The sale of all or a portion of the stock of a company to an Employee Stock Ownership Plan (“ESOP”) is a popular exit strategy for many business owners. The owners can sell on a tax efficient basis, the company can deduct the sales price, and the employees can become owners of their employer. It’s a win-win-win. Most companies, however, require financing to complete the ESOP transaction, the proceeds of which are used to purchase the stock from the sellers. This is a leveraged ESOP transaction and lenders who lend in this space can find opportunities for new financings, or for increases in their commitments to their existing customers. Opportunities that will be missed by other lenders.
Buchalter’s Commercial Finance Group has deep experience in representing commercial lenders in leveraged ESOP transactions of all structures, including bridge financing (day loans) and seller note swaps. At its core, a leveraged ESOP transaction is a type of commercial lending transaction, and Buchalter’s Commercial Finance lawyers are at the vanguard of this practice area. But the proceeds of the financing in the leveraged ESOP transaction are used to finance an ESOP, which is subject to the rules and regulations of ERISA and the Internal Revenue Code (“IRC”). Buchalter’s Commercial Finance lawyers work with the Firm’s ERISA and tax experts to make sure the leveraged ESOP transaction is ERISA and IRC compliant. The consequence of a purported ESOP transaction that is not ERISA compliant or fails to satisfy the IRC requirements may result in loss of tax benefits for the sellers and the company, tax penalties, liability for breach of fiduciary duty by the company or its principals, unwinding of the transaction, or all of the above. As part of the pre-closing legal diligence we perform for the lender, our highly-experienced ERISA and tax attorneys will review the ESOP plan and transaction documents prepared by the company’s attorneys to spot any errors that might lead to that unhappy result.
In addition to the usual and customary provisions that are standard for commercial loan documentation, Buchalter’s Commercial Finance lawyers prepare loan documentation that provides for all the typical ESOP reporting that the lender wants to see, and also provides all appropriate representations, warranties, covenants, events of default, and other guardrails that are specific to ESOP transactions. We assist in the crafting of financial covenants that address issues unique to ESOP accounting, and advise the lender on EBITDA addbacks and distributions that are unique to leveraged ESOP transactions. We make sure that any paper or other consideration issued to the seller(s) is appropriately subordinated to the bank debt. We make sure the lender’s security interest is properly perfected in all collateral, including an assignment of the inside loan documentation, and a pledge of the unvested ESOP stock. We guide the ESOP lender on what is and what is not market, and what is a reasonable ask and what is not, both from the lender’s and borrower’s side.
Above all, Buchalter’s Commercial Finance lawyers provide practical, business oriented advice to the ESOP lender, and efficiently guide the transaction to a smooth, uneventful closing.