Four Reasons An ESOP Can Spur Growth, Boost Ultimate Sale Price Of Your Business
You’re a mid-sized player in a consolidating industry, and the phone rings regularly with investment bankers, private equity types and business development executives at larger competitors wanting to know if you’re ready to sell.
You’re not, but you should consider this: a too-seldom-used vehicle to help propel your company’s continued growth and greatly increase the price of its ultimate sale is the Employee Stock Ownership Plan, or ESOP.
You know from the years spent building your business — and watching competitors sell – that bigger, better-established companies fetch a higher multiple of EBITDA, operating income or whatever the valuation-benchmark-of-the-month is. And you want to keep working and would like to reap the upside of your company’s continued growth. It’s not time to sell. But oddly, it can be time to cut your employees in on the action, a move that can help them and also help you, the founder/owner/CEO.
In this article, I’ll briefly explain how that works.
First, a note on the hierarchy of valuation in consolidating industries, at the risk of stating the obvious. These industries include staffing, medical labs, dialysis clinic chains, auto dismantler networks, business-service software and many, many more; basically, anything that’s still fragmented. Publicly traded consolidators, growing rapidly through aggressive M&A programs, tend to fetch the highest multiples.
On Assignment (ASGN), a $1.6 billion-a-year staffing company, for instance, trades at a price-to-earnings ratio of about 21, based on trailing results, and at an EV/EBITDA of about 14. On Assignment’s sales rose 43% last year to $1.6 billion. It’s an active acquirer, most recently buying CyberCoders, a permanent placement personnel recruiter, for $94 million (plus performance upside to sellers); and Whitaker Medical, a doctor staffing business, for $17 million (plus performance upside), according to Duff & Phelps, which recently issued a study on 103 staffing industry transactions of 2013.
The next tier of companies down – typically privately held, concentrated in a niche or geographically but with significant scale and profitable operating history – claim the middle range of valuation. And at the bottom are the smallest, least-established and often least-profitable players.
Here’s why I recommend considering an ESOP if you’re in a consolidating industry:
1. Many such industries, including staffing, have low barriers to entry. That may be why you were able to get started. But it also means your best employees could walk away and start their own competitor to your company. Tie them to your business with ownership and they’ll stick around and help you grow, and by growing you’ll position yourself to collect a richer multiple inselling your business.
2. After a decade or more of owning and running a business, you may desire liquidity, as a way to reduce your concentration of risk and also for lifestyle purposes. But you don’t need to sell the while thing. Outside minority investors bring a raft of issues. But a partial ESOP, say 30%, brings many of the tax and operating benefits of the ownership structure yet leaves you in control as majority owner. (Employees buying a piece of your business through an ESOP, of course, will have advisors who negotiate hard on price.)
3. ESOPs aren’t, despite what you’ve heard, the Land of No Return, a permanent exit from other capitalization formats. Far from it! Private equity buyers have purchased ESOP-owned companies. And ESOPs have been used to buy companies from private equity owners. This flexibility, I believe, will be a major boon to company owners of all types in comes years, and to millions of owner/workers.
4. Your ability to keep scaling your business – and become more profitable – enabled by an ESOP, you may decide to become a consolidator yourself, rather than a seller. And you may enjoy your work life more, as employees act like fellow owners.
ESOPs aren’t for everyone. If your company has high levels of employee turnover, that makes converting to an ESOP difficult. If you already carry large amounts of debt, an ESOP isn’t ideal. There are other caveats, as well. But you shouldn’t weigh any eventual exit strategy – or growth strategy, for that matter – without including as ESOP in the mix. Just as you wouldn’t exclude private equity, a strategic buyer or an IPO from your menu of options.