Host (00:01):

From Lazear Capital, this is the ESOP Insider. In this four-part podcast, we will take you through all you need to know about selling your company, through an Employee Stock Ownership Plan, or ESOPs as they’re commonly known.

(00:14):

As industry leaders in the ESOP space, we know there is a lot of noise, and frankly, just poor advice floating around. We here at Lazear Capital have brokered more than 200 ESOPs, which is a sizable amount more than any other firm in the nation. And in the year of this recording, 2024, we will close over 40 new ESOP deals. All that to say, we feel pretty confident on this subject.

(00:36):

Now maybe you’re here because you’ve heard of ESOPs before, but are just looking for more info to educate yourself. Or maybe you are in the process of selling your business right now and thinking about doing an ESOP. Wherever you are in the process, this series is for you. Our goal with this show is to not only give you those high level talking points, but to actually really dive down and take you through the strategic and emotional business decisions.

(01:00):

We’ll do this through talking with ESOP industry experts, employees of ESOP companies, and business owners like yourself who have made the call to do an ESOP. So without further ado, let’s dive in.

(01:13):

ESOPs can be an excellent vehicle for selling a company, but they do come with their fair share of complexity. To better understand this complexity, we sat down with Ted Lape, partner at Lazear Capital, to frame up what an ESOP is and how to best utilize it.

Ted Lape (01:27):

I’m Ted Lape, one of the three partners at Lazear Capital. Started out in banking, and banking is a commodity. So I always like to find things where I could provide a solution that was a little different than what everyone else had. ESOPs were perfect for that, because it’s a life event for people. And when they are thinking about what they want to do, if they decide to do an ESOP, then they also start thinking about all their banking. And I just thought it was a really great solution for people who don’t want to sell to private equity or to a competitor, because I would hear that over and over again.

(02:05):

And then of course, there’s all the tax advantages. So I started to get into ESOPs, and went around, just started telling everyone about it. And did that in banking for a while, and then joined here and brought that expertise over here.

Host (02:19):

Ted and his team at Lazear Capital are the preeminent experts on ESOPs. And as I set up top in Lazear Capital’s 20 plus year run, the firm has brokered more deals than anyone else in the nation. So if there’s anyone qualified to speak on the subject, I’d say it’s Ted.

(02:35):

So Ted, if you wouldn’t mind, can you explain to me in just the most basic sense what an employee stock ownership plan is?

Ted Lape (02:42):

Yeah, the easiest way to think about an ESOP, it’s like you’re selling to a 401k plan, except rather than having the stock of Apple or IBM or somebody, the stock in the retirement plan is your stock. So you’re essentially selling to this defined contribution plan, like a 401k, and you’re putting your stock in there instead of, as I said, Apple or IBM.

Host (03:09):

So if you’re a business owner, is there a litmus test of some sort that can more or less indicate if an ESOP is going to be right for your company?

Ted Lape (03:16):

Yeah, there’s really nine easy reasons that people can understand to do an ESOP. The first is total sale proceeds before tax typically will end up being more than in a third-party sale. And that surprises most people.

(03:32):

The second is you have the ability as the seller to sell tax-deferred, and ultimately tax-free. Post sale, if you do a hundred percent ESOP, which most people do, the company typically becomes federal and state tax-free. Yeah, the government really wants you to do this. Bernie Sanders loves ESOPs. Republicans love ESOPs, because it gives employee ownership, it’s a good thing.

(03:53):

So they’ve created a way that you can sell tax-deferred, and ultimately tax-free. And if you think about it, it’s 20% federal tax. Then most states have a five or 6% tax. If you think about places though, like New York, or California, or New Jersey, it can be up 13, 14%. And even states like Texas that don’t have any tax, we do a lot of ESOPs then. But the ability to sell tax-free, people like.

Host (04:20):

So just to pause here, yes, tax benefits are a huge driver in a business owner’s decision to go ESOP. And as you just heard, these tax benefits are unique and many, especially when you start adding up all that you actually pay in a conventional sale. Now, with all that said, before you go running out the door to get Lazear Capital to structure your ESOP, there are some other major considerations to hold as well. Let’s get back to it.

Ted Lape (04:45):

The owner typically wants to maintain operational control post-closing, and they do in a ESOP. And that’s usually very, very important to them. Usually the owners made a lot of promises to those key employees, and the ESOP allows them to keep that, because we do a very, very robust management incentive plan, that is worth usually millions of dollars to those key people.

(05:08):

The employees also do very well. Even the lowest level employees typically get hundreds of thousands, to sometimes over a million dollars, to supplement the retirement that otherwise they wouldn’t be able to afford. The due diligence is a lot easier in an ESOP than it is in a third-party sale. There is a fair amount of, you are selling the company, there’s a fair amount of information you have to give. But it’s a whole lot easier and less intrusive than a third-party sale.

(05:36):

And it’s a lot more confidential. You don’t typically have to worry about your competitors finding out, your employees finding out, your suppliers finding out, and all the problems that creates.

(05:48):

Third-party studies show that ESOP companies out perform on ESOP companies. Studies by Rutgers and others show four to 5% increase in productivity, less turnover, more growth. A lot of great outcomes from that. And another easy one for people to understand is, a lot of times people own real estate. And in an ESOP, you can keep the real estate and lease it to the company, or you can sell it. But a lot of times people want to just handle everything, and either it maintains a tenant for that real estate, whereas if you sold, they may move the company and now you’ve got an empty building, or it allows you to sell the real estate to the company, which is a great solution.

Host (06:31):

Ted, let me ask you, is there a model industry where ESOPs just work particularly well in?

Ted Lape (06:38):

Yeah. They’re in all industries. The last statistics I saw, manufacturers are the biggest people that do ESOPs. Two industries we see a lot are contractors. There’s often not a great way to sell your company if you’re a contractor, to a third party. The values aren’t great usually, unless you’re doing all service work. And it’s a way to keep all your team together. And then there’s all the other benefits of an ESOP we’ll probably get into.

(07:09):

And then the other one is professional service companies, architects, engineers, consultants, software people, because you have what are called elevator assets, which are your people, they walk out the door at night, you want them to come back the next day. And what an ESOP does is it helps with recruitment, with retention, to lower turnover. So if your asset is your people, it really helps motivate them, and get better with, as I said, recruitment, retention, and also performance.

(07:44):

You’ll see third-party statistics done by Rutgers and other folks. You’ll see a four to 5% increase of productivity. And then we also see them, when industries that don’t lend themselves to selling to a third party just because they’re really niche-y, and maybe not understood well, or they’re in the coal industry or whatever. We’ll see a lot of those, but we see them in all industries. We do distributors, we do basically all the different industries.

Host (08:15):

And then on the other hand, is there a business that an ESOP just doesn’t make sense in?

Ted Lape (08:21):

There’s more the characteristics than I would say the industry. So for an ESOP, you get a nice chunk of money at close, but you’re typically getting chunks every year for 5, 6, 7 years to get all your money.

(08:35):

So you want to feel pretty good that the company’s going to do well in the future. So that means hopefully the company’s got good dynamics and that you have someone to run it. So if you’re planning to go to Florida tomorrow, and you’re the whole company and you’re done, that’s not a good ESOP. Or you think Amazon’s going to come kill the company, or government is going to change something that’s going to destroy your company, those are all things you wouldn’t probably look at an ESOP.

(09:04):

But if you have a solid company, that you’re either have or are going to use the ESOP to go find and train people to run it, those tend to be better.

Host (09:15):

And then, Ted, looking after the deal’s done, what’s the timeline looking like post-sale to get your money? Or how are those funds transferred? Or what should someone expect?

Ted Lape (09:25):

Yeah, so you get your money in an ESOP. Typically, you get whatever bank will lend up front, and then the money you don’t get up front, you get a, let’s call it a 12 or 13% return on. And then, usually the bank gets paid down very quickly, whatever you borrowed, because you’re tax free, usually you’re tax free.

(09:48):

And so since the bank gets paid down very quickly, the bank at the end of the year is like, “Hey, I got goals I got to meet. I’d love to lend you more money.” And they lend more money and that to the company. And then the company takes that money and pays down the seller note. And you do it again. And usually it’ll take, I don’t know, four years to get the purchase price, another year or two to get all that extra interest. And so if you sold for 30 million, maybe you end up with 40 million kind of thing.

(10:16):

People like the fact that they get these chunks each year, and that they do get that extra money, because usually if they do an ESOP, they feel pretty good about the future of the company, so they think that it’s a pretty secure way to get your money. And now that the company’s tax-free, they’re getting it pretty quickly.

Host (10:37):

Ted, in the scores of ESOP deals that you have worked on throughout the years, could you maybe tell me a little bit about your experience with generational transfer and how that works within the world of ESOPs?

Ted Lape (10:48):

Yeah, so that’s obviously one of the questions we ask up front. And what we’re seeing more and more is either the family members don’t have an interest in taking over the company, or the owners are getting a lot more clear-eyed about whether their children are the right people to take it over. It’s actually somewhat rare that the right person to take over the company is your child, because they just may not have the work ethic, or the skills, or the desire, or the right age, or experience, or whatever.

(11:22):

And it used to be people would ignore that. Sometimes they’re the right person, but more often than not, they’re not. So with an ESOP, the reason that some of these owners that have children in the business like it is because there’s a role for the child, for as long as the child wants to work there, typically, as long as the child’s actually working.

(11:46):

And they could have as big a role as they’re capable of in that company. And they’ll do well through stock in the ESOP. There’s usually robust management incentive plans. If they’re part of management, they can get that. And of course, they’ll inherit from dad at some point.

(12:03):

But from the dad’s perspective, a lot of owners have not saved a lot of money outside the company, because they’ve kept all the money in the company to build it. And if they give it to Junior, and Junior, it’s like giving a Maserati to a kid and he wraps it around the tree. If that happens, you’re not diversified, and you got a big problem.

(12:23):

So they like the fact that the ESOP is going to diversify their wealth while allowing them to maintain a role for their children. Our role quite often, it’s a little bit of a psychologist because a lot of families have dynamics that aren’t great. And sometimes, a lot of times there’s maybe two owners, and they each have family. And maybe what we see a lot is one side of the family, the owner has kids that are probably pretty capable, and they’re working pretty hard, and the other side has some kids who maybe aren’t as capable and aren’t working very hard.

(13:08):

And so you have to kind of think through that. And the ESOP can actually be a wonderful answer because in that situation, often the family that’s maybe working in the business would like to buy out the family that’s not working as much anymore. And you get in these fights and then this could be in any situation, even if it’s owned by one family. What an ESOP can do is it makes a lot of sense to sell a hundred percent to ESOP, because you’re a hundred percent tax-free, and there’s other reasons. But it puts everyone on the same side of the table to get a great answer.

(13:51):

If you don’t have that, one side’s saying it’s worth a billion dollars, and the other side’s saying, “No, no, it’s worth a dollar,” and you get frozen. And it’s all this bad blood. Well, if you put everyone on the same side of the table, now they all are together for a great price. But then the people that want to work in the business can stay and keep working in the business, and the people that don’t can leave, and you’ve solved the problem.

Host (14:15):

Well, Ted, I want to be mindful of your time today, so thank you. And as a final question to just put a bow on it, in your words, what makes Lazear Capital special? What makes it stand out amongst all the other firms in the country that may have ESOP offerings? Why should I work with Lazear?

Ted Lape (14:32):

Yeah, that’s a great question. There’s a bunch of stuff. One is we’re the only firm that I know of, and there’s not a lot of firms that do this, just in the last conference, talked to a bunch of people and they all know how many ESOPs people do, and from what I gather from all the statistics are we are now the largest in the country doing this, but we’ve teamed that with small teams so you get the personalized service. The fact that we’re doing all those deals, we see more. And we execute everything out of our office here in Columbus, even though we have people in 10 cities, soon to be 12.

(15:06):

So they all talk to each other. And we have eight attorneys, we have eight accountants, we have valuation people, we got ex-bankers, we have all this in-house talent. We don’t practice law or accounting, but they have that expertise. And so every deal we do, we deal with the best attorneys, accountants, and people in the country, we learn new things every time we do a deal. So we’re able to bring those new solutions to bear for a deal. And so we come up with structures other people don’t have, deductions other people don’t have.

(15:40):

Also, our history as a sell-side firm, in ESOPs, unfortunately, a lot of times you get a lot of conflicts, where people try to wear more than one hat. And that creates some conflicts of interest. We only represent sellers. If you, for example, if we represented buyers, that would be doing valuations, our client would be the trustees who are the buyers in ESOPs. The trustees would be the ones sending us a lot of work.

(16:09):

And then of course, if we are now representing a seller, and negotiating with that trustee, it’s kind of hard because they’re our biggest client. And we’re getting a hundred deals from them, and this is only one deal from the seller. So we’ve just avoided that. Even though you can make a lot of money doing valuations, we don’t do that.

(16:27):

So we are a pure play. We only represent sellers, and then we have all these capabilities. And then the other thing is, when you think of an ESOP, it’s sort of two transactions. You got the sale ESOP, and because we have all these people and have the 95 point checklist, we think we do that better. But then you have to decide, when you go to do the ESOP, before you do the ESOP, do you want to sell tax-deferred and ultimately tax-free?

(17:00):

Well, that’s the second transaction. And the way you do that hadn’t changed a whole lot in like 50 years. So we came up with a new way to do that, that’s a lot easier, and user-friendly, and solved a lot of problems in the old way. And so that’s a big differentiator as well, is it’s very powerful to sell tax-free, but only like 20% of our clients were doing it because it was complex and there were some issues. And now most of our clients are doing it, because it’s a lot easier. And so that’s a big differentiator as well.

Host (17:44):

All right, so that was a lot of information, and though I bet you now know more about ESOPs than you came into this episode with, trust me, we still have a lot more to discuss and expand upon. Now we’ll do this in the coming three episodes, by exploring all the affirmation points Ted made, through the lenses of business owners who have all been through their own unique INSOPs, in their own unique industries, and who are all happily on the other end of their ESOP deals. We will sit down with David Phillips and Josh Ohl of ASI Commercial Roofing.

Speaker 3 (18:15):

People would quit pre-ESOP for 50 cents an hour. Well now they’re starting to understand that the ESOP’s pretty good, our benefit package is really second to none. The turnover has gone way down, and employees are the hardest thing in the world to find right now, is everybody knows, I don’t care what industry you’re in. We always call it the migration. Every spring, coming out a winter, all the hourly employees, roofers, they go find out where they can get the biggest button. We don’t see that now. I mean, they’re coming to us, but we don’t see them leaving.

Host (18:42):

Paul Grove and Justin Browder of Axia Consulting.

Speaker 4 (18:45):

Yeah, I think it’s a virtuous cycle. I think the ESOP concretely states that we believe that every individual that works for Axia is important. No matter what we can say in any meeting, we can’t match the fact that your account goes up when Axia grows. And that shows everybody that we mean it, that each individual is important, because we’re a people business, because we take time to recruit the best of the best. And so creating that culture that you feel like you’re a part, you are a part of ownership, I think allows for people to feel more comfortable when they are remote.

Host (19:19):

And Rudy Caligari of Edge Rentals.

Rudy Caligari (19:22):

At first, the employees have a very difficult time wrapping their head around it, because they may have never heard of it before. They truly don’t understand the value. And then after year one, people have more pride, they have more sense of ownership, they have a sense that they’re with us for the long haul. They know that in 10, 20 years from now, depending on what their age is, they’re going to be able to retire with capital that they would’ve never had before.

Host (19:52):

Now, each one of these leaders have their own unique ESOP story and really span the gamut of industries. The goal here is to see how an ESOP works and functions amongst many different style of company.

(20:04):

Now, to wrap up this episode and provide three takeaways, number one, we hope you now understand that there’s many reasons a company would want to do an ESOP, from tax advantages, to employee retention, to even emotional drivers. Number two, you now know the general roadmap and timeline for how an ESOP is transacted and how they differ from other business sales. And number three, you have a better idea of what goes into an ESOP for all parties involved.

(20:32):

So we hope you enjoyed episode one of this four part series. Like I said, we have plenty more to dive into in the coming episodes, so stay tuned. Now, we know you have questions and hopefully we have those answers. Please reach out no matter what step of the business sale process you are in, so we can help. You can drop us a line or get in touch with us at lazearcapital.com. That’s L-A-Z-E-A-R-capital.com. And make sure to check out the show notes on the site for this episode for an even deeper dive into all that we talked about today.

(21:02):

See you next episode.