The owners of Demcon and D&D Concrete were facing a challenge familiar to many trade contractors. The San Diego based structural concrete contractor grew significantly over its 20+ year history, but shareholders Derek Leffler and Ed Stoughton were approaching retirement and weighing their options for ownership and leadership succession. Winding down operations or doing nothing and going out with their boots on were not attractive outcomes. Neither was selling the business to a third-party as the shareholders feared it would result in a change to the company culture they had spent years developing. Seeking an alternative, Derek and Ed turned to Acuity Advisors to explore a sale to their employees through the implementation of an Employee Stock Ownership Plan (ESOP).
Goals and Challenges
An ESOP sale addressed several of Derek and Ed’s concerns. First, they would be able to receive fair market value for their stock while realizing a tax advantage through the tax deferral offered by section 1042 of the internal revenue code. Second, they would be able to maintain company culture and transition management control to the next generation of leaders. Lastly, but perhaps most importantly, they were able to reward the employees who helped build the business with a new retirement plan and the opportunity to build significant wealth over time. With an ESOP, as the value of the company grows, so does the value of the employee’s shares. This can provide a significant source of retirement income for employees who have been with the company for many years.
The Challenge Met
While a sale to an ESOP appeared to satisfy the goals of ownership on its face, there were several hurdles to overcome. Acuity first prepared a detailed feasibility analysis that showed various options in terms of transaction structure and plan design. Complicating matters was the fact that while Demcon and D&D Concrete historically operated with many shared resources, they were technically organized as separate corporate entities. Further, Demcon utilized a union workforce, so it was imperative for the shareholders to explore the implications of various structures on the level of benefits that would be provided to employees. After exploring various options, Acuity assisted the shareholders with procuring the appropriate legal counsel to reorganize the two corporations under a single holding company, 3D Holdings, through a tax-free reorganization. This would allow the formation and sale to a single ESOP, rather than a costlier two-plan approach that would not have provided additional benefits.
Subsequent the reorganization, Acuity assisted the shareholders with introductions to professional independent fiduciaries, resulting in the company selecting a qualified third-party to serve as the ESOP trustee, which is the representative of the employee owners, in the transaction process. After a comprehensive due diligence process in which Acuity assisted the company with responses to inquiries from the trustee’s legal counsel and financial advisor, the negotiation process began with an initial offer to sell. Concurrent with the ESOP transaction negotiations, Acuity assisted the company with securing outside financing to provide the additional liquidity necessary for the shareholders to effect the election of section 1042 and the tax advantage it offered.
After a thorough negotiation between the parties, terms of the transaction were agreed upon and a target closing date was selected. Acuity then assisted the shareholders and company with ensuring certain precedent conditions were met before closing, including securing appropriate insurance coverage and approvals from the company’s bank, surety, and union. Ultimately, the sale was successfully executed and 100% of the company was sold to its new employee owners. While the sale was complete, Acuity’s job was not over. Michael Lovett and Chris Kramer were welcomed to the company’s kick-off celebration and assisted with the communication of the transaction and the unique benefits offered by the ESOP to the employees of 3D Holdings.
Lessons Learned
Selling to an ESOP carries a number of complications, ranging from valuation to deal structure. Careful consideration must be given to the various options available to the shareholders and company. Through proper planning, analysis, and advice, the right result was reached for the sellers and the new employee owners of 3D Holdings.