Private Equity Sponsors

Private Equity Sponsors

We are advisors to private equity sponsors and are dedicated to helping these partners identify acquisition targets, manage the execution process, raise the capital to fund the transaction and, when the time is right, work with them in exiting their investments.  Our skills and experience are similar to other firms in our business and we can provide the same execution services.  We truly differentiate ourselves, however, in two ways.

First, we have a robust business development group that is solely focused on generating deal flow for our partners.  We are aggressive in our approach to marketing and touch thousands of companies every year.  This discipline leads to more opportunities for our private equity partners.

Second, we have a distinctive depth of expertise in structuring ESOP leveraged buyouts.  We know how to integrate private equity investment and ESOP structures into the various lifecycles of a company.  Specifically, we help our private equity clients (a) use a leveraged ESOP as a portfolio company exit vehicle, (b) co-invest into ESOP companies (either as a leveraged recap alternative or as growth capital) and (c) purchase ESOP owned companies (ESOPs need exits, too.)

Leveraged ESOP as exit vehicle

When it’s time to exit a portfolio investment, private equity firms traditionally sell to financial or strategic buyers.  In today’s market, the traditional alternatives may not produce the desired results. There is another alternative, the Leveraged ESOP, under which the firm is sold to management and the employees.

Under a Leveraged ESOP:

  • ESOPs can pay fair market value.
  • The transaction can support a complete buyout (all cash.)
  • ESOP transactions tend to have less execution risk.
  • Transactions can close in three to four months.
  • Disruption to the business is minimized.
  • Management retains control and can earn 15-25% of the company value.

When the sale is structured as a 100% S-Corp ESOP, the company does not pay Federal income tax.  This generates significant incremental cash flow and strengthens the ability of the company to service debt and fund operations.

Leveraged ESOP as acquisition vehicle

The highest priority for our private equity partners is identifying great companies and creating an intriguing way to engage with the owners that ultimately results in an opportunity to invest.  From an economic perspective, this structure can still offer firms operating and management control and provide desired investment returns.  Rather than investing equity into the transaction, the firm provides carefully structured subordinated debt that provides an equity-like return.

The subordinated debt is structured with a large warrant position at a nominal strike price. The warrant position is large enough to provide the firm with an equity-like return but with a risk profile that is a hybrid between debt/equity. The structure generates current income, while also preserving upside potential.

From a control perspective, the scenario is simple. Through documentation, we incorporate a board level operating structure that creates a partnership between the private equity firm, management and the ESOP trust.  The private equity firm participates as an active board member with “control by covenant.”  This means that the transaction documentation provides our client with a similar level of control as it would have using the more traditional acquisition structure.

Purchasing ESOP-owned companies

In many ways, purchasing an ESOP-owned business is no different from any other acquisition a private equity firm may review.  However, there are several important aspects that must be managed in order to assure a successful execution of the transaction at market terms.

When acquiring an ESOP-owned business, the firm needs to make a fundamental decision as to what to do with the ESOP.  Termination is generally going to be the likely decision, as the benefit level needs to be rationalized to ensure that the private equity firm is maximizing potential value.  If there are other benefit plans, such as a 401(k) with an employer match, overall benefits may be high relative to peers.  However, all the options need to be reviewed, as the ESOP can be a friendly co-investor.

The seller’s approval process will generally be two stages, management and the board.  While this is no different from traditional acquisitions, the dynamic is different.  The board in a 100% ESOP company is named by the trustee on behalf of the participants.  Approval from the board and trustee, therefore, is dependent upon the trustee’s finding that the transaction is more beneficial to the participants than continuing to hold the stock and participating in the value that would be generated by the company as a standalone business.  At Butcher Joseph Hayes, we understand this dynamic and have worked with a number of private equity firms in navigating these waters.  If you’re looking at acquiring an ESOP-owned business, we should talk.

We’re one of the only financial advisory firms experienced in these types of structures and transactions. The next time you’re analyzing a potential acquisition, investment or exit, give us a call. We’d love to talk about Leveraged ESOPs, the alternative you may not have considered.

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