Companies with ESOP plans invest in a great deal of thought and planning during their infancy stage. This stage includes an investigative analysis, a preliminary valuation/analysis, a feasibility study, and implementation. Additionally, several decisions need to be made throughout this stage including choices on plan design, transaction design, and potential corporate reorganization. Once these steps are taken and an ESOP plan has been established, the ESOP starts to take form and grow. During the growth stage, the line of thinking begins shifting from infancy to maturity.
Below are critical considerations for ESOP companies once they reach the maturity stage.
ESOP Plans and Sustainability Planning
Similar to planning in the infancy stage, sustainability for a growing or mature ESOP also involves a planning stage. The ESOP company should conduct internal discussions regarding the long-term objectives and evaluate how its goals align with the day-to-day operations.
Developing a plan for a sustainable ESOP typically begins with evaluating the repurchase obligation, which is the company’s commitment to creating a market for the stock when it is bought back from ESOP participants. The company should review the relationship between the repurchase obligation and valuation forecast and should consider how cash flow implications can affect company objectives and management succession.
Repurchase Obligation Planning and ESOP Plans
Repurchase obligation planning allows the company to quantify the number of shares that will need to be repurchased in order to fund the obligation that occurs when plan participants become eligible for distributions.
Variables to be used for consideration during the repurchase obligation planning phase include the following:
- Payroll information, including hire and termination dates, wages, and hours
- Stock price projections
- Projected ESOP contributions, dividends, loan payments, and share releases
- Key ESOP plan provisions regarding entry, allocation eligibility and method, vesting, forfeitures, and distribution timing and method
- Anticipated distribution funding method (redeem, recycle, or re-leverage)
- Turnover rates
- Workforce and salary growth
Whether an internal or external study is completed, using the above variables will be useful. Once the results are in the company should begin to incorporate the projected cash flow requirements into their internal cash flow projections. Management should assess whether the repurchase obligation is manageable with ongoing operations and projected company growth.
As a best practice, many companies stress test the repurchase obligation, typically in a worst case scenario approach. What happens in the case of key employees with large balances retiring early? What happens if the stock price increases substantially? These are unforeseen events that could drastically change a repurchase obligation plan and it makes sense for a company to review.
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