#AICPA_Auto

AICPA Auto Dealership Conference

National Harbor, MDOctober 18, 2013

Liquidity & Succession Planning Using ESOPs

The State of the Market

#AICPA_Auto

Merri E. Ash is vice president of First Bankers Trust Services. Merri has more than 34 years experience in employee benefits services. Her past work experience includes work as a senior trust officer with SunTrust Bank, employee benefits consultant with Wyatt Company, benefits manager with Jonathon Corporation, an ESOP company and team leader and senior benefits consultant with the National Automobile Dealers Association.

Merri is a past chairperson for the administrative advisory committee of The ESOP Association, current board of governors member for the National ESOP Association and current Board of Trustees member for the Employee Ownership Foundation. Merri has been with FBTS since 2002.

Merri AshFirst Bankers Trust Services

Vice President

#AICPA_Auto

Kathryn has been appraising businesses and business interests since 1988. She is a nationally recognized speaker on employee stock ownership business valuations for The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO). Kathryn provides financial advisory services and fairness opinions in transactions.

Kathryn is a member of TEA where she currently serves on the Board of Directors, Board of Trustees, and Board of Governors as Chair of the Advisory Committees’ Chairs’ Council (highest professional appointment). In addition, she is past Chair and member of the Valuation Advisory Committee; a member of the Interdisciplinary Committee on Fiduciary Issues; and Vice President of the Northwest Chapter. She is an Accredited Senior Appraiser in Business Valuation of the American Society of Appraisers (ASA) and a member of NCEO.

Kathryn is a frequent speaker, lecturer, and instructor on matters involving general valuation, ESOP valuation methodologies, and financial advisory practices. She has presented on valuation issues to the American Institute of Certified Public Accountants (AICPA) Task Force on Pre-IPO Valuation, to the U.S. Securities and Exchange Commission (SEC), and to the U.S. Department of Labor (DOL).

She earned her Bachelor of Science degree in Business Administration, Finance, with a minor in Economics, cum laude, from George Washington University.

Kathryn DalyChartwell Capital Solutions

Managing Director

#AICPA_Auto

Steve Greenapple is a shareholder of Steiker, Fischer, Edwards & Greenapple, P.C. He has represented ESOP plan sponsors, shareholders selling to an ESOP, and ESOP trustees in transactions establishing and amending ESOPs, increasing ESOPs’ share ownership, using ESOPs to acquire other businesses, and terminating and buying out ESOPs.

He is also experienced in designing and implementing other forms of equity compensation plans such as stock appreciation rights, phantom stock plans and stock option plans. Steve is frequently brought into transactions as special ESOP counsel by clients’ corporate counsel. He has also served as an expert in litigation related to ESOPs in State and Federal court.

Steve is a member of NCEO as well as The ESOP Association, where he currently serves as the New York State Chapter Vice President and the chairperson of the national Legislative and Regulatory Committee. Steve received his Bachelor of Science from Cornell University and his J.D. from Cornell Law School. He is admitted to practice in New Jersey, New York and Pennsylvania. He has received Martindale-Hubbell’s highest “AV” rating.

Steven B. Greenapple, Esq.Steiker, Fischer, Edwards & Greenapple, P.C.

Shareholder

#AICPA_Auto

Agenda

Leveraged ESOPs as a Tool for Shareholder Liquidity: What they are & What they are not

State of the Market for Financing Leveraged ESOPs

Special considerations for ESOPs in Auto Dealerships

#AICPA_Auto

Leveraged ESOPs as a Tool for Shareholder Liquidity:

What they are & What they are not

#AICPA_Auto7

Why Care About ESOPs?The Problem of Liquidity and

Succession All businesses must be sold or transferred – privately-held

companies have no ready market

Current economic conditions have slowed private M&A transactions but have not eliminated need/desire for liquidity and succession

Approach should be based on shareholder goals in the context of achievable alternatives

#AICPA_Auto8

Liquidity & Succession: Alternatives

A finite range of choices: External Buyers

• Strategic – competitors or new entrants• Financial – private equity• IPO

Internal Buyers• Family• Management• Partner (Redemptions & Buy-Sells)• ESOP

Liquidation

#AICPA_Auto

What is an ESOP? “Employee Stock Ownership Plan” Qualified retirement plan under IRC

• Regulated by US DOL and IRS• Company funded benefit - no employee contributions • Assets held in a Trust; employees do NOT own the stock directly• Intended to be invested primarily in company stock

Only qualified retirement plan that can:• Borrow money• Engage in transaction with related party

Tax efficient and controlled means of selling stock Since 1974 over 20,000 companies have adopted an ESOP Today, ESOPs include over 13.7 million employee-participants with

over $923 billion in assets (average of over $67,000 per participant)

#AICPA_Auto

Advantages of an ESOP Transaction

Maximize after-tax proceeds• Sell stock (capital gains) vs. sell assets (ordinary income and C

corp. double taxation)• Pay no tax on sale of company stock (C corp. / §1042 election)

Flexibility – Control transaction timing & design • % of stock sold – diversify wealth, resolve incompatible

shareholder goals, or sell 100%• timing of sale• subsequent transactions – single or multiple transactions• Seller financing – attractive IRR, equity based return

Process is confidential

#AICPA_Auto

Ongoing Advantages ofan ESOP Company

Tax Benefits for Company• Deduction of loan interest AND PRINCIPAL• Pay little or NO corporate income taxes (S corp.)

Control• Seller may continue as executive and Board member

Legacy• Preserve Company identity• Preserve employees’ jobs

Motivate and attract employees ESOP does not limit options for management incentive plans ESOP does not limit options for future M&A transactions

#AICPA_Auto

Common ESOP Misperceptions An ESOP is a Stock Option plan

• ESOP is a qualified retirement plan under ERISA. Employees are entitled to the company’s financial

information• Employees are entitled to their own account

statement. Company has to be a C corporation

• Since 1998, S corporations can also be ESOPs. ESOP must own ≥ 30% of the company

• ESOP can own any %, and can buy/sell shares in one or more transactions.

Employees own the stock of the company• Stock is owned by a Trust, for the benefit of

employees/participants. Employees are not shareholders and do not have shareholder rights.

True or False

True or False

True or False

True or False

True or False

#AICPA_Auto

ESOP Ownership: Beneficial vs. Direct

Shares purchased by the ESOP are owned in a trust, not by employees directly• Employees are “beneficial” owners of the trust• Beneficial owners/employees are not entitled to

company financial statements or the ESOP valuation The ESOP has a trustee who will represent the plan

interests The ESOP Trustee will vote the stock owned by the

ESOP, except in special cases (pass through voting)• Special cases are merger or consolidation, sale of

substantially all assets, liquidation, dissolution, recapitalization

#AICPA_Auto

C Corporation ESOP Tax Benefits – IRC §1042

IF: Company is a C corporation on the day of closing; ESOP owns at least 30% of Company after closing; Seller has a 3 year holding period; Stock satisfies the definition of “employer securities” (best

dividend rights and best voting rights); Seller invests proceeds of sale to ESOP in “Qualified

Replacement Property” (QRP) within 12 months;

THEN: Seller may elect not to recognize any gain on

the sale of stock to the ESOP.

#AICPA_Auto

C Corporation ESOP Tax Benefits – “QRP” Floating Rate Note

Specially designed as Qualified Replacement Property:• Highly rated issuer;• Long term;• Floating rate;• Put option.

All result in Floating Rate Note:• Stable value;• Highly marginable.→ Allows Seller to satisfy requirements of

§1042, AND obtain an actively managed investment portfolio.

#AICPA_Auto

S Corporation ESOP Tax Benefits

S corporation shareholders are responsible for paying for their pro rata share of the company’s tax liability

An ESOP is a non-tax paying shareholder and is EXEMPT from paying federal income taxes

Thus, a 100%* ESOP-owned S corp operates completely tax-free• Doesn’t have to be 100%; the percentage of ESOP

ownership is tax-exempt.

#AICPA_Auto

Characteristics of Best ESOP Candidates

Profitable and growing Not overleveraged Strong financial reporting Deep and broad management team Employees are an important part of the value of

business Owner(s) concerned about Legacy Owner(s) wants to retain “control” Owner(s) strongly dislikes paying taxes

#AICPA_Auto

Eich Motors History/Background

1910: Sold first “horseless carriage”

1960: Became the 5th VW dealership in the state of Minnesota

2009: Recognized as the 9th oldest dealership still in operations in the United States

2012: Established ESOP ownership

2013: Received Wolfsburg Crest Diamond Award, given to 20 Volkswagen dealers nationwide for excellence in customer service and performance

TimelineTimeline

Owned and operated by family for four generations

Continually ranks as a top VW dealership in the Midwest

Favorable market trends

#AICPA_Auto

Ownership Transition Options

Family

Management

Nothing

ESOP

Third Party

#AICPA_Auto

Shareholder Succession Considerations

Personal goals and needs Company dynamics and timing Impact on employees and community Condition of capital and M&A markets Tax environment

#AICPA_Auto

ESOP Team and Roles

Eich Motors Management Team ESOP / ERISA Counsel Independent Financial Advisor ESOP Trustee

#AICPA_Auto

ESOP Stock Appraisals

ESOP Trustee hires a third-party, independent appraiser as an advisor

Appraiser should be experienced in valuing stock for ESOP transaction purposes

ESOP stock must be reappraised annually

#AICPA_Auto

Feasibility of Employee Ownership

Business valuation• Discounted cash flow• Guideline public

company• Merger & acquisition

Unique industry considerations• Floor plan financing• Manufacturers’

incentives & rebates Growth projections Other feasibility

considerations

0%

50%

100%

150%

200%

250%

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

Five Year Index Performance

S&P 500 Index Public Peer Group

#AICPA_Auto

Lender

XYZ Corp.

ESOP Selling Shareholder

SUSPENSE ACCOUNT

P1 P2 P3 P4 P5

Stock

$10 Million

Promissory Note

$10 Million

$10 Million

ESOP Promissory Note

The Leveraged ESOP

#AICPA_Auto

XYZ Corp.$2 Million Earnings

Before Taxes

Lender

$2 Million Contribution

$2 MillionLoan Payment

ESOP

P1

SUSPENSE ACCOUNT

P2 P3 P4 P5

Participant Allocations

1. XYZ makes a tax-deductible contribution to the ESOP

2. ESOP uses the contribution to repay its loan from XYZ3. Participant allocations

4. XYZ repays Lender

Payment of Leveraged ESOP Financing

#AICPA_Auto

State of the Marketfor Financing

Leveraged ESOPs

#AICPA_Auto

Senior Bank Debt Overview

Leverage multiples have increased since the financial crisis (still below their peak), due to stronger bank balance sheets, coupled with economic stability which has increased the appetite for lenders/investor to deploy assets

Pricing has become more aggressive over the last 12 months

Cash flow lending is back across the capital markets

Structures continue to be more attractive for borrowers

Average Debt Multiples of Middle-Market LoansDefined as issuers with EBITDA of $50M or lessPrior to 2011, media and telecom deals were excluded.EBITDA adjusted for prospective cost savings or synergies

#AICPA_Auto

Forms of Junior Capital

Subordinated Debt

(Mezzanine)

Junior Subordinated

Notes

Convertible Preferred*

Junior Capital

#AICPA_Auto

Mezzanine Pricing

Subordinated debt pricing fell from the previous quarter and is less than the quarter year-over-year

Pricing is expected to remain aggressive, but the market has begun to stabilize

Ample liquidity is available looking for opportunity

Subordinated Pricing

#AICPA_Auto

Special Considerationsfor ESOPs

in Auto Dealerships

#AICPA_Auto

Special Considerations for ESOPs in Auto Dealerships

Dealing with Manufacturers / Franchisors• Consent to transfer / change of control• The ESOP as a shareholder under the franchise

agreement Control Groups

• What entities can / must be included?• Corporations and LLCs• Tax free reorganization

Impact of leveraged ESOP financing on floor planning financing

Corporate governance

#AICPA_Auto

Contact InformationMerri Ash

Vice PresidentFirst Bankers Trust Services,

Inc.Philadelphia, PA

610-521-1616merri.ash@fbtservices.com

Steven B. Greenapple, Esq.Shareholder

Steiker, Fischer, Edwards & Greenapple, P.C.

Cedar Knolls, NJ973-540-9292

sgreenapple@sfeglaw.com

Kathryn DalyManaging Director

Chartwell Capital SolutionsPortland, OR503-416-4422

kathryn.daly@chartwellcapitalsolutions.com