ESOP Repurchase Liability Management Solutions

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2007 Sales Stampede Repurchase liability management ESOP consultants average 20.3 years of experience Provide services to more than 900 employee owned companies covering more than 670,000 participants Source: The Principal Financial Group ®, as of December 31, 2014

2007 Sales Stampede Repurchase liability management Provide services to more than one-third of the nations top 100 majority employee owned companies Source: The Employee Ownership 100, National Center for Employee Ownership (NCEO), June 2014.

What is the ESOP repurchase liability? A long term corporate employee benefit obligation Participants hold a “put option” requiring the corporation to buy back their vested stock account balances at fair market value; IRC 409(h) Off balance sheet liability \ obligation

1.Retire 2.Terminate Employment 3.Become Disabled 4.Die 5.Diversification –25% at age 55 and after 10 years of participation –After six more years up to 50%) What events trigger the liability?

What are we managing? The conflict between the cash flow required to repurchase shares and the cash flow required to operate and grow the business What are the goals? Strike a balance Mitigate risks Repurchase liability management

2007 Sales Stampede Repurchase liability management Step 1 Forecast ESOP repurchase liability Run multiple scenarios to determine range of possible outcomes –Change the assumptions –Establish “most likely” scenarios –Look for projected liability “bubbles”

What % of company is owned by ESOP? Is goal to maintain ownership? Increase ownership? Shrink ownership? What is the tax status of the company? C corp 100% ESOP-owned S corp Partially ESOP-owned S corp Employee demographics Age of workforce Age of Key Employees Projected size of ESOP account balances Projected liability bubbles? Timing Size Repurchase liability management

Step 2 – evaluate the results Review forecasts vs. long-term strategic plans & financial projections –Future cash projections –Existing debt \ future debt –ESOP ownership % - Will ESOP acquire greater %? Understand the factors influencing the magnitude and timing of obligation –Stock price, diversification elections, turnover, retirements –Sustain, increase or shrink ESOP? Understand how the obligation affects value Repurchase liability management

Step 3 – evaluate funding alternatives “Pay as you go” from working capital or earnings Pre-fund the obligation –Inside the ESOP –On the balance sheet Repurchase liability management

Step 3 – evaluate funding alternatives cont’d. Tap unused debt capacity –Line of credit \ term loan –Pay participants with a note Create a market –Internal – allow employees to buy –External – private sale to a third party \ IPO Repurchase liability management

Step 3 cont’d. – plan design considerations: Re-leverage Re-shuffle \ re-balance Delays in distributions Lump-sum versus installment payouts Redeem versus recycle shares Segregate accounts at termination Repurchase liability management

Step 3 cont’d. – pre-funding considerations: To what degree do you want to remove assets from operations to hedge against an uncertain financial future? Recognizing that in addition to cash flow for operations and growth you may have other cash flow commitments for: –ESOP repurchase –SARS, phantom stock, deferred comp. SERP, other nonqualified plans –Commitments to non-ESOP shareholders Repurchase liability management

Step 3 cont’d. – pre-funding considerations: Establish the desired size the of the reserve Establish the investment policy for the reserve Work with a financial professional to appropriately match the assets in the reserve with the projected repurchase liability Repurchase liability management

Sample funding policy: Maintain a repurchase liability funding reserve equal to approximately the next 3 years of the projected repurchase liability Meet current liabilities from cash flow to the extent possible Tap the reserve when needed Use debt when appropriate; consider effect on debt \ equity ratios, credit market conditions, available loan terms, etc. Repurchase liability management

Step 4 – Monitor, re-evaluate and adjust as needed Review repurchase liability study assumptions Update cash flow and debt projections Update strategic plans Evaluate investment results Rebalance portfolios Discuss with the board and senior management Repurchase liability management

General conclusions: Private company shareholders face liquidity challenges whether they have an ESOP or not Repurchase liability management is risk management exercise Consider the shares owned outside the ESOP and the liabilities associated with other plans such as SARs, Phantom stock, deferred compensation, etc., in your planning Diversify the funding approach Repurchase liability management

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