1. Planning for ESOP Repurchase Obligations Judy Kornfeld ESOP Economics, Inc. 215.546.6590 www.esopeconomics.com © Copyright 2006 ESOP Economics, Inc. All rights reserved. The Ohio Employee Ownership Center Annual Conference April 21, 2006 Akron, OH

2. 2 Introduction Repurchase obligation planning cannot occur in a vacuum – it must be integrated into the overall corporate financial planning process The process is often iterative, as repurchase obligations affect earnings and cash flow – and consequently the resources available for growth Repurchase obligations may also affect the share value

3. 3 The goal To develop a strategy for how the company will meet its obligations to its employee owners and, at the same time, to maximize the value of the business to its shareholders

4. 4 Components of the planning process Forecast repurchase obligations (“repurchase obligation study”) Incorporate into corporate financial projections Determine sufficiency of resources Adjust ESOP distribution policy if appropriate Develop funding strategy Test robustness of strategy Monitor, update and adjust the forecasts and strategy regularly

5. 5 The process is iterative Stock Value Combined with Demographics and Distribution Policy RepurchaseObligations Earnings and Cash Flow

6. 6 Forecasting repurchase obligations To quantify them, you need to do a repurchase obligation study This is a long-term projection of ESOP distributions and the associated cash requirements that the company will face It is based on assumptions about a number of variables

7. 7 The forecasting process Acquire software or build model Define scenarios Develop assumptions Do projections (integrate with corporate financial projections) Analyze results

8. 8 Key variables Timing of repurchase obligations is affected by –Distribution policy –Demographics (age distribution) –Turnover Amount is affected by –Account balances –Stock value

9. 9 Good assumptions are essential! Assumptions need to be : –Reasonable –Internally consistent –Consistent with other financial planning Get “buy-in” on the assumptions from key members of management

10. 10 How reliable is the forecast? Projecting multiple scenarios is essential! How do you define the scenarios? Statistical models are not appropriate for this purpose Scenario planning is a more useful approach

11. 11 Developing a strategy How large are repurchase obligations relative to: –Cash flow? –Earnings? –Payroll? Can repurchases be handled without interfering with growth? Should changes in the distribution rules or other plan rules be considered? What funding methods are appropriate?

12. 12 Components of a repurchase obligation strategy - distribution policy Modifying distribution policy –Delays vs. immediate payouts –Installments vs. lump sum payouts –In-service distributions –Redeeming vs. recirculating

13. 13 Components of a repurchase obligation strategy - funding methods The main methods for funding repurchase obligations are: –Pay-as-you-go –Cash accumulation in ESOP –Sinking fund in corporation –Corporate owned life insurance (COLI) –Debt –Internal market

14. 14 Developing a funding strategy To what extent can repurchases be handled out of current cash flow? Is some sort of advance funding (sinking funds or insurance) necessary and feasible? Will it be necessary to use debt or look to third party solutions to meet the repurchase obligations? How does the funding method affect –Company’s cash flow and earnings –Valuation –Participants’ benefit levels

15. 15 Understand the limitations of your strategy Test the robustness of the repurchase obligation strategy in some “what if” scenarios that are more optimistic and some that are less optimistic –Under what range of scenarios will the strategy succeed? –Contingency planning is appropriate if the strategy is not viable under some scenarios

16. 16 Keep planning, stay nimble Externalities can change rapidly and unexpectedly You need to be nimble in responding to externalities, and corporate strategies (including repurchase obligation strategies) need to be flexible Planning is an ongoing, dynamic process

17. 17 In closing... Begin planning early in the life of the ESOP Forecast the repurchase obligations using a range of assumptions Develop a plan for managing and funding the repurchase obligation and test its robustness Review and update your strategy regularly