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

Makenzie Wirth 0:15

Hey everyone!

Welcome and the Mandela Effect

Makenzie Wirth 0:16

Welcome back to another episode of Journey to an ESOP & Beyond. I'm your host today, Mackenzie Wirth. And 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.

Makenzie Wirth 0:16

A question for our listeners is: Have you ever heard of the Mandela effect? It's a phenomenon in which large groups of people confidently remember something that never actually happened or remember it differently from reality. Some common ones are Darth Vader's quote, a famous quote from Star Wars that is often remembered as "Luke, I am your father." That's actually not the line. Or you may think of the song "We Are the Champions" by Queen, and everyone likes to say that the song ends with the line, "We are the champions of the world," but really it just ends with "we are the champions."

Makenzie Wirth 0:16

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 all can resonate with that.

How ESOP Myths Become “Facts”

Makenzie Wirth 1:35

And that had me thinking about ESOPs. And 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... and over time those pieces become certainty.

Makenzie Wirth 1:35

The problem is that many of those facts aren't actually facts. They are stories from someone else's transaction. And 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 discovered during an ESOP process that you simply can't unsee afterwards.

Pricing Truths and Fair Market Value

Makenzie Wirth 2:43

So, let's start with the stories that almost everyone has heard. The ESOP Mandela Effect, we'll call it. I'd say one we often hear is that you have to sell your company for less than what it's worth.

Makenzie Wirth 2:43

So, let's uncover this a little bit and think: Why do people believe that? Why is that a common misconception about ESOP transactions? I think the key thing to point out here is that there's a difference between a valuation ceiling, quote unquote, versus a discount.

Makenzie Wirth 2:43

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 in place that must be followed, or standards in place, and one of which is that the ESOP cannot pay for the stock more than fair market value. This could differ from what you would receive in another type of transaction, let's say from a strategic or financial buyer. However, it doesn't always mean that it is going to be lower than those options. And it definitely doesn't mean that you're selling your company for less than what it's worth.

Makenzie Wirth 2:43

But going back to the Mandela Effect, people remember that it's less than what it's worth or less than other options. But really, 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 that we have questions about when we speak to 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. The fact that employees own and run the company is not true at all. Employees do not directly own the stock... ever. They only receive beneficial interest. There is a difference between that and employees owning and running the company. Operational and governance-wise, there are no changes. Employees cannot barge 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 ask for as part of the transaction, depending on how much you're selling to the ESOP. And the only intent with that is to ensure that employees are protected and that someone is representing them. However, employees never truly or directly own the stock. They only receive beneficial ownership through their retirement plan. And by no means are they 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. It is all seller-financed. That's one thing that is also not true. We often see the seller finance the entire transaction. However, that is not the only option. You may invite a bank into the picture so the seller can receive liquidity up front... 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... with private creditors that can provide liquidity up front. And in that case, there could be a scenario where none of it's seller-financed. And finally, another myth we hear is the owner staying on or leaving immediately and what that transition looks like. There is plenty of flexibility in the transition. There are no rules about whether the owner or seller has to leave immediately or has to stay on. And we'll peel that back a little more as we move on to our next segment, which is one word that comes up with these Mandela Effects myths. We'll call it "always." When you hear people say an ESOP is "always" XYZ, 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, the same EBITDA. However, Company A has recurring revenue, a large management team, and diversified customers. Whereas Company B may have more cyclical revenue, be more founder-dependent... maybe it has a lot of customer concentration. And again, even though they have the same revenue and the same EBITDA, that's a completely different transaction. Going back to my point about the owner's transition, staying on or leaving, goes back to this point. Well, it depends. Does the company currently operate where everyone is essentially dependent on the owner? Or would the business not perform at the levels it has been if the owner left tomorrow? Or do they have good management depth and they have leaders that they've been developing and people that are lined up to take over roles that the owner can easily transition out, and maybe it's not tomorrow, but maybe it's within a year. It depends on the circumstances and the situation that each company at hand has. So instead of thinking of it as, "Can an ESOP do this?" Maybe ask, "Can this specific ESOP do this?"

Makenzie Wirth 9:32

What the ESOP Process Reveals

Makenzie Wirth 9:34

Our third segment is what the process reveals that you simply can't forget. Even if you ultimately decide that an ESOP isn't 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 the best years in terms of revenue. However, that does not mean that your value immediately jumps up. What value focuses on, and what really drives value, is your EBITDA and your EBITDA margins. The top line is only one part of that piece. Another revelation that may come throughout the process is that you, as the owner and seller... kind of back to that point, you may be your company's greatest asset, but also the greatest risk. How dependent is your company on you as the owner and as the seller? And what's at risk if you were to leave within a year or within two years? And what is not at risk? Another revelation is that culture isn't just what people say. Culture gets rewarded. And with an ESOP transaction, having that ownership mindset and that ownership culture isn't something the ESOP is going to provide automatically. You have to have that culture or some culture already that exists... that the ESOP then is a supplement to and rewards that culture. If you are considering an ESOP, rather than " Can my company be an ESOP?"... "Is an ESOP a right fit?" The question I'd ask yourself is "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?" And all of these questions matter... whether you choose an ESOPsell to a strategic buyer, a financial buyer, or decide never to sell at all.

Write Your Own Story

Makenzie Wirth 11:53

So, in summary, the Mandela Effect teaches us something interesting, which is that humans don't 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. And some may be true, some may be partially true, some were true for someone else's company... but none of them are a substitute for understanding your business, which is why every ESOP transaction is different. So one takeaway from today's episode is... don't let someone else's experience become your conclusion. Let it become your question. Because the goal isn't to collect more ESOP stories, it's to understand your company well enough to write your own. I hope you enjoyed today's episode, and thank you for listening. If you did enjoy it, please share with a friend, like, and subscribe. And don't forget to interact with us as well. So thank you for listening, and we will see you again next week.