EP21 - What Happens After Closing?

In this episode of Journey to an ESOP and Beyond podcast,  Jason  and Mackenzie discuss the full lifecycle of an ESOP company. The conversation covers what changes in the first 90 days after an ESOP transaction, including new debt obligations, administrative responsibilities, and the importance of employee communication and engagement. The podcast also discusses how boards and leadership teams evolve over time, why committee structure matters, and how companies can successfully navigate the growing complexities of mature ESOPs. From early-stage growing pains to long-term planning challenges like diversification, repurchase obligation, and balancing opportunities between long-tenured employees and newer participants, this episode provides a practical and candid look at what it truly means to operate as an ESOP company for the long haul.

Transcript

[0:10] Hey everyone welcome back to another episode of journey to an aesop and beyond i am your co-host today mckenzie worth i'm jason miller and today we will be discussing, the life cycle of an aesop we'll start with once an aesop we spent a lot of our time on the podcast talking about um you know owner preparedness and also the details of the actual transaction. But today we're starting with when the ESOP is actually formed or born. And today I'm actually, I'm putting Jason in the hot seat. I'm asking him a bunch of questions, but I know that he'll twist some back to me. As many as I can, as many as I can. Try to keep him in the hot seat for as much as possible today. All right. So how does that sound, Jason? Well, I'm ready for whatever you got. Let's see how we can do. All right. So the Aesop is formed. Maybe today is the day we're announcing. How would you describe the first 90 days after closing? What does that look like for the company? Okay.

[1:32] I imagine that it is very strange. And some of the reason that I think that it's very strange is, as we often say, the company is after the ESOP, just like it was before the ESOP. Only ownership has changed from an individual or series of individuals to now a trust set up for the employees. But work feels the same. Uh, so if you're, you close on a Friday and your, your ESOP is born on Friday and you come back to work on Monday, it's like, this feels just like every other Monday that we've ever had here. And then in the next number of weeks, um, the question becomes, well, what changed when.

[2:23] What are we now? Like we're an ESOP and that's great. Are we supposed to be doing something?

[2:31] It doesn't feel like much changes operationally. That's right. As it shouldn't.

[2:39] Operationally consistent. But the questions do start coming in around, okay, well, we closed on a certain date. So we have to finalize everything numerically and do a true-up process after the close that then determines all of the parameters around however the transaction was structured. So if there's basis in the transaction or not and seller notes and how all of that gets adjudicated. And then some level of education on, well, how do we record all of these things? I think you've done at least one episode on ESOP accounting on how to record those things. So financially, there are some changes. Now we have debt. We got to kind of wait until we figure out how to book the debt and then handle the debt, make payments to the bank, make payments to the former owners. What payments do we make? When do we make them? All of that. So financially, there is a change, but it's almost like a no man's land for a period of time until things are finalized. Does that make sense? Yeah, definitely. So there's less of an operational impact, but especially for companies that, which we see often, don't have any debt before an ESOP transaction. They're not used to debt payments and any sort of debt service. Now they have to get used to it and they have to figure it out.

[4:08] So whether or not budgeting and forecasting and cash flow projecting was a part of your, day-to-day, or maybe not day-to-day, but month-to-month or quarter-to-quarter tasks, it should now be. Is that right? That's exactly right. And debt becomes the 800-pound gorilla in the room for the next number of years in the ESOP life cycle. So we're going to come back to that a lot and how it changes over time, I imagine, in our conversation today because it becomes so important on we have it, we have to pay it. We may not have had it before. We don't know how to handle it or we're not familiar with how to handle it. And now we have new questions that we're asking. What's the right use or best use of the capital that we have at hand? And what are our options now with it when some of it is already spoken for by making these, these debt payments. Mm-hmm.

[5:16] What about from an administrative perspective in that first, maybe not 90 days, but first year, first couple years as you're getting accustomed to what's required? Yeah. So you have a retirement plan that requires its own administration. It's a third-party administrator. Please use a third party.

[5:40] I would not envy anyone that chooses to do the administration in-house. Um, it's a one-time, an annual event basically related to the stock price in the beginning, right? So you have to determine, you've already determined the formula that's written into the plan, and then you need someone to adjudicate the formula when the share price gets determined by the trustee and the valuation firm at the end of the fiscal year. And so there are new things administratively that you're going to have to handle. And build into, having a great TPA to help you with that is going to be vital so that it is properly administered. But that's the plan portion. Then there is, what about all these committees? And what about the board? How often should the board be meeting if we didn't have a board before, when do we need to bring in independent board members from what we negotiated in the transaction?

[6:50] And which committees do we need first, whether it's a compensation committee, whether it's a nomination committee, whether it's a communication committee, those are going to help determine the direction of your ESOP the earlier that you get them set up and in place. As well as the board cadence, like I mentioned. So there's the actual. No, that was, that was great. So there's the actual administrative piece, which is the actual record keeping of the retirement plan, which again, third party makes your life easier. And then there's also the governance perspective from within the company that may look a lot different than it did before if you're not if you didn't already have a board set up or any any committees you mentioned a few committees one I think that you left off that we hear sometimes which is usually, I don't believe, requested by a trustee, but it's a committee that is probably good to have once you become an ESOP, is an ESOP committee. What would you describe? How would you describe the role of that committee? Um, nanny.

[8:18] That's, that's how I would look at it. And not not in a negative way, or derogatory way at all. But you need someone who is looking out for making sure the ESOP hits the milestones that it's required, communicating with the trustee and the valuation firm to make sure that things happen with your CPA, with the bank, with the IRS, making sure every item that you are required to do for the care of the ESOP for all of the parties that are interested get done, as well as the general health and welfare of the ESOP.

[9:02] And that could be determining which committees are essential and which other committees. And so that's why I, in my head, when we're saying that when the Aesop is born and then what should we have? Well, you have an Aesop committee. What is that? That's kind of like the, that the nanny is the first word that came to mind when you said that. Yeah. And I think this committee is very important and kind of goes back to, or reminds me of previous episodes we've done where if you're essentially not designating a responsibility or a task giving a specific person or committee ownership of certain things, then nothing's going to get done or things will fall through the cracks. And being an ESOP company, it's pretty imperative that you have your ducks in a row related to everything that's involved post-transaction. Yeah.

[10:00] I would say in that aspect, it's obviously much different than being acquired by a strategic or PE coming in. This creates administrative tasks and well-organized mechanics within the company to stay in compliance. It is such a great distinction. And acquisitive, strategic, or private equity have a very disciplined process of integration on that administrative layer and on the change layer. And in an ESOP transaction, because you are the same company that you were before, you're not responsible for making huge changes to systems or processes or assimilation or whatever you want to call it. But there is this additional administrative burden and burden of care for the new ownership that can't speak for itself. And I say that by it's the trust document and not you as an individual. But that's a great distinction in how that will feel afterwards. I had another thought. What was it?

[11:27] Yes, I remember. It takes a village. And what you said around setting up the committees and who to get on, the board is a tool. You've heard me say that before. And the ESOP-related committees are also tools for you to help get other employees involved in the life of the ESOP that isn't a huge lift for them individually. But helps to increase engagement around the health of the ESOP and understanding of the ESOP and distribute institutional knowledge.

[12:06] As you and your executive leadership team have kind of worked on this up to the date of closing, not everybody knew. And there's typically a huge announcement like here it is. And sometimes it's not given away ahead of time. Sometimes it is, But the announcement is still really important and that communication has to carry on. But think of a means of communication as involvement. How do I get people involved? And the best way to get people involved is to give them a responsibility that doesn't impact their day to day, but does greatly impact their ability to engage with, well, what are we now? And what's an ESOP? And what can I do? And how can I help? And you mean it benefits me? And I have a, I have a say or a role. And if you give them a role, then, uh, in awareness increases along with that responsibility. And you can rotate those out, um, on, you know, a biannual basis or someone's like, ah, this isn't for me. I'd rather just kind of work on this committee or that committee, but you want to increase engagement and use committees as a tool. Yeah. I think that's great it makes it less makes the Aesop less of just this like idea or like intangible thing that, manifests upon retirement only it's something that allows them to.

[13:33] Like you said, engage with it today.

[13:39] So still kind of staying on the topic of governance, with a board of directors, assuming the company has a board prior to the transaction, how would you say a board thinks differently in an ESOP environment? How could those conversations change?

[14:03] You have likely never thought about, how do I put this? You've likely never thought about driving a share price as a leadership team. You have thought about driving the business forward, achieving a vision, achieving results, achieving goals, aspirations. You've implemented strategy to do that. You've developed benchmarks, KPIs, and processes to do things. Now there's one other layer, which is there's a measurement, and that measurement happens every year. And there's grace in the fact that it happens every year and not every minute between 9.30 a.m. And 4 p.m. Eastern time.

[15:02] But you can learn a lot from how do larger companies that are answerable to a board and to shareholders how do they operate what changes in that room and if you are an investor and likely as an owner you you have other investments or you follow financial news, look for clues look for keys look for things you like or don't like about how people communicate things.

[15:28] Someone came out that was really interesting in a conversation I had on AI. Is AI going to be replacing jobs? AI is going to maybe redistribute jobs, in my opinion. Uh, Chris Fredericks had a great, um, and thank you, Chris, again, for participating last year, uh, and coming on the podcast. We'll have you back soon. Um, but had a great perspective on trying to stay ahead of what AI will do and being early adopters or, uh, fast followers in that. So, uh, you're, you're not just waiting and holding onto something that is no longer going to be there. Um but if we become a company that never lets anybody go regardless of what happens with ai how far behind would we get and if the answer is letting people go why would someone ever do that well a large company may do that because of what it could do to the share price uh and if in recent news there's a very very large company that due to ai improvements is laying off a multitude of workers, and the stock price goes up. Well, why does that happen? And when you have a 70 times multiple, and you save a few billion dollars in expenses, multiply that out and see what happens to the share price.

[16:54] And then you have to balance, well, does share price determine how we implement strategy or what choices we make? And the answer in an ESOP company is, well, it doesn't have to. But I would encourage you to think about how your strategy could impact the share price of your company. You never had to do that before.

[17:15] There's a lot of things to balance and think about as a board in an ESOP company where the employees are obviously very important. But when you're in a world like today with AI that's replacing your employees, how do you make those decisions? They're hard, and leadership makes hard decisions. And I don't know that there are ever any easy answers. They're just easier answers and they're difficult messages. Sometimes I'm hopeful that AI is augmentative and not something that replaces people wholesale.

[17:59] All right. So moving on to the topic of a mature ESOP company and mature. Slow down. We got one month and then then we're on a mature. So let's cover the first couple of years. So we got through year one. Like, what are we? What are we doing? How do we do this? How do we get everything set up? What does it feel like? By year two, it's going to feel like you just added some burden administratively, financially, process-wise. You're still trying to figure things out. You're attending conferences. You're attending webinars. And you're learning. You're learning how to walk as an ESOP company. And those first probably three years are going to feel like you're under the thumb of soul-crushing debt.

[18:47] You just are. The good news is likely that there are more advantageous cash flows alleviating some of what that burden would feel like without the ESOP.

[19:01] But your decisions at that board level and at an executive level are what's the most optimal use of our cash in order to continue to accomplish our strategic goals and also diminish the burden of debt. And so those first three years are that. How do we understand it? How do we get our arms around it? And when we do, as we're working through what it means to be an ESOP, all of that kind of aligns after a couple of years in that regard. The ownership mindset takes a couple of years to settle in with constant communication, constant education, constant outreach, constant trying to increase the engagement of the employees into the ownership. And if there isn't a concerted effort to do that, then that part might linger and it feels more like a retirement plan than it does a means of ownership. So those first two or three years are really critical, as you said, balancing all the new things. But I don't want to pull any punches with anyone and say, hey, it's going to be great. It is going to be great and it will feel different and it's going to feel like a mountain of debt.

[20:18] But not for long or not for not for long so now let's go from like year three to to year seven ish yeah right five seven uh you you found your rhythm in most cases administratively operationally financially like you got it um you've made some changes you've maybe rotated a member out on the board because they don't need to live there forever um and when you know you're I get where we are. People get who we are. We've established what we need to to continue to be us in the way that we wanted to. And usually around that, between those years five and seven, some of the people that have been with you for decades are feeling tired.

[21:05] And they have to start thinking about role replacement if they haven't already and be deliberate about that because they're not going to be there forever. No one's going to be there forever, but the company will if it's run well and sustainably. So those years that kind of three to seven is really critical from a leadership perspective on who is next for us. We carried it to here. We got it through the transaction, over the hump, charted the path, and we can't continue indefinitely. We can continue up to this far. This is as far as we go. And before we get to this is as far as we go, we should understand who's going to carry the torch for our role afterwards. And that's where all the things we've talked about will help to establish who those people are. And ESOP companies are really good, by and large, at succession planning because they're like, we've got to keep this thing going. So we've got to figure out who's going to do it behind us. Right. And the other side of that is not only planning for who's going to replace them, but in the context of the actual ESOP is what does that mean for repurchase obligation? Thank you.

[22:27] In most cases, nowadays, those early years, and I would say, again, most cases, through like the first 12 years, there will be isolated pockets of material repurchase obligation starting in that kind of seven-ish year time frame.

[22:54] Because you've had a vesting schedule. You've had some retirements. You have a long inside note, so there aren't a lot of shares that are allocated unless you chose to prepay the note to release more shares. And we've talked about that on a number of episodes and kind of what implications that could have in pulling repurchase obligation forward. Um and so you're in this sweet spot from years seven to twelve and you likely ordered or um, got your first repurchase obligation study in year four or year five as negotiated in part of your deal to say hey what really is it now that we're here and we got a few years of share releases behind us and our share price is going up. And then we have all these ages and of people and what, what, what is it going to be? What's the number going to be? And then how, how do we think it's going to happen? Um, and then it's okay. We, we have a handle on this now. When should we get the next one? And it's likely three years from that date, I would encourage anyone in year eight afterwards to get a repurchase obligation study done. That's because in year 10, we have this plan trigger. What's that particular plan trigger, Mackenzie? Quizzing me. Diversification. Diversification.

[24:22] So... What does diversification mean? So once an employee has had their account for 10 years or participated in the ESOP for 10 years, they are eligible to diversify their plan, their portfolio currently, which is all invested in your company's stock, but can now be diversified and invested otherwise. So I believe typically, correct me if I'm wrong, what happens is they'll exchange their stock for cash and invest that cash in other places. That's right. They at least have the option to. It's not required, but you have to give them the option. That's right. So it is optional, which means that it can be delayed. And if things are going great for ABC company stock people will look at that and go I'd rather be concentrated than diversified in this portion of my holdings.

[25:33] And since they have the ability to say well you know next year I can cash some of this out and then they see the stock price next year and they go maybe next year I'll cash some of this out and so then it kind of kicks the can down the road while more shares are being released to all workers, and more workers are being pushed towards the diversification window and towards their retirement date. And so you can see how many years down the road, how events and timing could possibly converge against you. Always keeping the company on their toes, trying to figure out when they're going to owe money to who, or need to...

[26:20] Use their cash for specific reasons related to the esop and not for other reasons that's right in the same window of time seven to 12 years most if not all of the transaction debt is paid off, in many cases uh and now uh especially you know post year seven regardless of whether you're a c corporate transaction or not and you're 100 i'm making the assumption of 100 esop, you're going to convert to an S Corp as soon as you can if you were a C Corp for the transaction because then you don't pay any tax on any of the income and your share price goes up your cash balloons you have one less obligation that you've had five six seven eight years of discipline paying a multitude of money out to the shareholders and then now that money sits there, you know what do you do with it and you can find all sorts of things to do with it you can grow you can acquire you can find a new product line you can you can do a lot with with money that's no longer taxable and because you're early on uh and you you listened to this podcast and others about prepaying that note and advancing reversion obligation you have this this window of man we we can be.

[27:46] We can be more us and we can have more of us and we can do a lot in that span of time when there's no immediate demand on the cash that's being produced by a successful ESOP company without debt. It seems like that puts mature ESOP companies at quite the advantage over their competitors who are non-ESOP companies. Teenage years. What are we doing for those teenage years, Mackenzie?

[28:28] So you still have obviously the repurchase obligation i was i was thinking kind of before we we moved on was that once you get like a hold of all the new administration and once you get in in the swing of things and you're like all right we're used to this now then there's another layer that comes and that's right there's always something to to stay on top of um which again goes back to having the right people in place having the committee set so that, everything continues to run as smoothly as it can.

[29:10] I think that's one of the things that I've always loved about ESOPs and the ESOP community is just that there's never a dull moment.

[29:20] And certain things demand more attention and more planning at different stages. And we can't ignore the importance of repurchase obligation and setting up the company as an ESOP. But we can right size its impact in those early years to give some breathing room to clients around that and then in these kind of teen years fast forwarding what even even year 10 if you look back on your company 10 years ago who's in the same role and you're going to be able to point to some people and then you're going to look at the gray hairs that they may have uh and go all right, now I have to think 10 years in advance or 20 years in advance. So if changes at the leadership level or the responsibility level and engagement level hadn't changed around that year seven or year 10, it's going to change in year 13, in year 15, in year 20. And that's when repurchase obligation becomes vastly more important for successful companies because the stock price has gone up a lot of the stock has been allocated there may or may not be stock left to allocate and then we start talking about what do we do then um.

[30:41] So those years are, again, vital for planning. And even though you may be required by a lender or by your trustee to do the repurchase obligation study every couple of years or every three years, you will know when you get one whether or not you need it every year or what to do about that.

[31:04] So in the teenage years, it's kind of either the same situation. I wouldn't say issues, but same, we'll just call it issues for now. The same issues that maybe weren't dealt with prior are now occurring now, or it's the same situation or circumstance that you're dealt with, whether that's, what do I do with all this excess cash? Are we thinking about acquisitions? It's kind of maybe the same situations, just in a different time period or under different circumstances.

[31:49] I would also offer that from maybe about year seven on, your founders are unlikely to want to continue on the board. Maybe they're unable to continue on the board. Maybe they're just waiting for everything to be paid off before they feel comfortable leaving their role at the board. But they're watching the ESOP grow from having to carry it. And listeners, this is you as a founder. There comes a time when you realize that it's okay for you to further remove yourself, not just from day to day and not just from executive leadership and not just from board governance over time. A very wise friend used to say that ESOPs are a glide path to an exit. And while most people use that as a financial wording, that's a role and emotional wording too.

[32:56] So I think we've covered the entire life cycle. Is there any other areas you would want to touch on? I guess.

[33:12] So imagine, hopefully, and feel free, listeners, to lambaste me in comments, send things in. Uh i'm i'm not i'm not a swifty but taylor swift song i was not expecting that i know you weren't it's great uh anti-hero are you familiar with the song uh so in the middle right there's i don't i don't know what the lyrics are i don't know it that well but like the family's squabbling about the you know she's she's looking up at us from a certain place and and and laughing over that not leaving them in the will. If you look at 20 plus, and there are people that were young when the ESOP was born and have been there for 20 years and aren't quite ready to go, they've accumulated a lot of shares. And decisions may have been made over that 20 year period where a lot of people that have been there for a long time have all or most of the shares, or all of them have been allocated and then there's a young person like me that shows up and wants to work for a great successful company that happens to be an ESOP. But when the year turns over and the allocation comes through, I'm one of a thousand people and no one's leaving.

[34:39] And there's no stock left to allocate. And if that type of dynamic persists, you have this, hey, you guys have been here forever. You've got these massive balances. You have all these shares. As much as we love you and want you to stay here, I'd like a little bit of that. And so how do we balance this? And the common phrase is the haves versus the have-nots. Because the have-nots are still doing a very useful function for the health and growth and life of the company and the share price that the haves enjoy and will enjoy when they retire. And so all of those R's that Pete Shuler had talked through on an earlier episode this year are relevant. What do we do to make this more equitable for the population that we have? And did we write our plan in a way that we're able to get shares out of the hands of people who no longer work here?

[35:44] And we didn't segregate or we didn't have the cash at a certain time to be able to buy them out. So they're enjoying the upside of where we are now without contributing. What do we do about that? And I think the pivotal thing I want you guys to walk away with in that is, Let me back up. The guiding principle should be, how do we keep shares getting into the accounts of the people who are contributing to the growth of the company? And if that's the guiding principle, keep and get shares into the hands of the people who are contributing, it's going to influence the way that you look at releveraging or whether or not you choose to do re-leveraging or recycling and all the R's, all those R words. And that's something way in the future that today you can plan for by saying, okay, we want to be able to put plan provisions in that allow us to get shares out of departed participants and back into the hands of the people who are here doing the work. And that can change and evolve over time as it needs to to address whatever is specifically happening to your ESOP.

[37:05] So things to even think about before you become an ESOP or as you're going through the transaction process in plant design, which is something that you and Pete touched on in your episode, is making sure you have that flexibility. But of course, there are ways to amend or make provisions to your plan But just always good to be as prepared as early on as you can for all of these fun Aesop nuances that come up in year 20. Um so all right I think my final question for you is out of the entire Aesop life cycle, which part would you say is the most underestimated, Ooh, that's a really good question, Mackenzie. I'm biased.

[38:13] And I would encourage every listener to constantly think about the cycles of leadership versus the stages of the ESOP. Not everyone's going to be here and sometimes life, makes it to where those people aren't here sooner than expected for good reasons and for not so good reasons but if you maintain a leadership structure and a posture towards growing new leaders, then the Aesop will thrive in whatever stage of maturity it is. If you drift from that or you don't directly address it, then it puts everything in jeopardy.

[39:16] Very true all right well we've covered a lot today from the esop being born through, the first month to a year three or seven which we'll call maybe semi-mature they're not they're not fully mature yet but getting there um all the way to a long-term mature esop in, their 20th year or beyond. So lots to unfold here. Of course, other nuances or pieces that come up within those years that we could spend even more time talking about. But I'm sure you can find there is an episode out there that we've done already on those topics. So be sure to subscribe if you like this episode today, share with a friend, interact with us on journey to an esop.com and we hope to see you back next week thank you.