E198: Unlocking Business Exits with ESOPs: Exit Strong with Employee Ownership with Michael Bannon

[00:00:00] Ronald Skelton: Hello and welcome to the How2Exit Podcast. Today I'm here with Michael Bannon. He is an expert in all things, ESOP. We're going to talk about employee, employee stock ownership programs. I always say option programs. It's ownership programs, right? So I'm, uh, excited about this.

I do have a big project I'm working on where I help business owners who want to become ESOPs do that. So, this will be, this would be a fun conversation. I'll learn some and the audience will get to share. So let's start off with kind of, who are you? How did you get into this kind of space? And, we'll just go from there.

Let's do, let's do a little bit of origin so people can kind of know who we're talking to here today.

[00:00:36] Michael Bannon: All right. Perfect. Yeah. Appreciate being on Ron and looking forward to the conversation.So I, I started my career actually in private equity and I was in what's called a fund of funds. I mean, so we took our investors capital and then we allocated into private equity funds or various fund managers.

In reality, it was a very useful skill. I learned a lot about different investment strategies, how different fund managers manage businesses, et cetera. But I think what was most interesting while I was in that role was that I was actually positioned, I was in China and investing across the Asia Pacific.

And so I think it, I think of it as a fantastic training ground for, understanding various market cycles, environments, politics, economics. We had everything from negative interest rates in Japan to 8% interest rates in India, high tech growth in China, and,healthcare, biotech and buyouts in Australia.

Right. We really ran the, the gamut in terms of so much dynamism and, creativity in a, in one space, right? In a short period of time. That being said, after a couple of years, I got a little bit antsy, wanted to get a little bit closer, one step closer to the business owners themselves and partner with business owners.

So for personal reasons, moved back to the U S and met with CSG partners, which is the firm I currently work at. I was really intrigued by CSG from a couple of different points. First of all, I came from traditional M and A in private equity space. So I knew all the advisors and investment banks and how they operated in traditional M& A.

But what CSG really impressed me by was they were helping middle market businesses. But really showing them, those business owners, their alternatives and opportunities and not trying to nudge them onto one traditional path, in terms of a buyout or third party sale. But trying to find something that can be flexible, to those business owners' unique objectives. And so I got very intrigued.

CSG specializes in employee stock ownership plans. I'd never heard of it. I had seen references to them in public company 10 Ks before, but that was the extent to my knowledge. So I really had to learn about them and all of, uh, what an employee stock ownership plan is and the opportunities there. But ultimately joined CSG.

I've been working with CSG since 2017. Helped hundreds of clients kind of think about their opportunities within the ESOP. Helped a number of them through the ESOP transaction. Quarterbacking the transaction for beginning to end analysis, capital raise, negotiation and closing, as well as structuring.

So, across the industries, across the country, no really, uh, necessarily niches that, that I'm exclusive to.

[00:03:28] Ronald Skelton: Awesome. So you lived overseas and stuff. Are you multilingual?

[00:03:31] Michael Bannon: I do speak Mandarin. Yeah.

[00:03:34] Ronald Skelton: I was gonna say, you almost have to for what you were, you're saying you're interacting over there. That's cool. So let's start, you mentioned you had to learn what a ESOP is. I'm positive we have listeners out there who don't know. So let's just start there. What is an employee stock ownership program? And,we'll go in from there to the benefits of it.

[00:03:53] Michael Bannon: Yeah. So from a textbook definition, an ESOP is a qualified retirement plan that allows employees to earn shares in their employer. So basically it's a retirement plan that holds stock for those employees as they invest and earn those stock shares over time.From a real world example, the question really depends on who you're asking.

So going through from a different, couple of different audiences. First, from a selling shareholders perspective, an ESOP is a liquidity transaction. It's a way to transfer ownership to employees in a tax advantage manner. As opposed to selling to a strategic buyer or competitor or private equity firm. And being able to get fair market value or comparable to what a private equity firm would pay for the company and stock. From an employee's perspective, it's a retirement plan, just like 401k. Except it's in your earning stock within the company you work for, and you don't have to set aside funds for it.

You basically earn that stock through your service to the company. So it's quite unique in that aspect. And then finally, I'd say from the management team, if you're, if the management team is not the selling shareholder, it's an opportunity to gain ownership in the company you work for without having to earn a compensation, pay taxes, and then pay the owner.

And the owner pays taxes in a kind of tax inefficient, uh, kind of what I would call internal buyout or management buyout. So it's kind of an opportunity for all the different areas, but unique to each of them.

[00:05:31] Ronald Skelton: So inside of that, when you said it's a liquidation opportunity for the seller, so a team comes in and does a valuation and let's just pick a number. The valuation is $10 million and he's going to transfer, let's say all of it. Or even let's just, just for sakes of fun here.

Let's just say 80 percent of it. He's gonna make an ESOP. So at some point he gets eight million dollars. How does that structure? Is there a bank loan that pays him off? Or does he walk away and his retirement with eight million on the day of close? Or is it paid over time like a seller installment? Or how does he receive his funds, the seller?

[00:06:07] Michael Bannon: Yeah. So I think first and foremost, it's just important to note that the employees are not coming out of the pocket to pay for the shares, right? Lots of times you see an ESOP announced and someone will comment online and say, Hey, you just saddled the employees with $8 million that they have to pay, right?

That's not how it works. How it really works is that it's company funded. So the selling shareholder in this example is selling 80% of the company for $8 million. There's two ways that could be funded. One is through a traditional kind of commercial bank loan or mezzanine loan, right, that the company takes on lends to the ESOP and then the ESOP pays the selling shareholder.

So let's assume we're able to raise $5 million from a traditional lender. That means the company takes $5 million of financing. Lends that to the ESOP. ESOP pays 5 million in cash to the selling shareholder. The other 3 million would be paid over time in the form of what's called a seller note. And it's a contractual obligation of the company to pay the shareholder back over a set period of time, over set terms with interest, just like any other sort of installment basis note.

[00:07:17] Ronald Skelton: So it's not much on not that much dissimilar than any other transaction. If I came to you, wasn't offering you an ESOP and I offered to buy your company. Chances are, I'm going to raise a certain amount through traditional financing. I'm going to ask you to have some type of earn out or some type of carry some type of note, but to leave some skin in the game, and it's going to be a blended type of structure.

So it doesn't sound like it's much different than that. And then the seller gets, the question I was having for the sellers listening out there, they get the benefit of, they get some of their money for retirement from that bank loan, right?

[00:07:50] Michael Bannon: Yeah, that's right. I mean, you hit the nail on the head. The way that we like to describe it is, it's a tax advantage, leveraged buyout of your own business, right? So the only piece that's not in the equation is someone coming in with equity. Because the employees aren't putting anything in.

[00:08:04] Ronald Skelton: Now, the reason it's tax advantage is that, a lot of people don't know this and they need to hear this from you and me, is the portion of the business that's owned by the ESOP. How does that treat it tax wise?

[00:08:17] Michael Bannon: Yeah, so the tax benefits for the company are that if you, in our example, we had a shareholder that sold $8 million of equity into the ESOP, right? So then at that point in time, the company gets $8 million of tax deductions. We kind of view it as a bucket of tax deductions that they can take, that the company can take over time.

And so basically, as you take those deductions, you're able to offset taxable income or what would otherwise be taxable income. And then long term, if you ever get to 100 percent ownership, or even if you just stay 80 percent owned by the ESOP, then basically 80 percent of the taxable income each year would not be, it would be taxed, it would still pass through to the ESOP.

ESOP is a tax exempt retirement plan, doesn't pay tax, so there's no tax on it. The other 20 percent would be paid as taxes.There's a couple of different ways to kind of fine tune that, that maybe is a little too complex for right now, but we could talk about in a little bit.

[00:09:18] Ronald Skelton: Right? So that's one of the reasons that debt coverage ratio doesn't impact the bottom line. The P and L of the company though, right? Is because it's paid primarily covered by that tax savings. There's an offset. Technically, I'm sure there's a check getting rode out to pay, pay that, that debt, but they also, they get the benefit of not being a tax exempt,having taxes and revenue.

And a lot of like, here I'm in California, that could be fairly significant.

[00:09:45] Michael Bannon: Yeah, it could be 50 percent of your cash flow, right? That's actually a key piece of the puzzle, right? When we run an analysis for a business owner that's considering an ESOP. And lots of business owners, maybe they had a bad experience of debt. Maybe they're just naturally debt a person, that's why they've been successful.

Right. And they say, look, I don't want to take on a lot of debt. And so we run the numbers and say, all right, well, let's just match up what your debt service would be and match it to how much you're going to be saving in taxes. So there's zero impact on the business or the business's cash flows. You still have the same cash flow that you can reinvest into capital expenditures, working capital, potential acquisitions. As opposed to paying it out to a third party.

[00:10:26] Ronald Skelton: Now I know the answer to this one, but I'm going to ask you, are you familiar with QSBS?

[00:10:31] Michael Bannon: Yes.

[00:10:32] Ronald Skelton: Can this work hand in hand with the QSBS? Can I have a qualified stock, a small business stock plan and sell, my liquidity inside of that event is to sell to an ESOP 

[00:10:45] Michael Bannon: We actually have had a couple of clients that have. Yes.

[00:10:47] Ronald Skelton: Okay. I knew the answer. But for those of those, for those of us listening out there, if you don't know what QSBS is, you can actually tax as for the, if you're the seller, so you'll buy something, you wanna run it for five or 10 years, and then you sell it like all the ETA, programs teaching college. The, that's a big taxable event if you don't structure it right.

But if you structure it correctly, you can tax exempt the first $5 millionof the sale. And if you put money into it to see you did an acquisition and you had to come out of pocket or you put money into the company, it's actually, there's a basis above a factor. I think it's 10 X what you put into it.

All right, so if you put in a 1, 000, 000, you could do of your own money, you could come out tactics up for 10, 000, 000. But,a lot of people, there's a rumor going around that you can't, you know, becoming an ESOP, isn't a qualified transaction. I'm like, that's not true. If you did it right. If you set it up with the right company, you can actually have a qualified transaction and still fall within the rules of QSBS.

[00:11:42] Michael Bannon: Right. And then there's a unique aspect with specific to ESOPs, which is called section 1042 of the code. And that's any business owner that's selling to an ESOP, if it's structured properly, you have the opportunity to defer all of the capital gains tax. So in California, that's pushing 40, 45 percent usually on average now, right?

So you could save, you could get paid $100 and keep 45 of it in your pocket as opposed to paying it out to Uncle Sam. There's some qualificating, qualifying activities that you need to do in order to take advantage of 1042. But it's a majority of our clients take advantage of it because it's a huge, it's millions of dollars that you're going to save on the back end.

[00:12:23] Ronald Skelton: Is that like a,there's a 1031 exchange inside of real estate. It allows you to, you have so many days to put it back into another qualified entity. Is that the same as an, is it a swap type of thing where you got to put it back in the a qualified vehicle?

[00:12:36] Michael Bannon: Yes. So it's a light kind of exchange. This one, unlike 1031 specific to real estate, 1042 is specific to selling a stock to an ESOP. How it works is, it's a lot, the rules are much more lax than 1031 exchanges. There's no qualified intermediary instead of whatever is 45 or 90 days. You have to reinvest, you have 12 months to reinvest. And then you can actually use leverage.

And so, for example, we have a lot of clients that will, buy, you know, uh, floating rate notes that, that, uh, can be leveraged by margin or by real estate, right? And so you get a hundred dollars, you can, might put 25 into the qualified retirement, qualified replacement property to qualify your 10 42. The other $75 you keep in your pocket and are completely tax free.

[00:13:26] Ronald Skelton: So a lot of times I ask questions, I've already kind of know the answer to, but I know the audience don't. So, uh, I, I go ahead and ask them. So, um, that said, let's talk about what are the advantages for the business owner and the community around the business to keep it employee owned and keep it, to do what you guys are doing?

[00:13:43] Michael Bannon: Yeah. I think there's multiple levels to that. I think let's start with the business owner themselves, right. And I've never started a business, but I've interacted obviously very closely with a lot of entrepreneurs, a lot of founders. And it's cliche to say, but they do, most of them, view their business as their baby, right?

And that means they're trying to, they've, they've raised it from square one. They've, uh, cultivated the team within the business and they've tried to prepare it for whatever the future may bring, right. And so part of the benefit of the ESOP is that you've been spending 15, 20, sometimes 40, 45 years building up the team within your company.

If you're happy with that team, you would assume that they are the people that you trust most to continue managing that business, right? And so an ESOP gives you an opportunity to hand the reins of leadership over to that management team or that, all of the employees within your organization. So there's a really big legacy component or succession component.

There's also a lot of flexibility with the ESOP because we're not going out and putting you on the market for other bidders to come in with their own structures and their own way to, to set up the transaction. We're really structuring the transaction for the business owners objectives on the front end. And then bring it to the market and saying with this structure, how much will you pay for the business? Right. 

So we have much more flexibility, much more ability to tailor the transaction to the selling shareholder or the corporation. As opposed to, most transactions, which are really structured by the buyer for the buyer on a post transaction basis.

[00:15:23] Ronald Skelton: And the employees benefit from two ways, right? The, they own, they now own the company. So any dividends and shares or, distributions that go out, they get a portion of those. That's a, kind of a, way for it to work. And then secondly, they can eventually sell the business themselves so they could grow it.

I was just talking to my, I guess he'd be my uncle, uncle in law. My wife's uncle, they work for the same company for, I'll just be nice and say 20 plus years. He's a little bit older than me. And their employer's retiring and they're transitioning over to ESOP. And he's like, I'm gonna stay on it for a few more years until all my shares vest cause it's significant. 

And, we were chatting and he didn't know a lot of the stuff about ESOPs. He didn't know that later on they could sell like a private equity company could come in and offer them a, you know, a substantial increase over what their current valuation is and they could turn around and sell. They just have to vote amongst themselves to do so.

[00:16:13] Michael Bannon: Yeah, that's absolutely right. I mean, the, the end game for any employee within an ESOP is really 1 of 2 strategies. 1 is, yes, you need to vest into your shares and usually it's over, five to six year timeframe, right. And then you'll be vested for the rest of your career. And once you retire, the most traditional way is you put those shares back to the company and the company has an obligation to pay you the cash value at that point in time at the stock price at that point in time.

To you personally, and it'll go into a personal retirement plan. So still not a taxable event. Rolls over into your personal retirement plan. And still you take distributions from that plan, just like a traditional 401k.That's the most common approach, right? And then those shares that you sold are recycled back into the business for new employees entering.

The other option, and one that comes up much more frequently than is usually talked about is that, the employees have been running the management team and employees have taken over the business and are running the business for a number of years. And they get approached by a private equity firm or a strategic buyer.

And it, the price is just too good to refuse. And they just all outsell all of the stock to that private equity firm, strategic buyer. All of those proceeds go to the employees that have vested shares in the company at that point in time. And that, that those proceeds roll over into their qualified retirement plan, personal retirement plans.

And so, yeah, if you have a business that's grown dramatically above where you're the original selling shareholder sold in, you can make a lot of money as an employee owner. And many of our clients and employees thereof have. Absolutely.

[00:17:51] Ronald Skelton: It's interesting. Now, you said that I think if I retire, so I, my company turns into ESOP. And then, eight years down the road, I passed, I'm vested. I decided to retire, the company would buy my shares out at current valuation. Does that mean that, some similarity or some regular frequency, I guess, is the word I'm looking for. There's a valuation done to determine the strike price of those shares.

[00:18:12] Michael Bannon: Yeah, that's right. Every single year after the company has an ESOP put in place, an independent firm comes in and values the stock. And then even if you're not retiring, every employee participant receives a slip each year that says, this year you have X number of shares, Y are vested. And the value of those shares is X thousand dollars.

Right. And so, you can kind of track year over year, how your personal ESOP account is building up. And then once you hit retirement, either really shouldn't be any surprises, right? It's not like a lottery where you've been waiting 30 years and you have no idea how much you have in your retirement account.

[00:18:49] Ronald Skelton: Yeah, I wanted people to understand that this is really well structured. It's just like another retirement plan. They're getting reports. They know where they're kind of standing. And, the one thing I'm unclear of, and this is a question I don't know the answer to. So I'm going to ask it. If I leave and I just, I really believe in the company.

Like, uh, when I left, I worked for Lockheed for years. When I left for a long time, I left my stock in the Lockheed stock. My, I left my money in their retirement plan. I pulled it out eventually cause I had a really, what I thought was a really great startup idea that really failed miserably and I burned through it that way. But, uh,intentionally I was only, but I have buddies that were working with me there and they still have money in the Lockheed stock plan.

Can I do that in an ESOP? If I really believe in the company and I retire out, can I leave the money over and roll it over later? Or do I, is it when I leave that it needs to happen?

[00:19:33] Michael Bannon: If you leave, when you retire, the company has an obligation to buy your stock back.You need to get those shares back for new employees that are just joining the ranks. If you leave and let's say you're 35 or 40 years old and you leave the business, it's possible, but it's not up to you. The company decides whether or not they want you to continue to hold your, the shares in your company.

Or if they want to buy it back. Most businesses say we really liked what Ron did, but we want to make sure that, that stock is going to one of the current employees that's working for our business. So most commonly when you leave the company, you'll buy it back. There's a chance that they may not.

[00:20:11] Ronald Skelton: Okay. I was curious. I mean, cause if I'm going to retire in five and I'm pretty sure it's going to sell in 10, pretty good chance I should probably sit on it. Right. Like,

[00:20:20] Michael Bannon: Yeah, there's, there's a lot of, honestly, we have a lot of clients that have employees that were, many have put in their retirement notice for the following year. Find out that you're going into an ESOP and say, yeah, I can put five more years in, right?

[00:20:32] Ronald Skelton: Right.

[00:20:33] Michael Bannon: It's worthwhile investment of their time.

[00:20:36] Ronald Skelton: That's where I'm pretty sure that's where my, wife's uncle was. I guess my uncle in law, I think it's what you call that. Yeah. I think he was pretty close, right? Like he's going to retire. And then they did this and think, you know, I'm gonna hang around for five years and get, be part of this.

Cause, like I said, they, I want to say he's been working there for at least 20, 25 years, maybe longer. They make some really cool stuff. They make the big stainless steel conveyor, like systems that do custom packaging for stuff. So, and, uh, like, most recently I, for Christmas, he gave my kids this giant case of like tootsie rolls, but they made the device that put the tootsie rolls or not tootsie rolls.

The lollipops that have the tootsie roll in the middle, whatever they call it. I'm trying to think of the name of it, but tootsie pop or whatever. But yeah, there's like huge case of them. And I was like, what do you, like, oh yeah we made the thing that put them in the box and organized them and laid them in there all perfectly closes the box.

So they make custom machinery and they've been doing it for years. 

[00:21:24] Michael Bannon: I love those niche manufacturers. They really specialize and do something that's that no one else can do. It's amazing.

[00:21:31] Ronald Skelton: I had a guy on the show once like you just, I love that too, because sometimes you figure out that like you never knew there was somebody that did that. There was a guy here on the show he bought a company that sorted, the made machines, big stainless steel machines that were food grade. They sorted shrimp.

So they like by size and add detectors on it. It could tell, I think it could tell if like something was bad or whatever, but it was just a big shrimp sorting machine. I was like, well, how much is a shrimp sorting machine? I can't say that without, it's almost a little bit tongue tie. Shrimp sorting machine.

Like, how much is one of those costs? Oh, they start around a quarter of a million dollars. Like, Whoa, you must be slick. Like sending a lot of shrimp to the machine. But he sold them around the world and then, it's a, it was a pretty good sized business. I want to say it was in the, seven figures.

Well, I don't know if it's quite eight figures yet, but it was a decent, small business. And,he'd bought that and now he travels around the world and goes to trade shows where they're like, people buys machines to sort shrimp. So, yeah, I love that. There's a guy, another guy I had on here who did, they make, they do precast metal.

So they make the casting, like, we were to pour molten steel into. And I asked him, what's the craziest thing they ever made. And they made grownup size rocking horses. Like you see in the playgrounds or like, the little steel rocking horse that you get on, it's got the giant spring on it.

Somebody in New York wanted three unicorn, but big enough that you or I, probably you, I'm a little bit big, but like grown adults could get on. So they could put these things in New York. And, they made them. They made the big molds for it and poured the, this, the casting and steel, and now there's these giant rocking horses somewhere in New York that you can get on that these guys made.

[00:22:59] Michael Bannon: I love those businesses. I mean, it's when lots of people in that case, it's not, not necessarily true, but in the shrimp sorting case, it's one of those businesses that, you'd never would have thought of out of, you know, I'm not a very creative guy, right. I'm not an entrepreneur, right. But, you hear about it and you say, of course, of course, someone had to make that right.

Of course, I'm not medium shrimp or small shrimp or large shrimp, just, I'm picking them, right. But, yeah, it's amazing what people can do.

[00:23:27] Ronald Skelton: I always had a vision of like, there's a thousand people in line, like just, sort it like manual labor. Kind of like, Oh, there's somebody out there sorting shrimp and the very expensive. They're like, no, there's a machine, we make a machine that does it. Like I got to see, a friend of mine in Tulsa has a, a brewery.

Guy used to go to meetings and entrepreneurial meetings with all the time. Has a big brewery in Tulsa, Oklahoma. And they got a German bottling plant brought over to bottle, the bottle his beer. And that was incredible to watch. This thing was enormous. Took up a whole warehouse, but, like somebody had to sit down and go, you know what, instead of so many sitting there filling up the bottles and capping bottles, we need a, elaborate machine that could do a hundred thousand bottles, bottles a month. And, uh, sure enough, some engineer, group of engineers sit around and designed it so.

[00:24:09] Michael Bannon: It's amazing. I was just going to say, I never got to the second part of the, your question earlier, which is about the,how an ESOP affects the community as well?

[00:24:17] Ronald Skelton: That's where I was going to ask again. That's where I was going. We're on the same wavelength here.

[00:24:22] Michael Bannon: Fantastic. So for the business owner, right. It's a succession strategy. It's making sure you're able to sleep at night, knowing who's taking over the business.

What I think is really under, underappreciated when we talk about ESOPs, is what it does for the community? And so one of the industries that I work pretty extensively in is manufacturing and industrials, just where like we're talking about. And whenever a manufacturing company is sold to private equity or a strategic buyer, a European conglomerate, right?

Whatever it might be. The media always focuses on the jobs, right? How many jobs are we keeping in town or in this County? And what is the commitment by the buyer? Right. And that's, I'm not trying to underplay that at all. That's exceptionally important. But the piece that's really missing is that what happens to the equity, what happens to all the profits of the business, right?

When you have a founding family, maybe it's one, two, four generations that has built up a business within a small community and created a lot of jobs, a lot of wealth for the community. They're also producing a lot of equity and a lot of, taking a lot of profits out. They're reinvesting that back into the business, into the community, into philanthropy within the community. 

Whether it's spending, investing, whatever it might be, right. It's staying within the community in most cases. What happens when you sell the equity to someone outside of the community is the profits go out, right? You sell it to a private equity firm, then it's going to a fund of funds that is being managed in China like me, right. 

That I used to work for a sovereign wealth fund, or it could be going to a multinational and soaked up in San Francisco, Seattle, New York. And so what happens with an ESOP is that all of that equity really stays in the community. And I think that's exceptionally important to understand those profits are building up equity that is dispersed across the employee base.

Actually, it actually reminds me of last year we did, two transactions actually. Coincidentally in the same rural county in, in the Southeast. And this county has almost double the national poverty rate. So not necessarily, it's a rural, but it's growing community, but it has a high poverty rate.

And what we were able to do between those two transactions was create over, I think it was around 3000 employee owners. And so now you have 3000 households that are building up equity value. In successful businesses when their communities and that just, that's really transformative for the community itself. Not, let alone the jobs that obviously are kept in the county as well.

[00:26:55] Ronald Skelton: And they get, it's just like I own stock in a company. If it, if the company did does a distribution, you get a dividend, right. That's the same way with the ESOP. If a, if there's an equity distribution, say I sell 80 percent to the employees and I decided to do a distribution, 80 percent of that distribution goes shattered out to all the vested stock and then the 20%, that goes to me.

[00:27:14] Michael Bannon: Yeah. Now that 80 percent would go into their retirement plan. So they wouldn't be taking out to spend it. But it would be building up equity within the retirement plan and it could be reinvested there. 

[00:27:25] Ronald Skelton: So what is it invested inside of there? Is it just sitting in the inside of there in an account? Or is it going to pay off the loan or how does that work? What's the schematic behind there?

[00:27:35] Michael Bannon: There's two different ways. So initially, after a transaction, remember how we took $5 million from the bank and we lent that to the ESOP and the ESOP paid the shareholder. Initially, when you start making distributions or dividends, that cash is sent up to the ESOP plan. And then the ESOP plan uses it to repay that debt that it owes back to the company.

So for the first few years after a transaction, usually that's what any dividends or distributions are used for. But then after that, after that debt is repaid it goes up into a retirement plan. And then their each employee's ESOP account then has a stock account and a cash account. Cash account could be invested into, money market could be invested into, kind of traditional 401k type investments. That's really what would be happening longer term with any sort of divi-, dividend or distribution.

[00:28:24] Ronald Skelton: And when they were at USCSG, do you guys give them a selection of the 401k? I mean, the type of investments, stocks and index funds and stuff they can pick from? Or is somebody else managing that? Usually there's an intermediary in there. Like if, if I go to work for back to Lockheed or something, I have a choice of, certain investments inside of my 401k.

One of them is Lockheed stock, but the rest of them are, just something the fund manager they hired, to, to oversee it. So is that fund manager you guys, and then there's a set of portfolio that you allow that to, like, here's, here's your choices?

[00:28:59] Michael Bannon: Yeah, so. CSG's role in the transaction is really much more on the front end. So we help business owners that are considering an ESOP versus an alternative transaction. We help set up the structure for them to optimize it for tax or legal purposes. We help raise the capital. We bring in the other parties that, you know, whether it's an attorney to help on the legal front or accountants.

And then ultimately negotiate the transaction on behalf of the company and the selling shareholders. Where on the other side of the table, you have an independent trustee that represents the interests of all the employees. So the, you're not sitting across the table from, a band of a hundred employees negotiating with you.

You have an independent trustee that's selected by those employees and that trustee is the fiduciary responsible for ensuring that the employee's interests are being taken into account.Our traditional transaction or our role really ends after the transaction is put in place. We still talk, I still talk with clients that we closed transaction for four or five years ago on a monthly or weekly basis, just to help out here and there.

But from that point on, you have a trustee that is continuing to manage the ESOP trust where the dividends are going into the stock is being allocated within. You have that independent valuation firm that comes in on a year to year basis to value the company's stock and update that valuation.

And then you have a third party administrator. So just like a 401k, TPA, or third party administrator that counts how many allocated contributions have been put into your 401k, this TPA probably specializes in ESOPs. Tallies up what everyone's stock allocations are for the year, what the value of those stock allocations are.

And then if there was a cash account, they would be helping manage that as well, similar to a 401k TPA that kind of gives you the options of your funds you could invest in.

[00:30:52] Ronald Skelton: So what's the overhead for this per year? Like, what does it cost a setup in ESOP and then what's the yearly maintenance to maintain it?

[00:30:58] Michael Bannon: So, the cost to set up an ESOP is pretty comparable to a third party M& A transaction. Bringing all those different parties I just listed out together it's comparable to M&A. The interesting part is some of these tax benefits could actually be taken advantage of on the front end. They, most transactions will offset all of the transaction expenses.

So you're basically paying for it through tax savings. In some cases it might be a little bit less, but majority is paid for through tax savings. So it really pays for itself. And then on an ongoing basis you're going to have the TPA, the trustee and the valuation firm. And it, the largest variable is the number of employees, right?

If you have a lower number of employees, there's less accounts to manage. I would peg that at, it's not a large, large number, but it is meaningful, probably 30 to 75 grand on an annual basis.

[00:31:55] Ronald Skelton: So a hundred employee company. 200 employee company. We're looking at 30, no, just that 30,000 plus. 30,000 to 70,000 depending on, you know. Just like anything else, the quality of people you bring in, right? If I bring in a, A game lawyer, it's gonna be high on the upper end of that.

Or if I bring in, an A game fund manager or the TPA that you called them, And they, they got a name for themselves. They've done really well. They're trust trusted. That might be more. Is that how the pricing ranges? Is it based off of who you bring in?

[00:32:23] Michael Bannon: Yeah, it depends on the parties, but I think most importantly, the largest variable is number of employees, right? If you have, if you have 25 employees versus 250, there's a whole lot more work on the 250 then.

[00:32:35] Ronald Skelton: So the, the trustee you mentioned that was chosen by the employees. Is that usually somebody within the company or a third party with certain expertise that you want to be the trustee?

[00:32:45] Michael Bannon: It can be someone within the company. We don't recommend it. ESOPs, because of all these tax benefits, because it's a qualified retirement plan it is heavily regulated by the Department of Labor and by the IRS. And so there are trustees that specialize in ESOPs and acting as trustee of ESOPs.

They're completely independent. There's no conflicts of interests. What would happen is the company's attorney would gather a, probably two or three of these independent trustees for interviews. And then a handful of employees selected by the management team, maybe four or five employees would interview each of those trustees and select one.

The trustee really has to make sure that the ESOP is in compliance with regular regulations with laws. They're taking on fiduciary risk, which is something that your average rank and file employee does not want to take on for an eight or $10 million transaction in our example. So it's, that's definitely what we would recommend in any sort of transaction.

[00:33:47] Ronald Skelton: Is it permanent? Or can this person be replaced if you're not, if you're not working out, if they're not being responsive, not doing what they're supposed to? Can you swap your trustee out?

[00:33:54] Michael Bannon: Yeah. The board can swap out the trustee.

[00:33:56] Ronald Skelton: Okay, so what else should we know about this? I've asked a bunch of questions. I feel like I'm missing a big chunk of this somewhere. From the employees perspective, there's always a resistance to change. A fear of change, right? And I believe that if somebody is thinking about doing an ESOP, they're thinking of doing one or three things.

They're going to sell it as an ESOP, bring the employees in because they're looking to retire at some point fairly soon. They're going to sell it privately. Or if either one of those goes down, they're going to retire anyway and shut the thing down, right? Or, there's always these other options, bring a family member in to run it or whatever.

But something's about to happen, change is going to happen, right? If they're thinking about this, change is about to happen. Now the trick is, is,is it this or something else? What should the employees,know about this process? Should there anything they should be worried about or anything they should know?

[00:34:45] Michael Bannon: I would say as an employee going through the transaction, it is important, I think most business owners wait until the transaction is closed to announce to the employees. Other than the handful that are trusted and kind of more management level that are helping through the transaction process. Rank and file employees that are announced, uh, ESOP is announced after the fact.

I think it's just most important to start understanding that, you're now a, an owner in this business, right? And so instead of just thinking about, Oh, I want to bump up my hourly wage by 25 cents this year or $2 this year, right? You can also be thinking about how, what in my role and responsibilities can I do to push that stock price higher?

And if you're in a business with 150 employees all thinking that way with an ownership mindset, there's really no reason why the company should fail. And that's, that's most important. Now if you're part of the management team that is going through the transaction involved in the transaction itself just like a third party sale, it is not necessarily a low amount of work, right?

You're still going through due diligence with the trustee and the valuation firm. That's going to be negotiating the transaction. There's still a lot of structuring being done. So you might be making sure you have,changing your, your books from cash to accrual. You might be bringing on a review or audited statements going forward.

And then you might need to just prepare for a number of months before you just dive into the deep end. So some business owners are very hands on and they know how the business is operating and whether or not it's ready for that lift. Others might need some guidance from the management team that's operating day to day and say, look, I'm really excited about doing the ESOP.

I want to be part of the ESOP, but we should first make sure that we have our books and records in order that we start gathering some of the information. We have key KPIs that we have, you know.Our contracts in order before we start bringing these parties in. And that'll make it much more efficient for the management team.

The owner is going to get a better result as a, because of this. And then the ESOP trustee and the valuation firm will be doing less work that, the attorneys will be doing less work, which ultimately saves money for the business itself. And then post transaction that management team's role is to get the rest of the rank and file educated and excited, right? 

If you just say we have an ESOP, you're an employee owner, and you don't explain how it works, then, okay. I'm just going to keep doing my job, right?

[00:37:13] Ronald Skelton: Right. There's, uh, there's something to be said about training employees to be owners, right? There's a different mindset and ownership mindset than there is I, you know, my 9 to 5, I'm going to work to make a paycheck and going home. We were talking about before the show there's a company I know out there that kind of trains people on this and they've got a mergers and acquisition timeline and track record of doing it really well. I'm not necessarily needing to bring them up right now. Other than the fact that do you see that a need for employees to be prepared for this? Like, if a company is big enough, they have a decent management team. Say they've got, four or five managers. They're at the point where they already have, a CPA involved, maybe a CFO or controller. There's somebody with the C title running finances.

It's not just the owner doing it. They have proper accounting. The management they have,somebody ahead of all sales. The owner's pretty much away from it. It's running. Do you think that there's, that's a pretty easy swap over to be in ESOP? Or do you think there still needs to be training and prep work?

[00:38:15] Michael Bannon: No, I think, I think if you have that C suite, if you have trusted management team, then it's a pretty seamless transaction or transition, right? One thing I should mention that is, is an owner doesn't have to step away after they sell to an ESOP, right? They can stay on for as long as they want. It's just important that once they do decide to step away that, you know you have a management team that you've mentored and developed to the next level of leadership behind you to take over.

And that's not something that happens overnight, right? That's something that takes years to, to accomplish. I would say the transaction and transition to the ESOP is quite seamless if you have that C suite. I think what is more in question is what you do after you announce the ESOP. And if that finance team and the HR team go back to their regular work without really proposing how to educate the rank and file employees that are now owners, then you're not going to see the benefits of the ESOP.

I think ESOPs usually we're calling statistics off the top of my head here. So, apologize if I'm wrong, but I think in the first year you see like a 5 percent productivity boost after you announce an ESOP. After year two, I think it drops to about 3 percent from there on out in perpetuity on average.

And if you compound that over 5, 10, 15 years, that's an incredible goal that every single business manager is trying to accomplish and this ESOP can do it. Those that bring that average up are the ones that are saying, what roles do we have in the company? And whether it's someone on the plant floor, if it's someone in the back office, what are they doing that they could be doing better?

And what are the roles that they want to develop into? To push the stock price higher, to create more profits, more opportunities for the business. And as soon as you get that instilled across, the rank and file employees, then it's going to be much more organic and natural. They're going to be talking about it with each other in the break room. Inside, outside of the office. Trying to find ways to improve their bottom line themselves.

[00:40:20] Ronald Skelton: So one of the reasons you and I are on this call today, and, it's because I have a project out there where I'm looking for business owners who would love to do this, but for some reason they may not have the time, knowledge or, patience to get it done. 

Maybe they have to sell a business because of some life event, a divorce or medical issue or family members got a medical issue and they're just, they're needing to exit sooner than the two to three years it takes to make that C suite ready to run it. I'm willing to put together the team, work with you guys, of course, CSG, and I actually have a company that we were talking about earlier, before the show. They've done 60 M and A transactions themselves.

They train people to be employee owners. They have, read, understand how to read the financials. How to understand how their individual job impacts those financials and how to increase, teach each employee how to increase their share, the share value. So my commitment is, find these companies where the owner really wants to do this, but for some reason, there's something stopping them.

And then contractually commit to all by the company. And I say, I have a team, our team will buy the company. And groom them and prepare them to be in ESOPs and within the three to five years, I think that's what it's going to take. We'll bring in the education companies to teach them andwe'll commit to turning it into that ESOP over a period of time.

We were talking before the show,you've seen people that come in and they're just not ready. You think that's going to be a viable source out there? I'm kind of vetting my idea with you. You think that I'm going to be able to find companies that, man, they'd love to do this. I know I've interviewed a couple. Man, if I could have, I would have made, that sold, that exited. They said, well, if I had, if I had more time, I would have made it an ESOP. And I was like, let's fix that.

[00:41:57] Michael Bannon: Yeah. No, I think that's a fantastic project. We talk, I talk with perspective business owners all the time. And many want the employee ownership. They want to take care of their employees. They want those employees to benefit from the equity that they've benefited from because they've developed the business alongside them side by side for many cases, decades.

But they just aren't at the level yet to be able to handle a larger or more complex transaction like this.I think it's absolutely a viable strategy. I talk with business owners all the time that are, want to do this. And I have to, tell them, look, this is what you need to do. You need to do plan A, B, C, D.

That's not what CSG focuses on. We help you get ready, but it's more of a short term preparedness. Four to six months to get ready, not two or three years. And many of them say, okay, I'll think about it. But time is outside of our control, right? You and I both know that.

[00:42:51] Ronald Skelton: And they're going to get told that most of those guys, a lot of the things, from what I'm getting from you, a lot of things they have to do to get ready to be an ESOP, they'd have to really honestly do to be ready to be sold at full value. A lot of the due diligence, you should be able to pass due diligence to have clean financials, to be done a certain way, to have contracts nailed down to everything they would need to be able to walk in and go, here's, we're ready. And you look at it and go, yeah, you are. They would have to do that on most exits anyway. Especially to, like private equity and some other stuff.

And if they don't, they're going to get dinged. The value is going to get dinged because that private equity has to do the work you haven't done. So that said, a lot of these guys, they just, for some reason or another, whether it's medical or just timeline or just, maybe they're burned out already and the company is starting to decline a little bit because they're burned out and they can see they're not doing, doing the best by it.

They don't have the three to five years. I want to step in and build a team around fixing that. And do multiple of them. I'd love to step in, get it up and running. And then be able to run two or three, focus on it until they're getting smooth. Buy a second one, do a third one and,have him, have a mix it to ESOP within a certain period of time.

Usually, I think, honestly, I think it'd be less than 5 years. Probably 2 to 3, 4 to 5 depending on the company.

[00:44:05] Michael Bannon: I think that, I think that's a tremendous opportunity, I think, for both for the business owners, the employees, yourself as a an advisor on that transaction. And then also, I mean, for the communities, I think. All the, all policy makers and economists are trying to find ways. How do we create a more dynamic, resilient economy with competition?

You know, that's what you need in a capitalist society. And the M and A kind of contradicts that because we're consolidating everything higher and higher, closer together, right? And, the Department of Justice might push back on that here or there, but it really starts at the bottom. 

The large $40 billion mergers and acquisitions are one to get all the headlines, but it all starts at the bottom where you have, a 10, $15 million company that is selling into a, to a $40 million company. And from there into 150, right. It goes from bottom up. So the more independent businesses and whether it's under an ESOP model or others, sort of private ownership that remains independent.

And doesn't necessarily get sucked onto the private equity track where you go from one fund to the next until you're at the top, is honestly fantastic for the national economy, the community, the employees, and the business owners from my perspective.

[00:45:15] Ronald Skelton: Yeah, and it really, it really isn't going to give back to these communities. You came from, we were talking before the show, you came from a small community. I did, I came from a small community, really small. Our town actually had, when I was little, we had one, two, three decent places in town that they could work.

I remember my, my grandfather, my family worked at each one of them, pretty much. There was a company called, Patty Precision. It was a machine shop and they actually made the release mechanisms for bombers, like airplane bombers. So the bomb racks, and then the device would let them go.

So they made that and they did some other stuff. It was defense contracting. My grandfather worked here as a machinist for years. And then another one was red wing electronics. And they made,uh, they did mil spec soldering and made like the, my mom worked there for a while. As they made the military, like the helicopter helmets. They did the wiring inside of the helmets for, you know, that I guess there's a, a display inside of the lens and all that stuff where they could see things and do stuff.

They did the wiring for those helmets and stuff. Both of those companies, one of them sold and got moved out. Like the, they sold the company and, it totally moved out of town. They sold it to a big guy, private equity, and they just folded it under something they had in a bigger, like in Houston or something. Within weeks so everybody had to switch. Move to Houston or be out a bit, you know, or not work. So now that place is going derelict. It's just like, nothing's been in it for 20 years. And then the other place, they sold to a big company. One of the Boeing's electronic, basically one of the, one of the guys that was providing a lot of the parts for what they did, like the helmet piece or something.

I think those, they bought them out. And within, two or three years it's vacant now too. I haven't been out there. I moved two years ago, but right before I left, I drove out there. Just drive around and goof around in both those manufacturing facilities is gone. 

The next town over is about 15, 20 miles, right? So now everybody's driving 20, you know, and then most of them live five miles on the country. So everybody's driving 25 miles away to work now, because the two sources of job in town, and they weren't big. Most of those places probably employed 80 to 120 people, you know, they were, but that's, you 

[00:47:17] Michael Bannon: In a town of that size. 

[00:47:18] Ronald Skelton: A town where the population was technically 780. Basically 300 people were employed at one of those two shops. Now I say that, we had 26 acres in the middle of nowhere.

[00:47:27] Michael Bannon: We weren't in part of the incorporated town. So we weren't included in the population. That was the majority of it. Like most of our farm was so small, small. We had 26 acres and all our neighbors had 3000, 5000, 6000 acres, right? We were the small guys in town. It's, it's really important for towns like that, that have built their economy around a couple of solid businesses. I was just talking with a business owner earlier today that specializes in, uh,metal fabrication and lots of different, you know, primarily for OEMs of various sorts.

But they had two lines of business. Four generations that built this up. They sold one of the divisions off to a multinational. Then multinational, and in that case it was in Europe. Was over leveraged, had full operations, sold it off to a private equity firm. And the, the jobs are kind of still there.

But it's just not the same culture. It's a completely different work environment and the families next door with their other division saying, Oh, let's just not do that again right. We need to make sure we keep this and grow this for the community and not for others that are taking advantage of what we've built within this group.

And that's not just the owners. That's for all the hundreds of employees that have worked at that business as well over the years.

[00:48:41] Ronald Skelton: Yeah, there was a steel mill in the town over that my, one of my cousins worked at. I have 37 cousins. So they worked everywhere, right. I have more cousins than most people do. I have some very busy aunts and uncles. That's, that said, there was a steel mill and it sold to a Chinese company and there was a contractual agreement.

The owner thought he was being bright and said, for two years, you can't, you know, you can't move this. Basically all the employees get to keep their job for two years. I'm telling you two years in one day, the place was vacant. They moved the whole operations to either another state or to China.

And there was a big, one of my cousins actually drove the crane for molten steel, right. He got a bonus if they didn't kill anybody within so many days. It's like, you do what? Like, yeah, it's so dangerous there. Everybody's wearing these aluminum suits and stuff. He gets a huge, huge bonuses, tens of thousands of dollars.

If they go X number of days, half a year or two quarters without anybody in the factory dying. So it was a very dangerous job. But then, within a few days of their, you know, his creative move, it was gone. So it's important if you,if you're a business owner, you're thinking about selling and you'd like to see the, the job stay local.

You really should consider this because, anybody you sell to, has that option to,to move it and consolidate and be honest, it's probably a bright, if you look at dollars and cents, it's a good business decision for them not to maintain the job in your small community. It probably is economy of scale to move it somewhere where it's, more lucrative to them.

So they're going to do it. Now, that said, the employees could turn around and sell it in 2 to 3 years too, right? They can vest out in 5 years and they can take that exit. But at least you've given them the opportunity to, do what you want and keep it local to the community.

[00:50:13] Michael Bannon: That's right. And I think lots of people ask, what is, for example, you ask, what should we, first things for the employees to think about? I think first thing for the business owners to think about whether you're thinking about M& A or an ESOP or any other strategic alternative is, sit down and write down your list of objectives of any sort of transaction.

Before you even just completely ignore the fact that there's ESOPs out there, that there's private equity out there. What are you really in an ideal world want to achieve? Whether it's three things, four things, five things, and then rank them. And then maybe you can't get all five as perfect as you want, but you, at least then you're going in with a clear picture instead of starting with, here I have an offer on the table and I could take it, but then I don't get this. 

Just start with a blank slate. Right down your list and then go out to various advisors and various resources and figure out what best aligns with, with those objectives that you wrote down. I think that's really the critical piece. And that'll, that'll certainly help offset any sort of,guilt or, or seller's remorse down the road, right.

[00:51:15] Ronald Skelton: Absolutely. Absolutely. So how do people reach out to you? If they've got, you focused on the manufacturing things, but if they, any company wants to reach out to CSG and take a look at the opportunity of an ESOP for their company and their employees, how do they reach out to them?

And if they have a manufacturing company and they, they follow within your bailiwick, how do you want them reaching out to you?

[00:51:36] Michael Bannon: Yeah. So you can go to csgpartners. com. On there you'll have my personal contact information along with all of my colleagues. Feel free to email us, call us directly. We're not shy of phones. We'll talk and, and if you just have a couple of questions or if you wanted to explore an ESOP or just learn a little bit more.

If it's a little fuzzy, we're happy to send resources, spend time with you, understand your objectives, as well as, educate about ESOPs. It's really what we, what we do day in and day out.

[00:52:08] Ronald Skelton: Awesome. Well, I want to thank you for being here and we'll call that a show.

[00:52:12] Michael Bannon: All right. Thank you, Ron.