Acquisition Strategies for ESOP Companies

Excerpts

From Chapter 2, "Managing Risk"

All purchase agreements include provisions that provide for indemnification of the acquiring company in the event the target company or its selling shareholders breach the reps and warranties. There are many different ways to structure indemnification provisions, but the following three provisions will be in every form of purchase agreement and are the most visible methods of risk allocation. When the acquiring company seeks indemnification from the target company’s selling shareholders for a breach of the reps and warranties (i.e., when it makes a claim), certain limitations are negotiated. Just because the acquiring company makes a claim, however, does not mean that the acquiring company will automatically be able to collect the claimed amount from the selling shareholders; the selling shareholders may deny any liability or dispute the amount. It is not unusual for claims to end up in litigation.

From Chapter 3, "Using ESOPs in Mergers and Acquisitions" (footnote omitted)

A successful acquisition will positively affect the buyer’s long-term stock price. In the near term, however, if the acquirer uses cash to wholly or partially finance an acquisition, there may be a significant temporary negative effect on the acquirer’s cash flow or its ability to make necessary capital expenditures or handle upcoming repurchase obligations. The buyer might also grant equity rights to certain target company employees, which would have a dilutive effect on stock value. It is possible that factors such as these could lower the share price of the acquirer’s stock, usually on a temporary basis, until the acquisition starts to add positive cash flow to the buyer. Should this occur, the acquirer may decide to amend the plan to provide that the company will make price protection payments for certain ESOP participants whose employment may be terminated before the debt can be repaid. If it does, it will also have to determine (1) the length of the protection (e.g., whether it will last for a set period of years or until the acquisition indebtedness is repaid in its entirety), (2) the members of the protected class (e.g., whether the class will include employees who are terminated due to death, disability, and/or normal retirement), and (3) the terms of the provided protection (e.g., whether the per-share value for the protected class will be determined (a) pursuant to a structured formula, such as one that references the new acquisition indebtedness without actually being tied to it, or (b) without regard to the entirety of the new acquisition indebtedness, but only to the extent necessary to make the post-transaction per-share value at least equal to the per-share transaction price).

From Chapter 6, "M&A Strategy: The Essential First Step to Growing ESOP Companies Through Acquisitions"

If the above strategies are impractical or present too long of a timeline relative to goals, the company can hire a “buy-side advisor.” These professionals are generally paid retainers to search for possible targets to present to the company. There are some outstanding buy-side advisors. However, there are also many highly ineffective ones. A cynical line you may hear from sell-side advisors is that professionals revert to being buy-side advisors when they can’t be successful as sell-side advisors. There are some incentives for the advisor to show deal flow even if it doesn’t match your criteria. In addition to retainers, they generally get paid a commission when a deal closes. Ask around and get references. Don’t be that company that pays a $25,000 monthly retainer and ends up with no results at the end of the contract period.

From Chapter 8, "Financing Alternatives for ESOPs Pursuing M&A"

From a leverage standpoint, mezzanine debt usually provides capital beyond a senior lender, up to 5.0x–5.5x total leverage. ESOP companies can use mezzanine debt to finance an acquisition when they have limited senior debt capacity or need to reserve their senior debt capacity for corporate operating purposes. Accessing mezzanine debt for an acquisition does not require disrupting a current bank facility or relationship. Rather, it involves bringing in a mezzanine debt fund to provide junior or subordinated capital under more flexible terms in exchange for a higher overall cost of capital.

Mezzanine debt can provide that level of “hard to raise” capital to fund an acquisition instead of having to access equity capital that can prove challenging under an ESOP structure. This financing type also does not dilute the ESOP or other equity holders. Typically, mezzanine debt investors also like to get involved with supporting the company from a strategy and operating standpoint and will have board of directors observation rights. They are participatory investors and partners to understand and support the company when integrating an acquisition or for ongoing strategic purposes.

From Chapter 9, "Should You Create a Holding Company?"

There are liability issues to be considered (this is where you seek out your corporate counsel!) when deciding whether to tuck an acquisition into an existing company versus keeping the acquisition as a separate entity. This is true for both stock purchase acquisitions (SPAs) and asset purchases. The SPA can be kept as its own legal entity or undone and absorbed into the acquiree. Assets can be absorbed into the purchasing company, or the purchaser can set up a new separate entity to form a company around the acquired assets. One reason for setting up a new entity for purchased assets could be to take advantage of economic development incentives (this is where you should speak with economic development agencies before making the decision).