The COVID-19 pandemic has dramatically shifted the economic landscape virtually overnight. The financial picture your business may have been looking at as of December 31, 2019 could be very different today. Many ESOP-owned companies are understandably focused on what this means for their annual valuation. But the next big threat to your business’s capital may not be on your balance sheet at all.
If the unprecedented situation of a global pandemic has prompted your business to consider drastic measures in order to cut costs, such as a workforce reduction, your ESOP will be required to pay the terminated employees the value of the shares in their accounts. If you have to terminate 15% of your workforce, will you have the necessary cash flow to make that repurchase? Or could the step that seems like a necessary cost-cutting measure today end up putting you in an even more precarious position when it comes time to pay benefits?
A Menke Repurchase Obligation Study can give you the answers and direction you need to make the decisions today that could impact your business for years to come.
What is a Menke Repurchase Obligation Study?
A Menke Repurchase Obligation Study is an actuarial projection of the cashflow you need to be able to fund the upcoming share repurchases under your ESOP plan, combined with timely, actionable, data-driven intelligence to help you stress-test your assumptions and make the best possible decisions for your business and your employees.
Our studies map out a baseline scenario and alternative scenarios, giving you a range of outcomes, from the best- and worst-case.. You can opt for unlimited additional scenarios that empower you to map out different strategies. What would happen to your repurchase obligations if you had to close that plant, or if you launched that new division you’ve been contemplating? Whatever roadmap you want to create, Menke can help you put it in terms of real numbers and real impact.
All Menke Repurchase Obligation Studies are completed by licensed actuaries with over 25 years of experience, powered by the expertise of Optimizing Foundations, LLC.
Why Do a Repurchase Obligation Study?
Repurchases are required upon retirement, death, disability, diversification, and termination of service. While health is foremost on everyone’s minds at this time, we do not actually expect to see a huge wave of repurchases triggered by death and disability. For most companies, the biggest hidden financial threats today are the termination and diversification repurchase triggers.
No one wants to lay off employees, particularly in employee-owned companies. Unfortunately, in many cases this may seem like an unavoidable option. Any employee-owner terminated this year will have to be paid for their shares pursuant to the terms of the plan, and in many cases beginning with the Dec 31, 2020 value of the company’s stock. Additionally, if your ESOP incurs a partial plan termination due to a large layoff, all terminating participants are treated as being fully vested. The potential costs can be devastating if you are not properly prepared for them.
For companies with mature ESOPs, diversification could present an even larger financial challenge. With so much uncertainty and so many companies seeing sharp declines in stock value, it comes as no surprise that many employees who are eligible for diversification would choose to exercise that option. Those who diversify this year will be paid out based on Dec 31, 2019 values.
Companies that fail to adequately prepare for these mandatory repurchases risk being blindsided by potentially massive costs that are likely to hit in the next 18 months, possibly just as your business is starting to recover from the current crisis.
When should I have a Repurchase Obligation Study performed?
Under normal, healthy economic circumstances, you should perform a Repurchase Obligation Study every one to three years to ensure that you are never caught off guard by a sudden wave of retirements and diversifications that necessitate repurchasing a high volume of shares at once. Many ESOP-owned companies have covenanted with their lenders that they will perform Repurchase Obligation Studies on this schedule as well.
Of course, we are not living in normal, healthy economic circumstances. Even if your company performed a Repurchase Obligation Study six months ago, the world has changed since then, and your business, your industry, and your market have likely changed as well. We are dealing with a new reality, and you need new data to be able to act accordingly. At Menke, we don’t think of these studies as a singular snapshot of a particular moment – they are performed in unison with your ESOP administration and valuation. They are working documents that evolve over time and can be updated and amended to include new data and new scenarios, and are a vital part of the ongoing process of ESOP administration and valuation.
Don’t be caught off guard by your off-balance sheet liabilities. Contact your Menke advisor today to discuss a Repurchase Obligation Study and give your business the information it needs to survive and thrive.
Menke & Associates, Inc. has helped over 3,500 companies successfully transition to employee ownership. Our holistic ESOP approach enables a positive outcome for the company, its employees and its shareholders. We believe ownership is powerful.
Phil DeDominicis is an ESOP strategist and M&A advisor who has guided 300+ companies through ESOP formations, financing, and transactions over 20+ years at Menke & Associates. He specializes in selling ESOP‑owned businesses to financial or strategic buyers and in helping ESOP companies acquire other businesses.
