ESOPs AS A LIQUIDITY OPTION

1. ESOPs AS A LIQUIDITY OPTION Ann B. McAloon LaSalle Bank, N.A.

2. The “How to Exit” Decision Process: Liquidity Alternatives • Objectives • Alternatives

3. What are my objectives? • Do I care about involving/rewarding key employees? • Do I or don’t I want to remain active? • Do I have a succession management team? • Do I or don’t I want a continued equity interest in the company?

4. What are my objectives? • How does this asset fit in my estate plan? • How does it fit with my portfolio diversification? • Do I have kids in the business and/or key management to protect?

5. Alternatives Do Nothing Corporate Goals Partial Sale Company Review Strategic Alternatives Stock Repurchase/ Recapitalization Shareholder Goals Sale of Company Financial Buyer/MBO Strategic/Corporate Buyer ESOP Recapitalization >30% Sale 100% Sale

6. What is an ESOP? • A qualified employee benefit plan that invests in the stock of the employer; • Provides tax savings and cash flow benefits to Company; • Provides tax benefits to selling shareholders; • ESOP rules regulations and tax issues are defined in ERISA and the IRS code; • Can improve morale and productivity; • An ESOP transaction can be structured in numerous ways.

7. ESOP Loan Company Lender Inside Loan Shareholders Stock ESOP Cash Leveraged ESOP Transaction Summary Sample Co. Leveraged ESOP Transaction

8. ESOP 101 • Harnessing government tax benefits: • 1042 capital gains deferred • Pre-tax debt • Tax-exempt company

9. Seller Defers Capital Gains Tax - 1042 Rollover ($Thousands) ESOP Transaction Non-ESOP Transaction Enterprise Value $100,000 $100,000 Less: Debt (50,000) (50,000) Equity Value 50,000 50,000 Multiplied by % Acquired 51% 51% Cash From Sale 25,500 25,500 Less: Capital Gains Tax @ 20% 0 (5,100) After-Tax Proceeds 25,500 20,400 Deferral of Capital Gains for Selling Shareholders

10. ESOP Tax Savings

11. ESOP is tax-exempt shareholder of an S-Corporation for all federal and some state taxes Pretax Income Tax Savings @ 40% Year 1 $5,000,000 $2,000,000 Year 2 $5,000,000 $2,000,000 Year 3 $5,000,000 $2,000,000 Year 4 $5,000,000 $2,000,000 Year 5 $5,000,000 $2,000,000 Total Cash Savings to Sub-S Election $10,000,000

12. ESOP Fables 10) AESOP really only wrote fables - They’re too good to be true.

13. ESOP Fables 9) United didn’t fly - how could I? 8) Enron proves employees are worse off.

14. ESOP Fables 7) They were outlawed when section 133 was repealed. • Too confusing • No beneficial for interest role 6) I’ll lose control of my company when I sell to an ESOP.

15. ESOP Discussion ESOP Fables 5) My employees could fire management, know senior executives salaries, interfere with operations, etc. 4) ESOPs will burden the company with too much debt.

16. ESOP Fables 3) Management can’t get superior equity incentive. 2) I’ll sell for less than FMV.

17. ESOP Fables 1) Lenders don’t lend money to ESOPs.

18. Case Studies ABC Company – 1042 Transaction XYZ Inc. – 100% S-Corp Sale Buy-Me Group - Acquisitions

19. ABC Co. - 1042 Transaction • Highly Leveraged Transaction • Multiple Financing Sources • Various ESOP and non-ESOP Securities • Profit Sharing Plan Money Used • Management Incentive Contracts

20. 1042 TransactionFinancing Solutions: • Maximize Asset Based Leverage • Improve debt service coverage with real estate facility • Term debt on revolver • Seasonal over-advance • Minimum underdrawn availability

21. 1042 Transaction $10 MM Plan Assets $45MM Senior Debt $5MM Mezzanine Preferred Stock ABC Co. ESOP 60% Residual Shareholder 40% 1042 $60MM Sellers • ABC Co. borrows $50MM from the various lenders and re-loans the money to ESOP. ESOP uses the loan proceeds to purchase stock from selling shareholders, and uses the PSP money to purchase a specially designed security.

22. XYZ Inc. – 100% S-Corp Sale • C-Corp 1042 converting to S-Corp post transaction • Complete buyout with ESOP • Equity investor in transaction

23. 100 S-Corp Sale • Selling Shareholders Desire 1042 • MBO Component • 100% S-Corp key to Financing • $20MM Private Equity needed to accomplish 100% buyout

24. Equity in S-Corp ESOP1042 ESOP Leverage Transaction Multiple Senior Lenders $60MM Private Equity $20 MM $80MM ESOP Loan XYZ Inc. C-Corp ESOP $80 MM Cash Stock Selling Shareholders 1042 Transaction $80MM • XYZ Inc. completes a 1042 Leveraged ESOP transaction with selling shareholders resulting in ESOP owning 100% of the company.

25. Equity in S-Corp ESOPPost 1042 ESOP Structure Multiple Senior Lenders $60MM Private Equity $20MM XYZ Inc. C-Corp 100% ESOP Owned Company converts to S-Corp Status • XYZ Inc. converts its tax status to an S-Corp.

26. Buy-Me Group: S-Corp Acquisition • Company 100% Owned by an ESOP • Company is an S-Corp • Desires to Purchase Competitor • Target is a C-Corp • 1042 Treatment

27. Buy-Me Group: S- Corp Acquisition 1042 Loan Shareholder Senior Lender Target 100% S-Corp ESOP Co. Buy-me Group ESOP • Target establishes an ESOP, with Target’s Shareholders selling to Target ESOP in Section 1042 Transaction.

28. Target ESOP Buy-Me Group: S-Corp AcquisitionCreate Merger Sub Merger Sub 100% Loan Buy-me Group S-Corp ESOP • Buy-me Group creates a wholly owned subsidiary.

29. Buy-Me Group: S-Corp Acquisition Target Merger Sub 100 % S-Corp ESOP Co. Buy-me Group Target ESOP ESOP • Target merged into Merger Sub which is owned 100% by Buy-me Group.

30. Conclusions • Need strong creative financial advisory team: • Financial advisor / Investment Banker • Experienced Attorney • Knowledgeable Lender • Reputable Valuation Firm • Plan Administration • 1042 Asset Management