A new study recently published by the National Center for Employee Ownership (NCEO) indicates that leveraged ESOP transactions exhibit a lower bank debt default rate than other types of leveraged bank loans. The NCEO’s survey of banks indicated that during the volatile 2009-2013 period, only 1.5% of ESOP bank financing resulted in a loss for the lender. The study compared these results to an S&P IQ Credit Pro report indicating that the default rates on a broad grouping of middle market commercial and industrial loans was 3.75% for the period 2010-2013.
While the two surveys do not necessarily provide a perfect apples-to-apples comparison, they do support the premise that ESOP companies are better at servicing their debt obligations. This should be no surprise for several reasons. First, as compared to alternative stock buyout transactions, the buyout valuation for an ESOP can be more moderate than other alternatives such as a private equity leveraged buyout. The more moderate value therefore requires less debt and it is therefore easier for the company’s cash flows to service the debt. Second, the unique tax benefits associated with ESOP transactions can enable the company to reduce and in some instances eliminate corporate income taxes, providing a significant enhancement in the cash available to service debt. Third, ESOP transactions typically involve a continuity of management and corporate governance that allows for a smooth transition of ownership without the disruptions of new owners who want to make immediate changes in company operations. Often times the shareholder (often a founder or key manager) who is selling to an ESOP is not necessarily making an abrupt departure from the day-to-day operations. Finally, the employee ownership and human resource aspects of an ESOP can eventually lead to greater sales and profitability from motivated employees who understand that they have a direct impact on the value of their ESOP retirement benefit.
The NCEO study strongly suggests that a properly structured buyout transaction can provide a company with a better opportunity to pay its debt obligations and likelihood of long term success.