Why One ESOP Company Looks Beyond the Periodic Repurchase Obligation Study
A repurchase obligation study may project an ESOP company’s future obligations for 20 or even 30 years. But the decisions that matter most to a company arise every year between formal studies. A company’s board needs answers to the question: What are our options?
That has been the experience of the CFO of one large successful, mature ESOP company.
As the company evolves, so do the questions its leadership and board need to answer. The company paid off its original ESOP debt, operated for many years as a non-leveraged ESOP, acquired businesses, completed restructurings, and reconsidered its approach to leverage, benefit levels, and ownership.
Economic and industry conditions change as well. Strategies that made sense at one stage of the company’s development did not necessarily fit the next.
For this CFO, repurchase obligation planning cannot be treated as an occasional exercise. It has become part of the company’s ongoing financial and strategic planning.
They review their repurchase obligation situation every year. They implement and adjust strategies to address the current situation.
The Company Changed. So Did the Questions.
The answers are not permanent.
As this company moved through different stages, its priorities shifted. At one point, the focus was paying down debt. Later, growth and acquisitions created questions about how shares would reach new employees. More recently, changing economic conditions led the company to look closely at benefit levels, leverage, and its desired ownership structure.
The CFO described it as a continuing learning process. Even with years of ESOP experience, the company encounters new questions as its circumstances change.
That is one reason a repurchase obligation forecast cannot simply be completed, presented, and put away until the next study.
From Two Separate Conversations to One Financial Picture
For many years, the company discussed its repurchase obligation and its other financial leverage as two separate matters.
One conversation concerned company debt and banking. The other concerned future ESOP distributions.
Eventually, leadership learned that the company needed to see them together.
The board now looks at the total debt picture, including bank financing, anticipated repurchase obligations, and the demands those commitments may place on the company over the next several years.
That combined view has become increasingly important as the company evaluates its borrowing capacity and financing options. Repurchase obligations may affect asset-based lending reserves, the borrowing base, fixed-charge coverage calculations, and other financial covenants.
Their bank does not treat their repurchase obligation exactly like traditional debt, but they do not necessarily ignore it. They want to understand how future distributions could affect cash flow and the company’s ability to meet its other commitments.
The company’s board considers that perspective when reviewing projections and discussing its banking relationships. The repurchase obligation is no longer viewed solely as an ESOP matter. It is part of the company’s debt stack and working capital.
The Long View Supports Near-Term Decisions
The company’s periodic repurchase obligation studies will project well into the future. The full projections cover 20 to 30 years. In practice, however, the company concentrates much of its attention on the next three to five years, with a broader ten-year view providing context. The near-term forecast is where many actual decisions are made.
The board needs to understand what the company may face during the same period covered by its operating plans, financing arrangements, acquisitions, and other demands on capital. Companies don’t base their strategic planning relying on 20 to 30 year forecasts.
A Board Conversation, Not a Shelf Report
Something involving the ESOP or repurchase obligation is discussed at nearly every board meeting.
The board reviews how the current year is developing, what information may affect the annual valuation, how the expected repurchase obligation compares with prior years, and where the company may be heading.
That frequency matters because many directors, particularly outside directors, do not work with the ESOP every day. Even experienced board members may need concepts revisited as the company’s circumstances and available options change.
The company’s directors bring different perspectives to those conversations. Some have strong financial backgrounds. Others contribute experience in operations, entrepreneurship, or business leadership. Independent and insider directors may also view the company’s responsibilities from different angles.
Before working through technical plan mechanics, directors need to understand the company’s objectives, the problem it is trying to solve, and how a proposed decision fits its larger strategy.
A rolling annual, or more frequent, forecast gives all of them a common foundation for discussion. Board and officer leadership can compare the effect of alternative leverage levels, distribution activity, changes in share value, or other assumptions.
Evaluating More Than One Possible Response
As a repurchase obligation develops, the company has multiple strategies available to manage it.
Depending on the company and its plan, those possibilities may include changes to distribution timing, a distribution window, delayed distributions, segregation or reshuffling, re-leveraging, or an assignment of the put obligation.
Each choice can affect more than the timing of payments.
A decision may influence company cash flow, the ownership available to active employees, benefit levels, the percentage of stock held inside or outside the plan, and the company’s future repurchase requirements. It may also involve legal, fiduciary, valuation, and trustee considerations.
For the board, the central question is not simply whether an option is available.
The board needs to understand what could happen if the company implements any of the available ESOP administration and design alternatives and what could happen if it does not.
What Happens Between Formal Studies?
This company will periodically commission a full repurchase obligation study, compared to many companies which do not. Recent restructurings and other significant changes have made that outside analysis important for them.
The challenge is that an outside study is a protracted project. The CFO estimates that a full study can cost approximately $15,000 to $20,000 or more and take eight to ten weeks to complete, using the prior year’s data.
Meanwhile, the company continues to change.
A restructuring may alter the forecast. Diversification activity may cause a meaningful swing in projected obligations. New financing may affect available cash. Company performance, reductions in force, valuation expectations, participant decisions, and industry conditions may develop differently than originally assumed.
The board may need to evaluate a decision before another full study can be completed.
Keeping the Forecast Connected to the Business
A useful repurchase obligation forecast depends on current information.
This company keeps its board informed about how the year is developing and shares relevant business information with its trustee and valuation professionals. Leadership discusses how the company’s businesses are performing and how external conditions may affect the outlook.
That communication helps reduce surprises at year-end.
The company also considers how its expectations are communicated to participants. The board wants employees to understand the company’s current position without creating promises about future benefits, distributions, or share value that the company may not be able to fulfill.
Lenders, directors, fiduciaries, valuation professionals, and participants do not all need the same information. But each conversation is affected by the company’s understanding of its current and future repurchase obligation.
Maintaining that understanding requires more than revisiting an older study when a question arises. The forecast must remain connected to what is actually happening in the business.
Moving From a Periodic Project to an Ongoing Process
For this company their experience does not suggest that periodic outside repurchase obligation studies are no longer necessary.
Instead, it shows why mature ESOP companies need an ongoing planning process.
Ideally, company leadership should be able to update the forecast as information changes, evaluate scenarios when decisions arise, and bring a current view into discussions with the board and outside professionals.
The company can then use external expertise where it is most valuable: reviewing assumptions, identifying issues, evaluating more complex decisions, and bringing an independent perspective to the analysis.
The result is not a choice between exclusively internal planning and outside advice. It is a more continuous process that allows the two to work together.
Repurchase Ready in the Boardroom
Repurchase Ready was developed for ESOP companies to maintain a rolling repurchase obligation forecast, update information as circumstances changes, and test many alternative strategies applying all of the available tools rapidly. They can avoid having to run every strategic scenario alternative through an outside process that moves more slowly than the company does. They have no limit to the number of “what ifs” they can test.
Repurchase Ready supports more informed conversations between boards, officers, fiduciaries, appraisers, and bankers.
Repurchase obligation planning should not be limited to reports commissioned every few years. For a company whose ownership, finances, and people continue to evolve, it must be an ongoing part of the planning process.
