligation study for them we talked with them about different options. Um and they've decided in the trustee was is is on on board with it it's it's the trustee has to weigh in on it certainly and approve it um and they are they are taking um the next couple of years I would say and they have very large distributions coming through and they are taking those shares out of circulation. I should say this they're going to be allocating them over a longer period of time um Redemption takes shares completely out of circulation they can be retribute recruited at a later point in time or they can be part of this revering that I'm talking about but when they're redeemed they're out of the ESOP they're not in existence they're not used to calculate per share value they're not in anyone's account.

[46:10] Recycling immediately put shares back in the accounts of active participants same year that the distribution occurred so leveraging is um has a benefit in that, it keeps the shares outstanding so you don't have that uptick uh in value that you would do when you redeem shares. Um redeeming shares again if I if my company is worth a million bucks and I go from. Um a million shares outstanding to 800,000 shares outstanding or 900 shares outstanding my per share value just went up because I'm dividing the share the the value of the company buy fewer shares. If I'm relever those Shares are still outstanding but I'm going to allocate them over some period of time typically loan would be set at 202530 who knows it's, we that's something we work on with the client that we understand they're going to have a few down the road so we make sure they're all going to fit in under the under the desired benefit level.

[47:03] Um so that is relever is pulling the shares out putting them in suspense.

[47:08] And allocating them over some period of timecan be controversial um I think it needs to be done with thought it needs to be done with. Um a good trustee it needs to be if you have an internal trustee I would not do relever with that internal trustee I would hire an external trustee to oversee the relever at least if not going forward um so needs to be done um and the idea is is that you're making the ESOP sustainable for the long term um not that you're hurting anybody you are you're definitely slowing the repurchase obligation down because uh you redeem you make the share the the per share dollar um per yes per share value higher sorry with the playing with words there uh you recycle you're putting the shares right back in either case it is um adding to your repurchase obligation you leverage your slow slung your repurchase obligation down so in this example I mentioned you know this particular client wanted to be about 17% excellent excellent benefit level nobody in America outside the sub companies get 7 I wouldn't complain. I would not complain at all I would not complain I've seen a few companies we've had that actually had very nice profit sharing contributions some in approaching that but it's very rare um so excellent benefit level. Um and they wanted to be around that level for all the reasons we discussed employee communication consistency and and the impact on their valuation is what they wanted it to be.

[48:32] Um and so they're really leveraging to keep it from being Thirty 35%. Uh it's typically not done because companies and matter of fact I've never seen it done because companies were in a cash crunch.

[48:43] Um it's not because they don't have money it's because they're just our constraints on getting money into the ESOP. And giving and having just that repurchase obligation continue to snowball to snowball to snowball. You just want to because that could they're not in a cash crunch now but if it continues to snowball and snowball and snowball certainly could get to the point where they would be in that cash crunch. And if you're constantly redeeming uh then you are definitely getting to the halves and Have Nots if you're all you're doing is redeeming, um you know your people with account balances the larger account balances you know before you started Redeeming the significant number of shares each year their value keeps going up and up and up. Now down the road you decide you want to contribute shares because your value is so high you can't contribute that many shares so it's still um still you have a has and Have Nots you're going to have people with very large account balances and people with small account balances.

[49:34] I would love actually to see 1 of those play out because I'm going to suspect you might be okay because your large account balance. Are going to go away and you you now have a new definition of large and small when the really big ones go away um but I wouldn't necessarily want to be the company that that experiment is done on because it just may not work out well but you're gonna have big repurchase obligations you are.

[49:56] So I'm I'm hearing uma lot today that.

[50:05] I guess prymrr let me back up a little bit so this is a lot of information um yes and it is a lot of if this then that but. It could sound really daunting and overwhelming to those listeners that are thinking about pursuing an ESOP, and they look ahead into the future and go well afterwards I have to deal with all of thisand what what I would offer as a word of encouragement is we were very deliberate. Uh and staging this to what needs what do you need to consider in advance that there is flexibility is is at a premium but there's no choice that you're going to make and plan design that's unforgivable later and unalterable, for for the most partthat's correct and you're you're not going to have to face these decisions all at the same time, and there's breathing room in the life cycle of the ESOP that it makes perfect sense to pursue 1 over the other and then you have assistance. And uh following through with really good best practices of getting a repurchase obligation study to help you get some site into. Uh what what may be coming up so this isn't something that everyone needs to know on Day 2 uh it's not something that they're going to encounter in the first year.

[51:22] Uh and there's nothing that they did before that's going to haunt them for forever that's going to jeopardize the sustainability of the ESOP would you that's a 100% 100 percent I think to the important thing that every. Person considering an ESOP every seller considering an ESOP or every ESOP that is just knew the thing to remember is just have good advisors don't skimp that will cost you far more in the long run, you want a trustee who's who does a lot has been a trustee for a while maybe not with their current company or maybe they set up their own shop but they've been a trustee for a while they they know what they're doing you want a valuation company that specifically values ESOP companies. Not there's a lot of valuation companies out there not all of them do esops so you want someone who does a lot of esops.

[52:05] Uh and I'm when I say a lot 5200 if they're not doing 5200 same with your TPA if they're not doing a 100 uh if they're not administering a 100 ES. Then you don't want to work with that uh you want to work with an attorney who's not just in odisha attorney. Um you want to work with an attorney that is also an ESOP attorney so a subcategory of odisha but they have a lot of experience in that it's a small community any 1 of your advisor who's in that Community is going to know who to refer from the rest of the community um and I am always a little nervous when I'm working on a on a transaction and there's somebody I don't know I'm like okay I need to keep an eye on that person yeah so um so yes you want people who have done a lot of it or if they're young that's fine as long as they have somebody in their firm, uh who's kind of leading them along and they're the 1 you know they're going to be learning but somebody in that firm has to have done a lot of these upwork.

[52:58] Well Pete you've been very generous with your time and your expertise today uh for those listeners that would like to get in contact with you how can they do that.

[53:09] Yeah uh easy I'm going to give you the phone number because it's easier than the email I'll give you both so my just give me a call and I'm in area code 614. 6561833.

[53:21] That's the phone number give me a call any time my email address is p Schuler psh there's no C in Schuler everybody wants to put it but it's not in my name act 1 blue ridge.com, so it's 1 that spelled out o n e and then blue and ridge all 1 string.com.

[53:41] Awesome well uh listeners thank you for your attention today to I know that you learned a lot because there was a lot to learn as we had this discussion and there is always more to learn and that effort. Uh we'll have Pete back on uh if if he's willing to tolerate us and our Inquisition in the future and we'll talk about compliance and 409 p. Uh and and all those other limitations or limiting factors and setting up these. We can dig into this very topic for another hour easy there's many different directions to go.

[54:13] It's it's incredible and again Pete thank you so much uh listeners thank you and we'll see you here next time on the journey to an ESOP and Beyond podcast.

[54:22] Excellent thanks a lot Jason enjoyed it.