December 10, 2024 • 27 mins
Welcome to the "Show Me The Way" podcast with David Seitter
In this episode of "Show Me the Way," Dave and Kelly Finnell, President of Executive Financial Services, returns to the podcast to discuss the current landscape of Employee Stock Ownership Plans (ESOPs). Kelly discusses the new involvement of the SBA in ESOP lending, the increasing attractiveness of ESOPs for companies of various sizes, and the advantages of ESOPs for business succession planning.
Ep. 60 — Why ESOPs Boost Performance and ProfitsIn recent years, significant changes have impacted ESOPs. Notably, the Small Business Administration (SBA) has become involved in financing ESOP transactions. Since Congress authorized this in 2020, the SBA's 7A program now allows companies to borrow up to five million dollars without requiring personal guarantees, offering a ten-year term and amortization. This development empowers businesses, especially smaller ones, to leverage ESOPs more effectively.
Furthermore, the acceptance of ESOPs among large firms has grown, with companies like BDO opting for employee ownership over private equity, illustrating the sophistication and credibility of ESOPs in today’s business environment.
The Psychological and Financial Benefits of ESOPsESOPs not only provide financial returns but also enhance company culture. Employees with equity stakes are generally more motivated, leading to better performance and profitability. Kelly emphasizes that a robust compensation plan should include a base salary, a short-term incentive bonus, and a long-term equity-based component, aligning the interests of both employees and employers.
Interest Rates and Banking ConsiderationsDespite increases in interest rates, ESOP financing remains accessible. Kelly explains that structuring transactions with a combination of company cash, bank loans, and seller notes ensures ESOPs remain financially viable, even in changing economic climates.
Political Stability for ESOPsESOPs have garnered bipartisan support, appealing to legislators across the political spectrum. Democrats appreciate the wealth distribution aspect, while Republicans are attracted to the tax benefits ESOPs offer. This broad support ensures ESOP stability regardless of changes in political leadership.
Compassionate Capitalism and ESOPsOver his career, Kelly has observed two types of business owners: those focused solely on personal gain and those who view the sale of their company as an opportunity to benefit themselves, their employees, and their communities. The latter group embraces what Kelly terms "compassionate capitalism," where selling to an ESOP not only provides fair market value but also enriches employees and potentially creates community benefits through strategic philanthropic planning.
Costs and Professional InvolvementAlthough setting up an ESOP involves multiple legal and financial professionals, it remains cost-effective compared to selling to private equity, as it typically does not require an investment banker. These savings can make ESOPs a compelling option for many medium-sized businesses.
Future OutlookLooking ahead, Kelly plans to continue expanding Executive Financial Services, leveraging his team's expertise to further serve business owners navigating their succession and exit strategies. With the baby boomer generation contemplating retirement, the demand for effective succession planning, including ESOPs, is expected to rise substantially.
For businesses considering ESOPs, Kelly Finnell and his team at Executive Financial Services offer a wealth of experience and guidance. ESOPs present a viable and increasingly popular path for business transitions, aligning the goals of business owners, employees, and the broader community.
Those interested in learning more can connect with Kelly through his company's website at execfin.com or on
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Dave (00:00):
Show me the way episode 60, the ESOP coach, which is from his
book and leader part do as in two forthose of you that don't speak French.
In this episode, Kelly Finnella, theexecutive financial services is going
to update matters relative to ESOPs.
(00:33):
Come to show me the way a podcastpresented by Spencer Fane LLP
about business succession planning,the merger and acquisition
experience and successful exits.
I am your host, Dave Sider.
Hey, thank you so much forlistening to my podcast.
If you're seeking assistance with yourbusiness dreams, please consider checking
(00:53):
out the various resources I made availableto you at either my LinkedIn page.
My podcast, my Amazon book, quietPlans, exciting Results that is both
in a written and a verbal format.
And my website, david cider.com,where you can find quite a bit of
content and also access a very briefsurvey that will allow you and I to
(01:17):
interact at a time of your choosingto get a better grip on where you're
at and where you seek to go, becausewe wanna support you in your dreams.
Until next we talk.
Be safe.
Hey ladies and gentlemen, it's a repeatperformance you're gonna be interested in.
(01:38):
We brought back KellyFennell, you may remember him.
He gave us a really.
Nice outline of what ESOPs are all about.
Kelly opened my eyes to theadvantages and uses of ESOPs.
I'm going to bring them back inbecause there have been changes like
everything else in the marketplace,things go one way or the other.
And I think you're going to find outthat ESOPs are even more attractive now.
(02:02):
So I want to once again,introduce Kelly to you all and
ask you pay close attention.
Kelly, welcome back to the show.
Kelly Finnell (02:11):
Thank you very much, Dave.
It's great to be back.
Dave (02:14):
We may have, I'm sure everybody listens to us religiously, but we
may have some first time researchers.
So let's give them a little flavor ofyour background again, and your early
business experiences, if you would.
Kelly Finnell (02:26):
Well, I grew up in Memphis, Tennessee.
You might be able to notice alittle bit of a Southern accent.
Went to undergrad at the University ofMemphis and went to law school there.
Following law school, I startedexecutive financial services.
That was in 1981, hardto believe 43 years ago.
And this is all that I've ever done.
(02:47):
I've been in the retirementplan business this entire Career
at the beginning dealing withdefined benefit pension plans.
I'm so old Dave, that when Istarted this business, there was
no such thing as a 401k plan.
It's hard to believe.
And for years we did 401ks and ESOPs and15 years ago, I sold the 401k part of my
(03:12):
business so that I could focus exclusivelyon And so that's all we do now.
We work from coast to coast.
Last year, we did a transaction inSeattle, Washington and in Miami.
So literally north to south, east to west.
Dave (03:28):
So you got to like this, ladies and gentlemen.
He's been doing this well over 40 years.
He's an attorney also by training.
The guy has got the background.
He's got the expertise, buthe's got the experience.
He's got the wisdom.
That's what you.
Need to know.
So let's get into and talk about ESOPs.
I've got to believe as with everythingelse with stock markets, with MNAs that I
(03:50):
see going on, interest rates, there had tohave been some new trends or developments.
Can you give us some ideawhat's gone on in the world of
ESOPs since we've talked last?
Kelly Finnell (04:01):
There have been a couple of things that have
changed since we talked last.
One of them is the SBAs.
involvement in lending moneyinto ESOP transactions.
Now,
Dave (04:13):
that I didn't know about.
That's a newbie for me.
Kelly Finnell (04:17):
Congress authorized that in 2020, but you know how
the regulatory process works.
It took the SBA a long time to catch up.
With the legislation, but effectivelast year, the SBA has gotten a look
at financing on many ESOP transactions.
And in the right situation,it's a great scenario.
(04:41):
The SBA 7A program allows acompany to borrow up to 5 million.
No personal guarantee and a 10 yearterm and a 10 year amortization.
So it is a great way to fund asmall ESOP or a portion of even
a medium or larger size ESOP.
(05:02):
And so that's been a great development.
That has given us another source tomake sure that when ESOP, they're
able to get a bank financing.
For part of that transaction.
Dave (05:16):
Excellent.
So do you see this happening more in,I take it smaller deals and by small
deals, what would that look like?
Or is it going to be an add onor an adjunct to a larger deal?
How do you see us playing out?
Kelly Finnell (05:29):
Well, first, yeah, let me talk about deal size.
And so what we've seen over the last threeyears has been a range in transaction
size for us and in our practice from.
The smallest in a company with 1.
2 million of adjusted EBITDA,up to the larger end, a company
(05:53):
with 56 million adjusted EBITDA.
That's a good size.
And the median has been 4 millionof EBITDA and 95 employees.
And that is generally whatthe ESOP market looks like.
That's our practice.
And that's pretty reflective ofwhat the ESOP market looks like.
So ESOPs usually don't work well for microsized companies, for companies with less
(06:18):
than a million dollars of earnings, butfor that middle market, ESOPs work well.
One of the other things that has beenvery exciting in terms of development
since you and I talked last is that BDO,one of the nation's largest accounting
and consulting firms, sold a big chunkof their practice to an ESOP last year.
Dave (06:43):
I had no idea.
Okay.
Kelly Finnell (06:45):
And that was a multi billion dollar transaction.
So over the years, this doesn'thappen much anymore, but 15 years
ago, when we would talk to somebodyabout an ESOP, they'd say, ah, you
know, that's for the unsophisticated.
That's for the small companiesthat don't have any other options.
(07:06):
They're not a candidate for privateequity and they're not smart enough.
to deal with investmentbankers and private equity?
Well, I think BDO might have disprovedthat theory and put the lid down
on that coffin once and for all.
You've got one of the largest, mostfinancially and tax sophisticated
(07:27):
organizations in the country deciding thatwhen other accounting firms are selling or
raising capital from private equity thatan ESOP was the right decision for them.
Interesting.
Yeah.
So that was very exciting.
Some of the other things that havehappened that have given additional
(07:48):
momentum and credibility to ESOPs.
I don't know if you saw it, buta few months ago, 60 Minutes did
a piece on employee ownership.
Dave (07:57):
I did.
And because I have arelative that works for KKR.
So yes, I did see that.
Go ahead, please.
And
Kelly Finnell (08:03):
KKR has been a big supporter of the concept
of employee ownership.
Now, their model does not utilize an ESOP.
Right.
But it could, and it's an endorsement ofthe concept that when you give employees
an equity stake in a business, that'sgoing to result in better performance
(08:25):
and better profitability for the company.
And that's been proven out throughDozens of academic studies, ESOPs
work in terms of motivating employees.
So a good compensation plan has a nicebase pay package for its employees,
a nice short term incentive in theform of a bonus plan, and then a nice
(08:49):
long term incentive in the form ofsome type of equity based alignment.
And that really alignsthe interest of everybody.
On short term and long term basis.
Dave (09:03):
That's a good analysis and very well thought out too,
especially the three levels.
It's a conversation you, you want tohave with clients all of the time.
What do you see?
This is going to be, this is goingto be, this is a volatile year.
And I, you know, I'm trying to thinkas everyone else tries to determine
(09:23):
how things are going to play outhere in a few months, and I'm talking
about November, and I'm just curious.
Let's kind of take thewhole hemisphere of issues.
Let's start first with interest ratesand what's been going on with banks,
because my familiarity with ESOPsis most of them are backed by banks.
(09:45):
That's just my analysis.
So what goes on in banking.
What developments have you seen this year?
Kelly Finnell (09:52):
Well, of course, interest rates have gone up.
The Fed said that it was going tobegin a series of rate cuts this year,
and that obviously hasn't happened.
And so credit is substantially moreexpensive than it was two years ago.
But it's still available in abundance.
And so part of what we do for a client isnot just set up a transaction for them.
(10:18):
We help them source thefinancing for that transaction.
And so we will send financing requeststo between 6 and 12 different financial
institutions for a client every time.
We do an ESOP and.
Despite increased interest rates, there'snot been a single situation over the
(10:40):
last two years where we've not beenable to get bank debt for a transaction.
So it's more expensive,but it's available.
One of the things that really helps ESOPsis Even when interest rates go up, an
ESOP transaction can still be affordablefor a company because we've got a seller
(11:03):
note component in almost every ESOP.
And so, in order to lessen thecompany's cash flow, Requirements.
We can spread out the term of thatseller note, and that allows us to deal
with the increased cash flow that'srequired by higher interest rates.
(11:24):
We spread the term of the seller note outanother year or so, and that can allow
us to build the cushion that we need.
For the company to be able to financethe transaction on an affordable basis.
Dave (11:40):
So help a little bit for my audience, Koos.
When I think of an ESOP, I think ofthe fact that there is a loan in place.
It's backstopped.
It's essentially, it's the bank's loan.
Are you talking, when you talkabout a seller note, another note
on top of that bank financing?
Kelly Finnell (11:58):
Yes.
A company is never able to finance100 percent of its value, so a typical
financing structure for an ESOP, let'sjust use an example of a 10 million ESOP.
A typical structure might be 2million of company cash loaned
by the company to the ESOP.
A loan from a bank for 4 million, andso now we've got 6 million of cash
(12:24):
into the ESOP and then a seller note tomake up that difference of 4 million.
And so that would be a prettycommon, typical structure for the
financing of an ESOP transaction,those three components of capital.
Dave (12:39):
Thank you.
Kelly Finnell (12:40):
You know, when we first start talking to business owners about
seller notes, a lot of times yourinitial reaction is negative, right?
And then I say to them, look, wecould go to another source of capital.
We could go to a mezzanine lender.
And perhaps get more cash up front for youby having them blend into the transaction.
(13:04):
And they ask, well,what's that going to cost?
Dave (13:07):
And what's that interest rate?
Yeah.
Kelly Finnell (13:09):
And when I tell them, they say, man, I wish I were in that business.
There you go.
And I said, I've got an opportunityfor you to be in that business.
And so the point is that the returnon the seller note is commensurate
with the return that you would seefrom a subordinated debt lender.
(13:30):
And so while the interest rate onthe bank debt might be eight percent,
the total return on the seller notemight be between 12 and 14 percent.
And so now the business owner stepsback and says, wow, that's going to be
the best investment in my portfolio.
Dave (13:48):
And I think I know a little bit about the business, so.
Okay.
Kelly Finnell (13:52):
Yeah, exactly.
So where else am I going to get thattype of return on something that I have
that much confidence in, and that Ihave such a high level of control over?
And so what initially might seemlike a negative to a business owner
often turns into a positive when theyrealize how the seller note works and
(14:13):
how attractive it can be for them.
The seller notes often willhave that return of 12 or 14
percent divided into two pieces.
One of those pieces is current payinterest, the coupon component of it,
and then the other component of itis warrants that are attached to the
seller notes, and for the partners inyour firm that specialize in estate
(14:39):
and gift tax planning, this is atremendous opportunity to transfer
wealth out of a business owner's estate.
The value of those warrants the day thatthey're issued is practically nothing.
'cause the underlying company that issuedthe warrants is fully leveraged now.
And so going back to our $10 millionexample, when the owner sold to the
(15:03):
esop, the value was $10 million.
The day after that, thevalue is practically zero.
'cause you've got $10 million ofequity and $10 million of debt.
So the strike price on thewarrant is virtually zero.
And so if the companyhas no organic growth.
And all it does is pay back the debt, andwhen that debt's paid back, the value has
(15:26):
gone from practically zero to 10 million.
And so, those warrants havea great return component.
They can be given away to a children'strust for virtually, or, Now, in
our practice, grandchildren's trust,
Dave (15:44):
right,
Kelly Finnell (15:45):
be given away for practically nothing and then blossom
into something that's tremendouslyvaluable for the trust beneficiaries.
Dave (15:53):
Brilliant point.
Absolutely.
So let's talk a littlebit about this year.
Let's talk a little bit aboutthe presidential election.
Let's talk a little bit aboutwhat's going on in Congress.
I don't know that we're going to touchon the Supreme Court, but I'd just
as soon stay away from them right nowbecause I am an attorney, as you are.
I can't explain them right now.
What do you sense isgoing to be happening?
(16:15):
How is that going to impactwhat you do this year as far
as helping people with ESOPs?
Kelly Finnell (16:20):
Well, Aesop's have been immune from Republican
and Democrat squabbling.
Both Democrats andRepublicans love Aesop's.
Democrats love Aesop's.
Bernie Sanders, believe it or not, isone of the biggest supporters of Aesop's.
And the reason is he loves thewealth distribution aspect of this.
(16:45):
And so, if what he would Say a richperson sells to private equity, the
rich person benefits and the privateequity group is going to benefit.
The employees don't benefit.
If a rich business owner sells toan ESOP, the business owner benefits
and now his employees benefit.
(17:06):
The Bernie Sanders Republicans lovethat wealth redistribution and the
wealth creation opportunity that now isavailable to the rank and file employees.
Republicans love ESOPsbecause of their tax benefits.
If you have a 100 percent ESOPowned S corporation, that company's
(17:27):
income is never again goingto be subject to income tax.
Not at the company level because it'san S corp and not at the shareholder
level because as you know, theincome passes through to the owner
and the owner of the ESOP stock isa tax exempt retirement plan trust.
And so you can have a forprofit company that operates
(17:51):
as if it were not for profit.
entity.
You can have your company operate like achurch or a synagogue for tax purposes.
And so there is something in ESOPsfor Republicans and Democrats.
So I'm not worried about theresults of the upcoming presidential
or congressional elections.
ESOPs are going to continue to thrive.
(18:13):
Since 74, when they were introducedinto the law, there have been something
like 24 legal changes to ESOPs.
Only two of those have been restrictive.
The rest of them have beendesigned to grow ESOPs.
Dave (18:29):
He is ecumenical, ladies and gentlemen.
Let's look at it that way.
You know, I've been watching your LinkedInposts on ESOPs and your theories about
the Not theories, but your position, yourphilosophy of compassionate capitalism.
I could see how thatwould tie into Aesop's.
Give me your thought process and whatyou're espousing and how did this develop?
(18:53):
Because I would think it'sdeveloped over the 43 years.
Yeah, it has.
Kelly Finnell (18:59):
I've noticed two types of business owners over my career.
There is one that I would.
Term as the Gordon Geckotype of business owner.
All they're concerned about is what'sgoing to end up in their pocket.
And then there's another type ofbusiness owner who's concerned
(19:19):
about that, of course, but they'reconcerned about more than that.
They have a more comprehensiveview of what it means.
To sell their company and they wantto do something that benefits them and
their families while at the same time,protecting and benefiting their employees
(19:39):
and their family, and often going beyondthat and benefiting their community.
So this second type of businessowner, who I term a compassionate
capitalist, takes care of them.
of himself or herself and their familyby selling at fair market value and at
(20:01):
the same time benefit their employees andwe find oftentimes as part of the ESOP
transaction that they make a gift of thestock prior to the transaction to a donor
advised fund at a community foundationand then when the transaction happens.
Maybe 5 percent of the stockis in that donor advised fund.
(20:24):
And the ESOP purchases thatalong with the 95 percent that is
still in the hands of the owner.
And so they create a benefit fortheir community while they're
taking care of themselves.
And so I wrote an article or co wrotean article last year for Compensation
(20:48):
and Benefits Review, which is apeer reviewed academic journal.
I'd written for tax journals beforeand written a book, but never
written for an academic journal.
And that's a whole different experience.
Dave (21:00):
Yes, sir.
Kelly Finnell (21:01):
And I wouldn't recommend it to the faint of heart.
But that was the title of the article,was Aesop's Incompassionate Capitalism.
The juxtaposition of greedand taking care of oneself.
Dave (21:15):
So I can see it now, ladies and gentlemen, 2028 Kelly Fennell.
We're going to get BernieSanders to back it.
And on the other side, Lindsey Graham.
I think he can take overand run the country.
Yes.
A lot of positive things.
Let's get down to the dirty business.
I hate to do this, but there'salways that thought process of,
okay, what's it going to cost me?
(21:36):
What professionals do I need?
What are you going to take me through?
Give us some encouraging words aboutthe expenses associated with ESOPs.
Kelly Finnell (21:45):
Well, first it's bad news, good news, and you
always want the bad news first.
Yes, sir.
No, I can say this because youand I are both licensed attorneys.
Business owners ask me, what arethe negatives involved in the ESOP?
I always tell them, number one,there are too many lawyers involved.
Bingo.
So you've got Dave, who's goingto do the transaction law.
(22:07):
You've got an ERISA ESOP specialistwho's going to do that part of it.
You've got.
trustee counsel who'sgoing to be involved.
If you borrow money from a bank, they'regoing to have their lawyer involved,
and you're probably going to get someoneat your firm who specializes in estate
(22:28):
planning involved in all of this process.
So whenever you have that manyprofessionals involved, in
addition to the trustee and thetrustee's valuation advisor,
you're going to run a lot of cost.
And so ESOPs are expensive.
But by comparison, they're not nearly asexpensive as a sale to private equity or
(22:50):
to a strategic buyer because you don'thave an investment banker involved.
And their fees are often two tosix percent of the value of the
stock that's sold to the company.
So you're going to haveall the same legal costs.
in financial expenses.
But if you can cut out the investmentbanker part of it, ESOPs are going to
(23:14):
be one quarter to one third the cost.
Uh, a sale to a third party.
Dave (23:20):
Ladies and gentlemen, you have got to like that.
I may not, but you probably do.
No, that's great insight.
And I agree with you.
What's what's next for Kelly Fennell?
Kelly Finnell (23:32):
Well, I'm looking at new office space.
We've been where we arefor the last 10 years.
It's time to move on.
And so I'm committed to anotherfive years in the ESOP world as
I signed a new five year lease.
We've got a great team here.
I've got a partner who's been withme 14 years, who also is a lawyer.
He has an LLM in tax, and we've gota couple of financial analysts to
(23:56):
have been doing this their entirecareers and are really good at it.
So we're going to continueto to grow the business.
We're up 20 percent.
This year over last year.
And I honestly, Dave couldsee that trend continuing.
We were talking before we went onair about the fact that you and
(24:17):
I are very fortunate to be at theright place at the right time.
We're helping business ownerscash in on their life's work.
And for the most part, we're workingwith baby boomer business owners.
And so that's that group ofpeople that was born right after
world war two, between 46 and 64.
And.
Our generation is now at that point whereit's time to think about cashing in on
(24:42):
your life's work, and whether it's asale to a third party, ESOP's art right
for everybody, or whether it's a sale toan ESOP, I think this space that we're
in of helping business owners developa succession plan and cash in on their
life's work is going to continue to be.
(25:03):
I'm glad to be here in this space.
Dave (25:06):
So if people are interested in knowing more about ESOPs,
how do they get ahold of you?
What's the name of the company?
How do they reach you?
Kelly Finnell (25:14):
Yep.
Our firm is called ExecutiveFinancial Services.
You can find us on the web at execfin.
com.
E X E C You can find me on LinkedIn,Kelly Finnell, and I'm sure that we're
going to have a visual that's goingto show the address, the email, or
(25:37):
the website address and the LinkedIn.
Dave (25:42):
Or they can reach out to me and I can put them in touch with you.
Ladies and gentlemen, again,I really appreciate Kelly
bringing this up to Battlespeed.
I learned some things, and I'velearned about some changes that
have gone on since last year.
So, from my heart Thankyou for doing that.
And I'm sure everyone listening inwill have some new ideas as they
start thinking again about howto exit their business via ESOPs.
(26:06):
Hey, thank you so much forlistening to my podcast.
If you're seeking assistance withyour business dreams, please consider
checking out the resources that I canmake available to you at either my
LinkedIn page, obviously my podcast,my book, quiet plans, exciting
results available on Amazon, andeither in a written or verbal format.
(26:27):
And as well, check outmy website, davidsider.
com, a lot of content, alot of information there.
And there's also a way for you toaccess an assessment, a quick 16
question survey that would allow usto get together and discuss where
you're at and where you seek to go.
I'm here to help you with yourdreams until then be safe.
(26:47):
This
podcast is provided foreducational purposes and is
not constitute legal advice.
It's not intended to establishan attorney client relationship.
The recommendations contained in thispodcast are not necessarily appropriate
for every individual or business.
In determining the best course ofaction, business owners should consult
(27:09):
with a professional of their choiceon their distinct circumstances.
Show me the way episode 60, the ESOP coach, which is from his
book and leader part do as in two forthose of you that don't speak French.
In this episode, Kelly Finnella, theexecutive financial services is going
to update matters relative to ESOPs.
(00:33):
Come to show me the way a podcastpresented by Spencer Fane LLP
about business succession planning,the merger and acquisition
experience and successful exits.
I am your host, Dave Sider.
Hey, thank you so much forlistening to my podcast.
If you're seeking assistance with yourbusiness dreams, please consider checking
(00:53):
out the various resources I made availableto you at either my LinkedIn page.
My podcast, my Amazon book, quietPlans, exciting Results that is both
in a written and a verbal format.
And my website, david cider.com,where you can find quite a bit of
content and also access a very briefsurvey that will allow you and I to
(01:17):
interact at a time of your choosingto get a better grip on where you're
at and where you seek to go, becausewe wanna support you in your dreams.
Until next we talk.
Be safe.
Hey ladies and gentlemen, it's a repeatperformance you're gonna be interested in.
(01:38):
We brought back KellyFennell, you may remember him.
He gave us a really.
Nice outline of what ESOPs are all about.
Kelly opened my eyes to theadvantages and uses of ESOPs.
I'm going to bring them back inbecause there have been changes like
everything else in the marketplace,things go one way or the other.
And I think you're going to find outthat ESOPs are even more attractive now.
(02:02):
So I want to once again,introduce Kelly to you all and
ask you pay close attention.
Kelly, welcome back to the show.
Kelly Finnell (02:11):
Thank you very much, Dave.
It's great to be back.
Dave (02:14):
We may have, I'm sure everybody listens to us religiously, but we
may have some first time researchers.
So let's give them a little flavor ofyour background again, and your early
business experiences, if you would.
Kelly Finnell (02:26):
Well, I grew up in Memphis, Tennessee.
You might be able to notice alittle bit of a Southern accent.
Went to undergrad at the University ofMemphis and went to law school there.
Following law school, I startedexecutive financial services.
That was in 1981, hardto believe 43 years ago.
And this is all that I've ever done.
(02:47):
I've been in the retirementplan business this entire Career
at the beginning dealing withdefined benefit pension plans.
I'm so old Dave, that when Istarted this business, there was
no such thing as a 401k plan.
It's hard to believe.
And for years we did 401ks and ESOPs and15 years ago, I sold the 401k part of my
(03:12):
business so that I could focus exclusivelyon And so that's all we do now.
We work from coast to coast.
Last year, we did a transaction inSeattle, Washington and in Miami.
So literally north to south, east to west.
Dave (03:28):
So you got to like this, ladies and gentlemen.
He's been doing this well over 40 years.
He's an attorney also by training.
The guy has got the background.
He's got the expertise, buthe's got the experience.
He's got the wisdom.
That's what you.
Need to know.
So let's get into and talk about ESOPs.
I've got to believe as with everythingelse with stock markets, with MNAs that I
(03:50):
see going on, interest rates, there had tohave been some new trends or developments.
Can you give us some ideawhat's gone on in the world of
ESOPs since we've talked last?
Kelly Finnell (04:01):
There have been a couple of things that have
changed since we talked last.
One of them is the SBAs.
involvement in lending moneyinto ESOP transactions.
Now,
Dave (04:13):
that I didn't know about.
That's a newbie for me.
Kelly Finnell (04:17):
Congress authorized that in 2020, but you know how
the regulatory process works.
It took the SBA a long time to catch up.
With the legislation, but effectivelast year, the SBA has gotten a look
at financing on many ESOP transactions.
And in the right situation,it's a great scenario.
(04:41):
The SBA 7A program allows acompany to borrow up to 5 million.
No personal guarantee and a 10 yearterm and a 10 year amortization.
So it is a great way to fund asmall ESOP or a portion of even
a medium or larger size ESOP.
(05:02):
And so that's been a great development.
That has given us another source tomake sure that when ESOP, they're
able to get a bank financing.
For part of that transaction.
Dave (05:16):
Excellent.
So do you see this happening more in,I take it smaller deals and by small
deals, what would that look like?
Or is it going to be an add onor an adjunct to a larger deal?
How do you see us playing out?
Kelly Finnell (05:29):
Well, first, yeah, let me talk about deal size.
And so what we've seen over the last threeyears has been a range in transaction
size for us and in our practice from.
The smallest in a company with 1.
2 million of adjusted EBITDA,up to the larger end, a company
(05:53):
with 56 million adjusted EBITDA.
That's a good size.
And the median has been 4 millionof EBITDA and 95 employees.
And that is generally whatthe ESOP market looks like.
That's our practice.
And that's pretty reflective ofwhat the ESOP market looks like.
So ESOPs usually don't work well for microsized companies, for companies with less
(06:18):
than a million dollars of earnings, butfor that middle market, ESOPs work well.
One of the other things that has beenvery exciting in terms of development
since you and I talked last is that BDO,one of the nation's largest accounting
and consulting firms, sold a big chunkof their practice to an ESOP last year.
Dave (06:43):
I had no idea.
Okay.
Kelly Finnell (06:45):
And that was a multi billion dollar transaction.
So over the years, this doesn'thappen much anymore, but 15 years
ago, when we would talk to somebodyabout an ESOP, they'd say, ah, you
know, that's for the unsophisticated.
That's for the small companiesthat don't have any other options.
(07:06):
They're not a candidate for privateequity and they're not smart enough.
to deal with investmentbankers and private equity?
Well, I think BDO might have disprovedthat theory and put the lid down
on that coffin once and for all.
You've got one of the largest, mostfinancially and tax sophisticated
(07:27):
organizations in the country deciding thatwhen other accounting firms are selling or
raising capital from private equity thatan ESOP was the right decision for them.
Interesting.
Yeah.
So that was very exciting.
Some of the other things that havehappened that have given additional
(07:48):
momentum and credibility to ESOPs.
I don't know if you saw it, buta few months ago, 60 Minutes did
a piece on employee ownership.
Dave (07:57):
I did.
And because I have arelative that works for KKR.
So yes, I did see that.
Go ahead, please.
And
Kelly Finnell (08:03):
KKR has been a big supporter of the concept
of employee ownership.
Now, their model does not utilize an ESOP.
Right.
But it could, and it's an endorsement ofthe concept that when you give employees
an equity stake in a business, that'sgoing to result in better performance
(08:25):
and better profitability for the company.
And that's been proven out throughDozens of academic studies, ESOPs
work in terms of motivating employees.
So a good compensation plan has a nicebase pay package for its employees,
a nice short term incentive in theform of a bonus plan, and then a nice
(08:49):
long term incentive in the form ofsome type of equity based alignment.
And that really alignsthe interest of everybody.
On short term and long term basis.
Dave (09:03):
That's a good analysis and very well thought out too,
especially the three levels.
It's a conversation you, you want tohave with clients all of the time.
What do you see?
This is going to be, this is goingto be, this is a volatile year.
And I, you know, I'm trying to thinkas everyone else tries to determine
(09:23):
how things are going to play outhere in a few months, and I'm talking
about November, and I'm just curious.
Let's kind of take thewhole hemisphere of issues.
Let's start first with interest ratesand what's been going on with banks,
because my familiarity with ESOPsis most of them are backed by banks.
(09:45):
That's just my analysis.
So what goes on in banking.
What developments have you seen this year?
Kelly Finnell (09:52):
Well, of course, interest rates have gone up.
The Fed said that it was going tobegin a series of rate cuts this year,
and that obviously hasn't happened.
And so credit is substantially moreexpensive than it was two years ago.
But it's still available in abundance.
And so part of what we do for a client isnot just set up a transaction for them.
(10:18):
We help them source thefinancing for that transaction.
And so we will send financing requeststo between 6 and 12 different financial
institutions for a client every time.
We do an ESOP and.
Despite increased interest rates, there'snot been a single situation over the
(10:40):
last two years where we've not beenable to get bank debt for a transaction.
So it's more expensive,but it's available.
One of the things that really helps ESOPsis Even when interest rates go up, an
ESOP transaction can still be affordablefor a company because we've got a seller
(11:03):
note component in almost every ESOP.
And so, in order to lessen thecompany's cash flow, Requirements.
We can spread out the term of thatseller note, and that allows us to deal
with the increased cash flow that'srequired by higher interest rates.
(11:24):
We spread the term of the seller note outanother year or so, and that can allow
us to build the cushion that we need.
For the company to be able to financethe transaction on an affordable basis.
Dave (11:40):
So help a little bit for my audience, Koos.
When I think of an ESOP, I think ofthe fact that there is a loan in place.
It's backstopped.
It's essentially, it's the bank's loan.
Are you talking, when you talkabout a seller note, another note
on top of that bank financing?
Kelly Finnell (11:58):
Yes.
A company is never able to finance100 percent of its value, so a typical
financing structure for an ESOP, let'sjust use an example of a 10 million ESOP.
A typical structure might be 2million of company cash loaned
by the company to the ESOP.
A loan from a bank for 4 million, andso now we've got 6 million of cash
(12:24):
into the ESOP and then a seller note tomake up that difference of 4 million.
And so that would be a prettycommon, typical structure for the
financing of an ESOP transaction,those three components of capital.
Dave (12:39):
Thank you.
Kelly Finnell (12:40):
You know, when we first start talking to business owners about
seller notes, a lot of times yourinitial reaction is negative, right?
And then I say to them, look, wecould go to another source of capital.
We could go to a mezzanine lender.
And perhaps get more cash up front for youby having them blend into the transaction.
(13:04):
And they ask, well,what's that going to cost?
Dave (13:07):
And what's that interest rate?
Yeah.
Kelly Finnell (13:09):
And when I tell them, they say, man, I wish I were in that business.
There you go.
And I said, I've got an opportunityfor you to be in that business.
And so the point is that the returnon the seller note is commensurate
with the return that you would seefrom a subordinated debt lender.
(13:30):
And so while the interest rate onthe bank debt might be eight percent,
the total return on the seller notemight be between 12 and 14 percent.
And so now the business owner stepsback and says, wow, that's going to be
the best investment in my portfolio.
Dave (13:48):
And I think I know a little bit about the business, so.
Okay.
Kelly Finnell (13:52):
Yeah, exactly.
So where else am I going to get thattype of return on something that I have
that much confidence in, and that Ihave such a high level of control over?
And so what initially might seemlike a negative to a business owner
often turns into a positive when theyrealize how the seller note works and
(14:13):
how attractive it can be for them.
The seller notes often willhave that return of 12 or 14
percent divided into two pieces.
One of those pieces is current payinterest, the coupon component of it,
and then the other component of itis warrants that are attached to the
seller notes, and for the partners inyour firm that specialize in estate
(14:39):
and gift tax planning, this is atremendous opportunity to transfer
wealth out of a business owner's estate.
The value of those warrants the day thatthey're issued is practically nothing.
'cause the underlying company that issuedthe warrants is fully leveraged now.
And so going back to our $10 millionexample, when the owner sold to the
(15:03):
esop, the value was $10 million.
The day after that, thevalue is practically zero.
'cause you've got $10 million ofequity and $10 million of debt.
So the strike price on thewarrant is virtually zero.
And so if the companyhas no organic growth.
And all it does is pay back the debt, andwhen that debt's paid back, the value has
(15:26):
gone from practically zero to 10 million.
And so, those warrants havea great return component.
They can be given away to a children'strust for virtually, or, Now, in
our practice, grandchildren's trust,
Dave (15:44):
right,
Kelly Finnell (15:45):
be given away for practically nothing and then blossom
into something that's tremendouslyvaluable for the trust beneficiaries.
Dave (15:53):
Brilliant point.
Absolutely.
So let's talk a littlebit about this year.
Let's talk a little bit aboutthe presidential election.
Let's talk a little bit aboutwhat's going on in Congress.
I don't know that we're going to touchon the Supreme Court, but I'd just
as soon stay away from them right nowbecause I am an attorney, as you are.
I can't explain them right now.
What do you sense isgoing to be happening?
(16:15):
How is that going to impactwhat you do this year as far
as helping people with ESOPs?
Kelly Finnell (16:20):
Well, Aesop's have been immune from Republican
and Democrat squabbling.
Both Democrats andRepublicans love Aesop's.
Democrats love Aesop's.
Bernie Sanders, believe it or not, isone of the biggest supporters of Aesop's.
And the reason is he loves thewealth distribution aspect of this.
(16:45):
And so, if what he would Say a richperson sells to private equity, the
rich person benefits and the privateequity group is going to benefit.
The employees don't benefit.
If a rich business owner sells toan ESOP, the business owner benefits
and now his employees benefit.
(17:06):
The Bernie Sanders Republicans lovethat wealth redistribution and the
wealth creation opportunity that now isavailable to the rank and file employees.
Republicans love ESOPsbecause of their tax benefits.
If you have a 100 percent ESOPowned S corporation, that company's
(17:27):
income is never again goingto be subject to income tax.
Not at the company level because it'san S corp and not at the shareholder
level because as you know, theincome passes through to the owner
and the owner of the ESOP stock isa tax exempt retirement plan trust.
And so you can have a forprofit company that operates
(17:51):
as if it were not for profit.
entity.
You can have your company operate like achurch or a synagogue for tax purposes.
And so there is something in ESOPsfor Republicans and Democrats.
So I'm not worried about theresults of the upcoming presidential
or congressional elections.
ESOPs are going to continue to thrive.
(18:13):
Since 74, when they were introducedinto the law, there have been something
like 24 legal changes to ESOPs.
Only two of those have been restrictive.
The rest of them have beendesigned to grow ESOPs.
Dave (18:29):
He is ecumenical, ladies and gentlemen.
Let's look at it that way.
You know, I've been watching your LinkedInposts on ESOPs and your theories about
the Not theories, but your position, yourphilosophy of compassionate capitalism.
I could see how thatwould tie into Aesop's.
Give me your thought process and whatyou're espousing and how did this develop?
(18:53):
Because I would think it'sdeveloped over the 43 years.
Yeah, it has.
Kelly Finnell (18:59):
I've noticed two types of business owners over my career.
There is one that I would.
Term as the Gordon Geckotype of business owner.
All they're concerned about is what'sgoing to end up in their pocket.
And then there's another type ofbusiness owner who's concerned
(19:19):
about that, of course, but they'reconcerned about more than that.
They have a more comprehensiveview of what it means.
To sell their company and they wantto do something that benefits them and
their families while at the same time,protecting and benefiting their employees
(19:39):
and their family, and often going beyondthat and benefiting their community.
So this second type of businessowner, who I term a compassionate
capitalist, takes care of them.
of himself or herself and their familyby selling at fair market value and at
(20:01):
the same time benefit their employees andwe find oftentimes as part of the ESOP
transaction that they make a gift of thestock prior to the transaction to a donor
advised fund at a community foundationand then when the transaction happens.
Maybe 5 percent of the stockis in that donor advised fund.
(20:24):
And the ESOP purchases thatalong with the 95 percent that is
still in the hands of the owner.
And so they create a benefit fortheir community while they're
taking care of themselves.
And so I wrote an article or co wrotean article last year for Compensation
(20:48):
and Benefits Review, which is apeer reviewed academic journal.
I'd written for tax journals beforeand written a book, but never
written for an academic journal.
And that's a whole different experience.
Dave (21:00):
Yes, sir.
Kelly Finnell (21:01):
And I wouldn't recommend it to the faint of heart.
But that was the title of the article,was Aesop's Incompassionate Capitalism.
The juxtaposition of greedand taking care of oneself.
Dave (21:15):
So I can see it now, ladies and gentlemen, 2028 Kelly Fennell.
We're going to get BernieSanders to back it.
And on the other side, Lindsey Graham.
I think he can take overand run the country.
Yes.
A lot of positive things.
Let's get down to the dirty business.
I hate to do this, but there'salways that thought process of,
okay, what's it going to cost me?
(21:36):
What professionals do I need?
What are you going to take me through?
Give us some encouraging words aboutthe expenses associated with ESOPs.
Kelly Finnell (21:45):
Well, first it's bad news, good news, and you
always want the bad news first.
Yes, sir.
No, I can say this because youand I are both licensed attorneys.
Business owners ask me, what arethe negatives involved in the ESOP?
I always tell them, number one,there are too many lawyers involved.
Bingo.
So you've got Dave, who's goingto do the transaction law.
(22:07):
You've got an ERISA ESOP specialistwho's going to do that part of it.
You've got.
trustee counsel who'sgoing to be involved.
If you borrow money from a bank, they'regoing to have their lawyer involved,
and you're probably going to get someoneat your firm who specializes in estate
(22:28):
planning involved in all of this process.
So whenever you have that manyprofessionals involved, in
addition to the trustee and thetrustee's valuation advisor,
you're going to run a lot of cost.
And so ESOPs are expensive.
But by comparison, they're not nearly asexpensive as a sale to private equity or
(22:50):
to a strategic buyer because you don'thave an investment banker involved.
And their fees are often two tosix percent of the value of the
stock that's sold to the company.
So you're going to haveall the same legal costs.
in financial expenses.
But if you can cut out the investmentbanker part of it, ESOPs are going to
(23:14):
be one quarter to one third the cost.
Uh, a sale to a third party.
Dave (23:20):
Ladies and gentlemen, you have got to like that.
I may not, but you probably do.
No, that's great insight.
And I agree with you.
What's what's next for Kelly Fennell?
Kelly Finnell (23:32):
Well, I'm looking at new office space.
We've been where we arefor the last 10 years.
It's time to move on.
And so I'm committed to anotherfive years in the ESOP world as
I signed a new five year lease.
We've got a great team here.
I've got a partner who's been withme 14 years, who also is a lawyer.
He has an LLM in tax, and we've gota couple of financial analysts to
(23:56):
have been doing this their entirecareers and are really good at it.
So we're going to continueto to grow the business.
We're up 20 percent.
This year over last year.
And I honestly, Dave couldsee that trend continuing.
We were talking before we went onair about the fact that you and
(24:17):
I are very fortunate to be at theright place at the right time.
We're helping business ownerscash in on their life's work.
And for the most part, we're workingwith baby boomer business owners.
And so that's that group ofpeople that was born right after
world war two, between 46 and 64.
And.
Our generation is now at that point whereit's time to think about cashing in on
(24:42):
your life's work, and whether it's asale to a third party, ESOP's art right
for everybody, or whether it's a sale toan ESOP, I think this space that we're
in of helping business owners developa succession plan and cash in on their
life's work is going to continue to be.
(25:03):
I'm glad to be here in this space.
Dave (25:06):
So if people are interested in knowing more about ESOPs,
how do they get ahold of you?
What's the name of the company?
How do they reach you?
Kelly Finnell (25:14):
Yep.
Our firm is called ExecutiveFinancial Services.
You can find us on the web at execfin.
com.
E X E C You can find me on LinkedIn,Kelly Finnell, and I'm sure that we're
going to have a visual that's goingto show the address, the email, or
(25:37):
the website address and the LinkedIn.
Dave (25:42):
Or they can reach out to me and I can put them in touch with you.
Ladies and gentlemen, again,I really appreciate Kelly
bringing this up to Battlespeed.
I learned some things, and I'velearned about some changes that
have gone on since last year.
So, from my heart Thankyou for doing that.
And I'm sure everyone listening inwill have some new ideas as they
start thinking again about howto exit their business via ESOPs.
(26:06):
Hey, thank you so much forlistening to my podcast.
If you're seeking assistance withyour business dreams, please consider
checking out the resources that I canmake available to you at either my
LinkedIn page, obviously my podcast,my book, quiet plans, exciting
results available on Amazon, andeither in a written or verbal format.
(26:27):
And as well, check outmy website, davidsider.
com, a lot of content, alot of information there.
And there's also a way for you toaccess an assessment, a quick 16
question survey that would allow usto get together and discuss where
you're at and where you seek to go.
I'm here to help you with yourdreams until then be safe.
(26:47):
This
podcast is provided foreducational purposes and is
not constitute legal advice.
It's not intended to establishan attorney client relationship.
The recommendations contained in thispodcast are not necessarily appropriate
for every individual or business.
In determining the best course ofaction, business owners should consult
(27:09):
with a professional of their choiceon their distinct circumstances.
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