Key trends for ESOPS and family businesses considering acquisition

In the world of private practice advisory, where I have spent my 30-year career, M&A and transactions almost always involve the sale of some or all of the equity in a private practice to an employee stock ownership plan (“ESOP”) or another company. means to. , or a private equity firm.

That being said, many private companies want to maintain their independence and continue their success. There is every reason for these companies to think about growing by acquiring other companies, as private equity and public companies often do. M&A can be an effective way to acquire talent, acquire new capabilities, and drive revenue growth beyond intrinsic growth opportunities.

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In recent years, as awareness of the benefits of M&A has grown, we have seen a dramatic increase in conversations with ESOPs and private companies looking to acquire. There are four key trends in today’s market that active acquirers and prospective acquirers should be aware of.

・Growth of the holding company structure.

· Increased use of earn-outs and other forms of contingent consideration

· Increase in unitranche debt and mezzanine capital to finance the transaction.

· New appreciation by sellers for the strong culture and stability associated with private company and ESOP ownership.

There are many ways to structure a transaction and future integration business, but forming a holding company (Holdco) has recently become popular as companies look to diversify in the wake of the market and economic turmoil of recent years. Masu. This structure allows both the original business and the acquired business to operate relatively independently while being integrated into an umbrella holding company that can be partially or fully owned by the ESOP. In the case of ESOPs, holdcos can be attractive buyers for companies that find the benefits of ESOPs attractive but struggle to create unique benefits. Hurdles may include the need for a seller’s memo and the cost of forming his ESOP. Selling to Holdco allows the outgoing owner to feel like the transaction is an outright sale while also reaping the future benefits of being an ESOP.

Given the significant fluctuations in performance that many companies have experienced over the past few years, acquisition structures and financing structures are increasingly incorporating contingent consideration. Conditional considerations address the long-standing challenge of smoothing out sharp macroeconomic fluctuations and short-term fluctuations in business performance when pricing companies.

After a peak, buyers expect business to return to lower-than-normal levels and are reluctant to pay for the possibility of a temporary peak. At the trough, buyers are hesitant to trust predictions of a return to growth, even though they understand what has changed.

Therefore, conditional consideration has proven to be an effective way to bridge these risks and reduce bid-to-ask spreads that have widened since the pandemic. There are many structures to choose from, such as earn-outs and rollover equity, but the effect is to make it easier for the buyer to acquire the business, while tying a portion of the seller’s profits to the success of the business after the sale. .

As financial markets continue to evolve, unitranche structures are becoming increasingly common. In a hybrid loan structure, he combines senior and subordinated debt into one debt instrument. Borrowers pay a mixed interest rate between senior and subordinated debt. This allows for flexible borrowing terms and increases access to capital for businesses.

Mezzanine debt is also a commonly used feature. It bridges the gap between debt and equity financing in the financing structure, being subordinate to pure debt but preferential to pure equity. Incorporating equity-based options such as warrants on lower-priority debt. This provides flexible long-term capital that can be used for acquisitions and growth financing. Mezzanine debt, which is often unsecured, typically bears interest at a higher rate than secured loans, and often gives the lender a stake in the company’s stock.

Although ESOPs and other private companies have not historically been significant buyers in the M&A market, data suggests that ESOPs and other private companies can be very successful acquirers, and the market is seeing their advantages. There is increasing awareness of Research shows that ESOPs are more stable, have better business performance throughout the cycle, and are structurally more flexible. Anecdotal reports from ESOPs that have pursued acquisitions suggest that sellers are more likely to take advantage of the company’s culture, how they will evaluate the target company’s employees going forward, and the owner’s ability to continue to participate in the growth of the stock if they choose. He says he is often attracted to ESOPs as a buyer.

Given that healthy acquisitions can significantly accelerate a company’s growth plans, well-managed, high-performing ESOPs and family businesses evaluate whether becoming an acquirer is in their strategic plans. is needed. Inorganic expansion is a proven method for public companies and PE firms to achieve their goals. ESOPs and family businesses may want to consider adding M&A to their growth arsenal.