EP29 - The ESOP Mandela Effect

In this episode, Makenzie Wirth delves into the Mandela Effect and how our memories influence the stories we tell ourselves. Many business owners begin their exploration of Employee Stock Ownership Plans (ESOPs) with fragmented information they have gathered from the experiences of others—some of which may be accurate and some not. These stories can subtly influence significant decisions. Makenzie discusses the common misconceptions surrounding ESOPs, clarifies which elements are unique to each transaction, and highlights insights revealed during the ESOP process that can drastically alter how owners perceive employee ownership. 

Transcript

Welcome and the Mandela Effect

Makenzie Wirth 0:15

Hey everyone!

Welcome back to another episode of Journey to an ESOP & Beyond. I’m your host today, Makenzie Wirth. Today, I’d like to start with something that probably seems to have absolutely nothing to do with employee ownership—or at least it doesn’t seem like it does. As you know, we always tie it in.

A question for our listeners is: Have you ever heard of the Mandela Effect?

It is a phenomenon in which large groups of people confidently remember something that never actually happened or remember it differently from reality. Some common examples are Darth Vader’s quote from Star Wars, which is often remembered as, “Luke, I am your father.” That is actually not the line.

Or you may think of the song “We Are the Champions” by Queen. Many people remember the song ending with the line, “We are the champions of the world,” but it actually just ends with, “We are the champions.”

Our memories are funny. We don’t actually remember facts; we remember stories. And when enough people tell the same story, it starts to feel like the truth. I think we can all relate to that.

How ESOP Myths Become “Facts”

Makenzie Wirth 1:35

That had me thinking about ESOPs.

After working with business owners, we’ve realized that most owners don’t come into the ESOP process completely uninformed. They come in with remembered knowledge.

They’ve talked to another business owner. They’ve heard something from their CPA or financial advisor. They’ve read an article. Someone at a conference told them a story. Over time, those pieces become certainty.

The problem is that many of those “facts” are not actually facts. They are stories from someone else’s transaction.

Today, we’re going to separate three different things:

First, what everyone seems to remember about ESOPs.

Second, what your specific transaction actually determines.

And third, the truths you discover during an ESOP process that you simply cannot unsee afterward.

Pricing Truths and Fair Market Value

Makenzie Wirth 2:43

Let’s start with the stories that almost everyone has heard. We’ll call this the ESOP Mandela Effect.

One misconception we often hear is that you have to sell your company for less than what it is worth.

So, let’s uncover this a little bit and ask: Why do people believe that? Why is that such a common misconception about ESOP transactions?

I think the key thing to point out here is that there is a difference between a valuation ceiling, quote unquote, and a discount.

In an ESOP transaction, you have to transact at fair market value. The ESOP transaction process is governed by the Department of Labor, so there are rules and standards in place that must be followed.

One of those rules is that the ESOP cannot pay more for the stock than fair market value.

This could differ from what you would receive in another type of transaction, such as a strategic or financial buyer. However, it does not always mean that it is going to be lower than those options. It definitely does not mean that you are selling your company for less than what it is worth.

Going back to the Mandela Effect, people remember that it is less than what it is worth or less than other options. But the reality is that the rule in ESOP transactions is fair market value. You cannot sell it for more than fair market value.

Ownership Does Not Mean Control

Makenzie Wirth 4:29

Another myth we often hear, or a question we often get from clients, is that in an ESOP, employees own and run the company.

There are different nuances to ESOPs in terms of governance, management, and responsibilities among the various parties. But the idea that employees own and run the company is not true.

Employees do not directly own the stock. They receive beneficial interest through the ESOP.

There is a difference between that and employees owning and running the company.

Operationally and from a governance perspective, there are generally no changes. Employees cannot walk into your office and tell you how things should be run just because the company is now employee-owned.

Governance stays the same, aside from what a trustee may require or request as part of the transaction, depending on how much you are selling to the ESOP.

The intent is simply to ensure that employees are protected and that someone is representing their interests.

Employees never truly or directly own the stock. They receive beneficial ownership through their retirement plan.

They are also not running the company the day after the transaction closes. Governance and management essentially stay the same, aside from the governance nuances that come with being an ESOP.

Financing Options and Owner Transition Flexibility

Makenzie Wirth 6:16

Another myth we hear is that the owner has to finance the entire transaction. That it is all seller-financed.

That is not true.

We often see the seller finance the entire transaction, but that is not the only option.

You may invite a bank into the picture so the seller can receive liquidity upfront. A portion of the transaction may be financed by a bank, and the other portion may be financed by the seller.

There are other options as well, including private creditors that can provide liquidity upfront. In that case, there could be a scenario where none of the transaction is seller-financed.

Another myth we hear relates to whether the owner stays on or leaves immediately and what that transition looks like.

There is plenty of flexibility in the transition. There are no rules that say the owner or seller has to leave immediately or has to stay on.

We’ll explore that more as we move into our next segment, which relates to a word that often comes up with these Mandela Effect myths. We’ll call it “always.”

When you hear people say an ESOP is “always” something, you should immediately become skeptical.

Not all ESOPs are the same.

We like to joke that when you see one ESOP, you’ve seen one ESOP because every transaction is different.

You may have two companies with the same revenue and the same EBITDA. However, Company A has recurring revenue, a large management team, and diversified customers. Company B may have more cyclical revenue, be more founder-dependent, or have significant customer concentration.

Even though they have the same revenue and EBITDA, those are completely different transactions.

Going back to the owner transition question, whether someone stays on or leaves depends on the circumstances.

Does the company currently operate where everyone is dependent on the owner? Would the business not perform at the same level if the owner left tomorrow?

Or does the company have strong management depth, leaders who have been developed, and people who are ready to step into roles so the owner can transition out over time?

It depends on the specific company and situation.

Instead of asking, “Can an ESOP do this?” ask, “Can this specific ESOP do this?”

What the ESOP Process Reveals

Makenzie Wirth 9:34

Our third segment is what the process reveals that you simply cannot forget.

Even if you ultimately decide that an ESOP is not the right exit strategy, going through the evaluation often changes how you think about your company forever.

One revelation is that revenue is not value.

You could have your best years in terms of revenue, but that does not mean your value immediately increases. What drives value is your EBITDA and your EBITDA margins.

The top line is only one part of that equation.

Another revelation is that you, as the owner and seller, may be your company’s greatest asset, but also its greatest risk.

How dependent is your company on you? What is at risk if you leave within one year or two years? And what is not at risk?

Another revelation is that culture is not just what people say. Culture is what gets rewarded.

With an ESOP transaction, having an ownership mindset and ownership culture is not something the ESOP automatically provides. You have to already have that culture, and the ESOP becomes a supplement that supports and rewards it.

If you are considering an ESOP, instead of asking, “Can my company be an ESOP?” or “Is an ESOP the right fit?” I would ask:

How dependent is the business on me?

How transferable are our customer relationships?

What actually creates value within our company?

What future am I trying to preserve?

What do I want life to look like after closing?

All of these questions matter, whether you choose an ESOP, sell to a strategic buyer, sell to a financial buyer, or decide never to sell at all.

Write Your Own Story

Makenzie Wirth 11:53

In summary, the Mandela Effect teaches us something interesting: humans do not remember reality. We remember the version of reality that gets repeated the most.

By the time someone comes to us to discuss an ESOP, they have been carrying months or years of accumulated stories related to ESOPs.

Some may be true. Some may be partially true. Some may have been true for someone else’s company. But none of them are a substitute for understanding your own business.

That is why every ESOP transaction is different.

One takeaway from today’s episode is: do not let someone else’s experience become your conclusion. Let it become your question.

The goal is not to collect more ESOP stories. The goal is to understand your company well enough to write your own.

I hope you enjoyed today’s episode. Thank you for listening.

If you enjoyed it, please share with a friend, like, and subscribe. Don’t forget to interact with us as well.

Thank you for listening, and we will see you again next week.