KeyBank ESOP expertise on "Journey to an ESOP" podcast

August 2022

Phil (00:06):

Welcome back, this is ESOP Guy. We are on a journey to an ESOP. So if you're just tuning in for today and this is your very first podcast, welcome to the podcast. We're happy to have you here. This is a resource that we've provided for folks that are thinking that they might want to use an employee stock ownership plan as part of their transition of their business. It could be a succession planning tool, it could be their exit, there's a lot of ways to use ESOP. So the podcast is really dedicated and we call it The Journey to an ESOP because it's dedicated to the very first steps that you go through all the way up to what I would call is the ESOP close. There's a lot of things to talk about when it comes to ESOPs. There's a lot of things post ESOP that you can talk about. So we just focus really primarily on that part of it.

Phil (00:52):

If you have an interest in this podcast, you can go to our website at, you'll find all the episodes. We're actually in season three. We're also doing this as YouTube as well, so you can go and Google on YouTube ESOP Guy, and you'll find all the episodes for the videos that we've we've done. So we get to do a lot of different things with media, so excited about today's topic as we get into it. This is going to be called underwriting the ESOP loan, and the main question that we're looking to answer in this as what happens at the ESOP closing? What's my liquidity event, or in other words, how am I going to get my money out of this company? And so this is one of those topics that I would say is probably ranks up there as one of the most important topics.

Phil (01:42):

It's probably second to, "Hey, what's the company worth on a purchase price?" And so we want to do it justice and we want to give definitely the time that it needs. And partly too, what's fun about the podcast is you get to talk to a lot of different folks about ESOPs. And so being able to bring in experts at the different topic is really one of the main drivers of value in this podcast. So today's expert is Douglas Dell, or Doug Dell with KeyBank, he's out of Colorado. He heads up the ESOP advisory for the entire bank. Doug, welcome to the podcast.

Doug Dell (02:21):

Thanks Phil, it's great to catch up with you.

Phil (02:23):

Great. Doug, do you go my Doug or Douglas, I'm not sure?

Doug Dell (02:27):

Doug. Always Doug.

Phil (02:28):

Always Doug, okay. Great. So one of the things that we do on the podcast, Doug, just to get rolling is we use a lot of movie topics as analogies or metaphors or just really just to have fun with it. So one of my first questions for you just really just to get started is of these three movies, what would be your favorite, this will tell us a lot about who you are? Gladiator, Braveheart, or the entire Jason Born series. So which of those would be what you would call your favorite?

Doug Dell (03:00):

All good ones. But I have to say Braveheart is probably in my top five of all times, so that's a standup for me. It's just character, is great action. I guess right now, unfortunately it's almost timely with freedom fighters and everything that's going on in the world.

Phil (03:19):

Yeah. That's probably my favorite too. And the thing I like about Braveheart is historical based, it's not all probably true, of course not, but it's historically based but all those are great action movies. So with the Braveheart thing, as you go into you a little bit and tell us a little bit about yourself, tell us a little bit more about on the ESOP side. How did you get started in ESOPs and then obviously gravitate or migrate then to KeyBank being your current place that you're doing ESOP financing for?

Doug Dell (03:52):

Yeah, sure. I started my career in banking, so I worked for 13 years in banking out of college, but then decided to be a CFO. I joined one of my clients and it turns out that client was a ESOP company. It was a minority owned ESOP, smaller percentage. But from that experience, I got my taste of employee ownership and I learned how to work with trustees. I did the valuation projections that the trustees valuation service did. I was even the ESOP communication guy within the company, trying to build up the benefits and motivate people so that was my first taste.

Doug Dell (04:31):

That company was actually sold, which was a great event for the employees. But I then went to work for the investment banking firm that was doing that company's annual valuation. So it was especially ESOP firm, and I got accredited in evaluation was doing that work and in helping to do feasibility studies. So that was where I really got engaged in the ESOP community, went to all the conferences and just learned what a close knit community it is and how helpful people are in it. And really what ESOPs do for employees so I've been a proponent of ESOPs ever since.

Doug Dell (05:09):

I did get recruited back into banking, that was 17 years ago. KeyBank called and banking was always in my blood, so I did that, but I kept my ties to the ESOP community. And I kept lending to ESOP companies now that I had a balance sheet to lend with. And then over time, over the 17 years, became known as the ESOP guy within KeyBank. And so got a lot of calls from our bankers across the country. And last year, it just got to be where the calls were coming in hot and heavy. And then I went to our executives and said, "I think we have a line of business here." And they said, "Yeah, go do it." So now I'm working full time helping employees or are helping companies convert to employee ownership.

Phil (05:50):

Sounds like you love it.

Doug Dell (05:52):

I do. I'm having a lot of fun.

Phil (05:53):

That's awesome. So that's something we have in common. So I started as a banker and then got into the, I'm a CPA firm. Now I'm a partner at a firm, but now I do all evaluation feasibility work like you were doing, but very interesting background. I think that helps you a lot when you're looking at transactions, because you're experienced out what this thing should look like so when people come to you and they say, "Hey, this is the deal I've got," it's got to give you a lot of good insight into evaluating the deal and seeing how the bank might want to go forward on it.

Doug Dell (06:26):

Yeah. Really I've been on three sides of the table, so to speak. From the company side, the valuation side and the banking side so [inaudible 00:06:34].

Phil (06:35):

I think that like a lot of people that are experiencing ESOPs, they have a lot of the same stories. They've done different things and they pull all that together and add a lot of value to their clients. So KeyBank, as we talk about KeyBank a little bit so people get a little bit more familiar with your bank. So really two parts to the question, what markets does KeyBank serve and then within those markets, how do you really help the local banker that works for KeyBank that may not be an expert like you are in ESOPs?

Doug Dell (07:06):

Yeah. Yeah, I think you may even have a chart to put up, but KeyBank, we're a super regional bank. We're the 13th largest bank in the country right now.

Phil (07:19):

Yeah. Here's our map.

Doug Dell (07:20):

There it is, good. So we're headquartered in Cleveland, Ohio. And as you can see, we're big in the Midwest, the Ohio, Indiana, Michigan. We actually acquired a bank, probably actually 30, 40 years ago. We were Society Bank, we acquired KeyBank, which was based in Albany, New York. So that had a great presence that you can see in new England, down through New York City. Then several years ago, we purchased a bank called First Niagara, which gave us that Pennsylvania area. So we filled that in, but that KeyBank acquisition years ago also included the Pacific Northwest. So we up in Oregon and Washington and the biggest bank in Alaska I understand. And also where I'm located in the Rockies with Colorado, Utah and in Idaho. So when I look at that, I look at it as the frost belt, especially with Alaska up there.

Phil (08:16):

You ever get to go to Alaska?

Doug Dell (08:18):

I am waiting for that call from the Alaska market president to say they have an ESOP up there and I will go in a second, but [inaudible 00:08:25].

Phil (08:25):

I love. I love it. Maybe you can go hunt whatever moose or something like that, but that's pretty cool. So when you guys have, looks like pretty much when you have a red colored state here and a company's there that's a pretty good fit for you as far as doing an ESOP deal, is that [inaudible 00:08:45].

Doug Dell (08:45):

Yeah. Yeah, that's we are. We're middle market lenders and we still feel it's important for us to be connected to our clients and be in the communities where they are and where we are. So most of our ESOP lending is done in those red states where we have a presence. If it's a much larger company, if it's what we call a corporate size company with EBIDA call it of north of 20 million. We do have corporate bankers that I work with who aren't tied to the geography, but instead they're more specialists in industry. So if there's a big enough size ESOP company, we can do it across the country.

Phil (09:21):

Excellent. Yeah, I think, go ahead.

Doug Dell (09:22):

I was going to say the second part of your question was how do I work with our local bankers, which is it's a great question. So I'm a product specialist, so I don't actually keep the loans in my portfolio. They stay in the portfolio of the areas where the company is located, which is great. We always want to have that local touch with our clients. The local bankers are the day to day contact. So I'm here to provide them with the expertise and with their clients with the expertise. But we'll get deals two ways.

Doug Dell (09:54):

One is deals will come to us from advisors like yourself who have clients that are looking for financing. So if that happens, I will contact the local market and we'll work the deal together. But if it's one of our own clients and a relationship manager comes to me and says, "Hey, we have our client in Cleveland that wants to go ESOP." I'll come in and help them through the decision and help them through the closing.

Phil (10:18):

Awesome. Yeah. So I'm going to pull off the screen now, but I think that's real helpful for people to see where you're and then just the idea behind how you work directly on your team. So you're one person, the ESOP guy for KeyBank. Are there issues in that if there's a lot of things happening?

Doug Dell (10:40):

Yeah. Well, hopefully we'll be growing because it's been successful, but I do have a commercial analyst that reports to my team. He's based in New York so we have a couple of areas of company a country covered there. Ultimately, I hope to have some business development folks regionally, but we're just six months into this right now so we're up and running.

Phil (11:01):

Yeah. So that's fairly new. And I don't know, as far as what you're seeing, are you seeing a lot of trends towards more and more deals because you've been full time for the last six months. I will tell from my perspective, I've seen a lot. I've seen just a lot of people coming in. Some of it I got a question about an ESOP, and I'm not sure if I'm going to do it right now. Other ones are like, "Hey, I've been researching ESOPs. I'm ready to go." So I'd say 2022, for me that's been very active, probably one a week at least. So what are you guys seeing?

Doug Dell (11:38):

Yeah. Well, I started full time at this in June of last year and we're extremely busy. I think there was a lot of concern last year that tax policies would be changing and people were accelerating their decisions to get out. And I also think business owners were tired, they just gotten through COVID so forth. So really busy last year, got a lot of closings done. It hasn't let up, especially the inquiries. I think the ESOP structure, now that it's what, some 40 years old, it's really come into its own and it's been professionalized and it's now more of a viable option that people know of.

Phil (12:15):

Yeah. I think that's part of it. People are starting to get the word out and I think they're doing that all over the country. So I know if you're not in the market, then it's about 20 million in need, but what's a range of the deal that you would do where you guys have lenders in the market?

Doug Dell (12:32):

Yeah. I'm really in a middle market practice, what we call our commercial banking. So for us, the low end is about a $5 million deal. And then we will go up to 100 million or more. KeyBank has the capability to lead a syndicated transaction, and then we did several of those last year where we'll bring in two, three, four banks depending on the size of the deal. Having a number of banks allows that customer to have plenty of what we call dry powder. So when it comes to refinancing their seller debt down the road or acquisitions, having a good bank group for those large transactions is really important and so [inaudible 00:13:14].

Phil (13:14):

For sure. When you say five million, you mean enterprise value?

Doug Dell (13:18):

Oh, no. That's the loan amount that we're looking at.

Phil (13:22):

Okay. That's just the loan amount. Okay, got it.

Doug Dell (13:24):

So loan amount. But we're happy with any client that wants to go and be employee owned. We believe in the concept and what it does for the employees and the community, so we're not so much tied to minimums as is it the right fit for this particular company. But ESOPs are, they're complicated and they can be expensive to install so you have to have some size to make them work. We kind of look at a $3 million EBITDA size as being a nice quality or a nice company to qualify for an ESOP.

Phil (13:59):

Yeah. $3 million, again, that's the EBIDA, right?

Doug Dell (14:04):

That's an EBIDA size, yeah.

Phil (14:05):

Yeah, got it. Okay. Yeah. How do your bankers going into that whole local banker type of thing, are they pretty much approached by the client or are they actually bringing this up as an idea? How do you guys work that out?

Doug Dell (14:23):

Yeah. What I've been doing is providing education to our 26 markets. We have 26 states, our markets that we're in. So I'm meeting with our bankers just to give them some high level education on what employee ownership is and how the structure works. So as that takes hold, we're seeing more and more of our clients from our own portfolios have an interest.

Doug Dell (14:50):

We also have a, what we call a wealth advisory service or a business advisory service that will work in partnership with to talk about succession planning in general. So maybe ESOPs is not the right venue for a particular company, maybe it's a third party sale or some sort of recap, but what we want to do is just recommend the product that's right for the situation.

Phil (15:14):

That makes sense. On the wealth advisory, do you do the 1042 transaction?

Doug Dell (15:21):

We don't actually make a market in the replacement bonds, the ESOP bonds. We'll partner with, I'll go ahead and say that UBS is a great partner for us there. They'll provide the bonds, we will provide the loan strategy behind those bonds to monetize that 1042 so we do that, and it makes it seamless for our commercial banking clients. We'll finance the transaction, then we'll also finance that 1042 piece for the individual sellers.

Phil (15:50):

Well, that's great. I didn't know you did that. UBS was actually on our podcast a while ago, but it was an interesting thing. We went deep diving into the 1042, which is obviously not we're going to do today, but it's really helpful to know where that fits sometimes with what banks do and what they don't do. So that's interesting that you guys do the financing part of the 1042.

Doug Dell (16:14):

Yeah. One thing I love about ESOP and being a banker is we're able to use the whole bank. We use our balance sheet to do the commercial financing. We use our private bank to do the 1042 financing, but we're also advising on wealth management. So we have highly qualified investment bankers, investment management bankers who will help the sellers with the proceeds of the sale and manage their newfound wealth.

Phil (16:38):


Doug Dell (16:39):

Yeah. And even the employees. We again, like to do business in the cities where we have branch locations, because we can take care of the ESOP company's employees and with an ESOP culture, that's important. So we can provide financial education, we can provide financial wellness tools, budgeting tools, and ultimately those employees, they're going to have a rollover retirement fund that will be rolled over to an IRA so it's just great business for the bank in general.

Phil (17:07):

Some of them are going to be millionaires, and we know that because it happened. So having a [inaudible 00:17:11] yeah, a mature ESOP company go through that. Some of these companies sell and then everybody gets the liquidity event and moves into the retirement account. I think that's a great structure to be able to help in all those different ways.

Phil (17:24):

And so just going through the ESOP process, and you talked a little bit about in your own experience, what we do is we start with evaluation modeling and feasibility, and then we move a client through. If those things check out, we then we move them forward to get to the next step. And it's only if it really works those two pieces. What I do normally is I want to talk to the bank earlier in the process, and the reason I do that is because I'm really focused in an ESOP transaction, not solely on just the transaction, of course, that needs to be done really well.

Phil (18:00):

But I'm focused on the overall sustainability of the company, and part of that is the banking relationship needs to be a good relationship. And in some cases, the client's not going to stay with the incumbent because the bank is simply not going to be able to do ESOP financing. So one of the things I like to do, I do it early. What, what do you think for yourself, you being doing this for so long? Is the best part or the preferential stage that you guys would come in to really evaluate the transaction and also the financing piece of it?

Doug Dell (18:34):

Yeah. Well, if we can come in first and introduce the idea to the client, that's obviously the best thing for us because then what we'll do is bring in a group of advisors, including folks like yourselves who would do the feasibility study and the tax planning and so forth. But we'll bring in advisors that we know work well together and that we know will execute the transaction well, make sure that we're within Department of Labor Standard and so forth. So if we can introduce the idea to our clients, that's great and we hope that the relationship is strong enough, they'll use our services, our commercial banking.

Doug Dell (19:09):

But more often than not with all the advisors across the country, it's just like you said, they've walked their clients through the decision process. They've decided to go ESOP, they've done a feasibility study. Hopefully, that advisor knows KeyBank well enough to call us and say, "Hey, we're putting together this cap structure, what do you think?" And we're able to even insert some of our thinking into the advisor's work.

Doug Dell (19:38):

But if it's somebody that we don't know, a client we don't know, they'll bring that feasibility study to us, maybe a what we call a CIM, a confidential information memo to get to understand the deal. And we'll do our due diligence and produce a term sheet based on that. And there's a lot of negotiation that goes back and forth on that term sheet. But when it works and they like us ,we'll move forward.

Phil (20:02):

Yeah, for sure. Or you may not want to do the deal too. It might not fit into what you're okay with, so I don't know if that happens a lot, but certainly it sounds like were you guys, and this is something as an old banker, I was talking to a lot of my friends when I first started doing a lot of ESOP deals was like, you guys are needing to be the advisors and tell people about the ESOP, because if you don't, somebody else is going to do it and then you're going to be stuck bidding on your own client.

Phil (20:31):

And it's interesting. I have a friend of mine, who's a banker, he called me this last week and he has same the same and I went to his whole bank and I made a presentation so they would understand ESOPs, they're now in the same position. They're competing for their own client to keep the client and they could have been more in the advisory seat, but they're really not. So I think that's great that you're doing that. And partly, I think partly is just because your bankers will have better careers being more in the advisory role as opposed to differentiating yourself in that way.

Doug Dell (21:06):


Phil (21:07):

So when you're thinking about now looking at the deal and you're going through the underwriting part of it, and what we mean by that is just you're getting your bank up to speed on the credit, making sure that it's going to work, what kind of structure you're going to put together. What's your normal process of doing underwriting? What sort of things are you really focused in on when you're underwriting specifically an ESOP deal?

Doug Dell (21:32):

Yeah. Well, first all the underwriting it's not dissimilar to any kind of commercial banking. It's really what we're focusing on is what's the sustainable cash flow of this company? More important than anything, and especially in ESOPs is how strong is the management team. If you've got an owner who's selling, is he going to be staying with the company? Is there going to be a transition period? Do we have succession management? I've always said it's management who pays us back, it's not assets are collateral. So that's the most important thing is does this management team, are they experienced with debt?

Doug Dell (22:11):

Now we're going to be a leveraged company, maybe we haven't had debt before. That's a different management problem to be able to handle that. So we want to really focus on management, but other than that, it's kind of the standard commercial Banking. Do we have their concentrations of clients that we need to understand? What's the business model, what's their competitive advantage? What's the competition like? Those things that we're going to ask in every type of a commercial deal.

Doug Dell (22:44):

One thing that's important with ESOP, so is we don't want to over leverage the company. They're going to be taking on debt call it non-productive debt, it's not going to be producing revenue for them. So we want to make sure that this company still has enough dry powder, that we have lines of credits for working capital for them to operate and continue their growth. Do they need to do capital expenditures, capital acquisitions, are they acquisitive? So we want to understand their projections. We want to understand what their strategies are going forward and just make sure we've got enough capital to do everything they want to do without them just being focused on repaying ESOP debt.

Phil (23:22):

Yeah, for sure. So going into the structure, because 100% ESOP deal, which basically just means I sold 100% of my stock immediately, that was the transaction versus a partial ESOP sale, which is like I could sell some portion or percentage of my company less than 100%. Obviously if I sell a smaller amount, it's a little easier, I'm not really overleveraging in a sense. When you talk about Overleveraging, what are some ways when you're looking at that because 100% deal is pretty common and we all know that?

Doug Dell (24:00):

Because the tax advantages are so good people tend to do that.

Phil (24:02):

Yeah. So we're going to be facing the difficulty of now we're plowing a bunch of debt on the company in form of senior debt, which is what you do and seller notes. So how do you get just in general, comfortable with that much debt going on the balance sheet immediately after the transaction?

Doug Dell (24:27):

Yeah. Yeah. Great question. One of the things that a bank that's ESOP savvy will do is just understand that seller debt portion of it. That's really the down payment. If you were thinking of an M&A buyout, that's the down payment, that's the equity. So that seller debt has to be structured so that it looks as much like equity as it can. So there's four, five different attributes that we'll make sure are in place.

Doug Dell (24:56):

One, it's unsecured debt. There's what we call no rights or remedies so that the seller debt holder can't call a default in front of the bank or put the company in the bankruptcy. We will allow interest payment on the debt and we can talk more about that structure, but there's no schedule to principle payments on the debt. Otherwise, it would look too much like debt and not equity. And the maturity of that seller debt is actually beyond the maturity of the senior debt too. So those are how you structure that seller debt so that our regulators even say, "Okay, we understand that that's not over leveraged, that's the equity in the company. So that's really important for a bank to understand.

Doug Dell (25:46):

But then, this is back to basic commercial lending, how much senior debt will you put on. Kind of a magic line for banks with some regulatory reasons is three times your EBIDA, it's a real number. So you can probably expect to be below at or below three times for the senior debt, and that really depends on, like we were saying before, what kind of cash flow needs does this company have going forward? If we're too close to three, they may not have the ability to go out and borrow for their capital expenditures or other things. If you're a contractor and you don't have that visibility that may be a stable manufacturer does to the future of three, four, five years down the road, you're going to have a lesser amount of senior debt and pay it back quicker than you will maybe if you're that stable manufacturer.

Doug Dell (26:41):

But what you hope is, even in the case of a contractor with maybe less term debt, you pay that down quickly, that allows us to come in and refinance that seller debt more quickly and really deliver the transaction and get the seller his cash.

Phil (26:55):

Yep. Yeah. And you're typically going to come in at, I'm going to ask you a question I already know the answer. But typically, an amortization on that first tranche of debt at what?

Doug Dell (27:10):

It all depends. But what we see most is a five year commitment with either a five or a seven year amortization. So if you have a seven year amortization, you'll have a balloon payment done to five and we'll refinance it at that point if we haven't already. So that five year term, seven year amortization is really common. You'll find some cases where there's some collateral that maybe others don't have,.if there's some real estate as collateral, that may allow us to go out 15, 20 years. So there's different circumstances. But if the company is a service company and you're lending on receivables, you're going to have a shorter amortization than if there's equipment or monetary value.

Phil (27:54):

A long term asset.

Doug Dell (27:56):


Phil (27:56):

Yeah. Some kind of long term asset to attach to. And you haven't mentioned this, but I was going to throw into the mix. Again, we're talking about as a bank, I'm still a bank. I don't have the equity upside of the transaction so I'm maxing out on my interest rate and my fees. So I need to appropriately structure the risk side. So with a five year to seven year schedule, then the other, I guess, mechanisms you guys would use is some kind of debt recapture. And so talk about that a little bit in terms of formulaically, is that pretty standard? This is always 50% of cash flow every year or how does that get decided?

Doug Dell (28:42):

Yeah. Some of it depends on amortization that we're able to put together. Myself, if we have a five or seven year amortization, I think that's plenty. But if for some reason we've gone out to attend year amortization, we might see that, then we might say, "Yeah, let's have an excess cash flow recapture," which essentially says, "Hey, there's some percentage of your cash flow over and above your debt service requirement in your capital expenditures that's free and we want capture some of that to repay the debt sooner." So it's common. Personally, I always think, hey, if a company's doing really well and there's excess cash flow, I'd rather not be paid back. I'd rather collect my interest.

Phil (29:22):

Well, it's true.

Doug Dell (29:25):

If a company's not doing well, they're not going to have excess cash flow anyway. So I tried to set that amortization that's comfortable for both the company and the bank and be happy with that.

Phil (29:36):

That's a good way to do it. I think there's a sense of control that banks might feel like they have when they have the debt recapture where they're able to go ahead and pay it down. It's kind of this weird push and pull because they want to get paid back, but then they also want to re-lend money to the client as long as everything's good. So it's this weird balance between the two things.

Doug Dell (30:01):

In actuality, if you're 100% ESOP, you're an S corporation, you don't have to make distributions anymore for taxes. So you have this free cash flow that is available to repay your debt. So if you don't have other uses for it, we often will see the client just pay down that debt as quickly as they can again, so they can refinance their seller debt and be done with the transaction.

Phil (30:23):

Yeah. I'm modeling one right now, and typically, because it's hard to know exactly after the five years we do the seller note model and this company, we're going to accumulate a lot of cash because of the purchase price, we're only doing a 20% senior debt note and there's just a lot of cash left over. And so you can say, "Well, either we use that money to pay down the debt quicker," which to me that's, that makes a lot of sense just so you have a lot of options at some point getting through that so you can get to the seller note. And the goal here is for the company is we want to get the company as soon as we can to a debt free situation, because this is a lot of ways like you had said, it's not created debt for revenue. It's created to change out the ownership.

Phil (31:17):

And so we as finance people, it's like, we just want to get through that phase, then we can really accumulate, well, we are accumulating value for the shareholders, the participants as we go because as soon as we pay down debt, we are doing that. But ultimately that we want the value to be there for the participants and getting through that. So complicated wise and this probably doesn't affect you guys as much, but when you evaluate a transaction that has warrants attached to the seller note, do you have any other concerns at that point because that's really past your payment anyways?

Doug Dell (31:53):

Yeah. And that's a good question. We see warrants now more often than not attached to seller debts and I actually like them because the alternative is a higher interest rate on the seller debt, and so that puts more pressure on the company to be able to debt manage that cash flow. So if you're putting warrants onto the end of the transaction, typically you're seeing a very low interest rate on the seller debt, which is good for the company. And if those warrants are gaining value, that means the company's growing and gaining value so everybody's winning. The employees are winning, the company is winning, the selling owner is now participating in the growth of the company too. So I think they're great. Certainly, I think the Department of Labor, they have their issues with them, but for the health of the company, I think that's the way to go.

Phil (32:45):

I had done this presentation to a bunch of bonding people a couple weeks ago and I asked a question in the middle of the presentation. I'm like, "How many of you guys like warrants?" And of course, nobody raised their hand and I was kind of like, "I get it," right? Because all they see is this big obligation coming down the road. And I just said just similar like, "Look guys, I get that that's an obligation and it could be worth X amount, but we know if it's going to be worth X amount, then the company's doing well."

Doug Dell (33:18):

That's right.

Phil (33:18):

"And secondly, the company has more cash flow in the beginning." So they're rebuilding their balance sheet a lot faster with a lower interest payment to the seller on that seller financing. Bonding companies in my opinion are not yet to that point where they really get ESOPs, but they're being asked about them all the time that's why I got asked to talk to these guys. So I thought that was interesting.

Doug Dell (33:43):

And bonding companies still struggle with just the balance sheet treatment of ESOPs and the effect on net worth.

Phil (33:49):

Yeah. They still struggle with that and subordinate debt and like, okay, I guess I get it, but it's still negative because we have senior debt on there and unearned ESOP shares.

Doug Dell (34:01):

Back to warrants, selfishly as a banker, there's another transaction for me, I've been paid off from the original transaction, now five, six years later, let's refinance those warrants. It's in the best interest of the company to take care of them sooner rather than later because they're going to keep growing.

Phil (34:18):

Yeah. That's a great, I didn't think about that. Again, you're in that position of you want to do more business with the company but the parameters are there. So yeah, you get through all that debt and if it's worth more, then you already have the EBITDA probably lend to so that's pretty interesting.

Phil (34:36):

So getting into your normal landscape, when you talk about banks, in general, banking is a very competitive industry. We all know that. What are you seeing in terms of ESOP deals, do you feel like it's really super competitive and then if it is, what are banks competing on when it get down to the, is it interest rate, fee structure? What are you seeing when you win a super competitive deal, what are you guys got to do?

Doug Dell (35:07):

Yeah. It's an interesting landscape. ESOPs are still specialty niche lending, so there's not a lot of banks yet, but it's a growing number of banks so we all know each other and we all understand what each bank's strengths are and so forth. But it's a strong group of banks and competition is to a place where interest rates and origination fees have all fallen into a normal range, so you're right. We don't see a lot of competition on price, everybody's there. It's what you mentioned at the outset, how much cash can we get up front in the sale? That's a big piece of the negotiation is what is that leverage level that allows the seller to be satisfied, but yet doesn't over-level the company. That's the biggest piece. There's also, you brought it up again, the cash flow recapture. Is that a piece or is that not?

Phil (36:08):

Sure. Yeah. How much flexibility is there and is there a lot of commitment to the second tranche in terms of, "Hey, we'll do it or we feel good about it." Is there any kind of commitment or formulate commitment, a guidance commitment to like a tranche?

Doug Dell (36:28):

That's always a topic that comes up because that seller wants some certainty that when can we refinance. Just because we're mindful of how the regulators look at this, we really want that ESOP seller debt to look like equity when we go to regulators. So there's a balance there. We will say, "Hey, here's the leverage level that we're comfortable at. So if you start at two and a half times and you pay down to one and a half times, let's take it back up to two and a half times." So we give them some roadmap of how you do this refinancing. But it's always hard to predict because hopefully that EBITDA is growing and it's growing quick and that increases the leverage that we can put on the company. And so, we always want to do this quicker than later.

Phil (37:17):

Yeah. Well, that's a good segue into the next question about we started off in January and everybody knows stock market has had a lot of volatility, all kinds of weird news. You've got the, of course the war and all that's happening over in Ukraine. And then you've got just the uncertainty related to interest rates with, I guess it's more certain they're going to keep raising rates, but what's your take on the economy going forward? Are you not as concerned about the volatility or are you thinking it's getting a little bit more like recession time?

Doug Dell (37:59):

Yeah. I anticipate you might ask that so I did call up our economist and [inaudible 00:38:04].

Phil (38:04):

Okay, good.

Doug Dell (38:05):

Where are we? One thing I found interesting about this economy is from our ESOP clients, most have come back stronger from the COVID break in 2020 than they were before. I think there was a lot of pent up demand and our companies have really benefited from that. So our companies are in a strong place right now. And yeah, we are seeing interest rate increases. We expect that the Fed's going to raise by 50 basis points, at a half percent in May. We expect another 50 basis points in June and maybe 25 after that. So you've got one and a quarter percent already baked in to what everybody's expecting.

Doug Dell (38:45):

But what I've noticed is that our clients over this inflationary period have been able to raise prices, they've got pricing power. And I think they have more confidence that as rates continue to rise, they'll be able to follow with price increases and maintain their profitability. So I think it's important for the fed to do this to get inflation under control, but I think they're not going to break the economy if they do it in measured amounts.

Phil (39:11):

Yeah. Yeah. Yeah, if it's responsible and you can't let inflation go at the pace it's going because we're going to have some major issues in this country. I think it's the responsible thing to do.

Doug Dell (39:24):

Yeah. Yeah. Our folks don't see a recession in 2022, but I noticed Chase just made an announcement yesterday where they're adding substantial amount to their reserves because of now uncertainties with the war and inflation. So you're starting to hear the recession rumbles.

Phil (39:43):

Yes, you are. So my plan in this ESOP thing podcast is definitely to do a little more work on recession proofing your business I think that's going to be an important topic just because we are hearing rumbling. If it's not in 2022, I think we need to know it's coming eventually. There's no way that we can't have cycle and corrections, and that's just part of the way that the economic cycles work.

Phil (40:05):

So we're getting at that place where I wanted to get to the end of this a little bit. Of course, we'd love to talk all day. I guess to sum everything up from your perspective, thinking about a company that's listening to this podcast, what would be advice you would want to give them just from the perspective and the expertise that you have as far as the ESOP process and going through what would be a good thing for them? So just anything in general that you think would be helpful for them.

Doug Dell (40:38):

Yeah. I think I have more of a global view. As you said, I've sat on different sides of the table. So for me, it's the owner who's considering selling to an ESOP, what's most important thing for him or her. I don't think it should be that the tax breaks. I think what's important about a successful ESOP is that the company culture and the management and the employees have all bought into just what a benefit it is to be employee owned. You're leaving a legacy for yourself, that's important to many baby boomers who've already been successful. They don't want to see their companies maybe be sold to private equity and then maybe dismantled or moved. They care about the communities.

Doug Dell (41:34):

They care about the fact that when employees and management are alliance through employee ownership, you're going to be a more profitable company. You're going to grow and you're providing a benefit now to the employees for the retirement plan, but you're also going to see more growth in your warrants that we've talked about. And ultimately, even though you may not get as much cash upfront with the NEOP as a third party sale, with the tax benefits with those warrants, you're probably going to come out better.

Phil (42:01):

I think so.

Doug Dell (42:02):

And you've given all of this benefit then to your employees and to your community. So to me, that's what it's all about. It's, it's, "Let's make this structure successful."

Phil (42:12):

Yeah. I would basically summarize what you said which was really good is the best thing about an ESOP for me is if it's done right, is that it's a win, win, win. You win as the selling shareholder, the employees win, the community wins, I think your customers win. Everybody wins. And ultimately, you can be proud of that because I think a lot of times it's not just about the money, it's about something holistic. So ESOPs are very, very unique in that, they do help everybody. And so that's why I do it. That's why I'm the ESOP Guy, I love doing it.

Doug Dell (42:50):

Yeah. We think alike.

Phil (42:52):

Yeah, so wonderful. So Doug, thank you for your time today. It was really great having you on the podcast and look forward to future discussions as we go on, and I think your advice was very helpful for people.

Doug Dell (43:05):

Oh, my pleasure. Thanks so much for having me.

Phil (43:07):

You're welcome. So thank you guys for listening and we will see you on our next step on this Journey to an ESOP.

Thinking about entering an Employee Stock Ownership Plan (ESOP)? KeyBank's Doug Dell is featured on the "ESOP Guy: Journey to an ESOP" podcast in an episode titled "Underwriting the ESOP loan with Doug Dell from KeyBank." Doug offers insight into this extremely important step in the ESOP process to help answer the question: "How am I going to get my money out of this ESOP deal?"

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