209 - Phil Hayes of Berman Hopkins CPA & Assoc Podcast

6:54PM Aug 7, 2023

Speakers:

Keywords:

esop

company

valuation

work

architectural firms

transaction

business

employees

owner

shares

call

transition

cash flow

culture

year

aesop

build

plan

closely held company

trustee

A lot of the ways architectural firms are structured. They're much more team oriented and I think that works really well for ESOP companies.

Hello, and welcome to the Business of Architecture. I am your host, Ryan Willard and today I have the great pleasure of speaking with Phillip Hayes, who is a succession planning partner of Berman Hopkins. Now Philip joined Berman Hopkins team in 2000 and became the succession planning partner in 2006. In 2010, he was named the managing partner, he transitioned his role as managing partner in 2020 to pursue his passion as the full time leader of the firm's employee stock ownership plan, otherwise known as ESOP practice and launched the ESOP guy podcast, which I highly recommend that you go and check out, which explains the process of the ESOP transaction from a business owners perspective. So Philip has over 30 years of experience in finance and business consulting. In addition to directing Berman Hopkins strategic efforts, he is a certified valuation analyst through the National Association of Certified valuators. And analysts, Philip provides consulting services for a variety of business industries. And in this episode, we talk about what an ESOP is why it might be the right pathway for you as a business why people architecture firm owners, particularly are moving into Aesop's, we talked about the valuation of an architecture practice, how does that happen? What are the processes involved? And what kind of experts and other consultants do you need to make sure that you're getting a fair and accurate valuation of your architecture practice? And we should talk a lot about whether or how to determine whether the ESOP pathway is the right fit for you and your business. We talk a lot about the benefits of the ESOP, what do employees actually get? We talk about the enterprise value, the equity value inside of a company. And we go into the importance of financial transparency when your business is operating as an ESOP. So I think this was a really fascinating conversation, and probably the most detailed conversation we've had him on the show about Aesop's and and Phil's expertise was absolutely second to none so thoroughly, thoroughly enjoyed speaking with him. So sit back, relax and enjoy Philip Hayes. This episode is sponsored by Smart practice, business of architectures, flagship program to help you structure your firm for freedom, fulfillment, and financial profit. If you want access for our free training on how to do this, please visit smart practice method.com. Or if you want to speak directly to one of our advisors about how he might be able to help you please follow the link in the information. Philip, Welcome to the Business of Architecture. How are you?

I'm doing great, Ryan, thank you for having me.

Excellent. Well, I'm very excited to have you on the show you are you're a CPA by training, right?

Actually, no, this is where I'm unusual. I am a partner of a CPA firm. And I was actually one of the first non CPA partners back in the 2000, early 2006 2005 timeframe. And so, so that was kind of a new thing for firms back then. And then, in 2010, I was actually the managing partner of a CPA firm. So, you know, that's another kind of back then it was a very new thing for a CPA firm to have a non CPA running the practice. So it's part of it. It's part of the reason I think it's important, it's it's part of the approach to the market, when we get to the topic of Aesop's, that I think has been very effective, because we are a CPA firm, but to do the work that we do, it does probably take more of the disciplines of banking and finance, business valuation, m&a, and more of a somewhat of a legal background as well. So these are not necessarily CPA type of skill sets. And so it's interesting like for us we have, we're able to do this kind of work. And then we get to kind of round that out with with other CPAs to just be in the delivery process be a lot more effective than just having

so how would you describe your current role?

Yeah, so my current role is, in terms of the ESOP world, I would be known as a sell side advisor. And so in an ESOP transaction, very similar to other types of what we call m&a transactions, merger and acquisition transactions. There's, there's typically a sell side advisor, most of the time in the marketplace, you're looking at that being performed by an investment banking firm. And that's very, very traditional approach. I'm going to sell my business. I mean, I've an investment banking firm helped me through the process. So that's the sell side advisory type of role. In an ESOP transaction, it looks very similar to a normal m&a transaction. So it won't surprise you that most of the sub deals that get done are done by investment banking firms. But in this is something we can talk about a little bit deeper. But really, they're the differences between a normal m&a transaction and an ESOP transaction, I think are, are really important because you don't necessarily need an investment banking firm. And the reason, the reasons are, is that an ESOP transaction is a regulated transaction. It's not, it's not like an investment banking firm that comes in and finds a buyer that nobody can find for you and I in a normal traditional m&a deal, in ESOP transaction, we're going to a buyer group, that's that our trustees that everybody kind of knows it's a finite group. They put themselves out there as a buyer, and so you're hiring them. So the buyers are kind of a known entity. And then the other part of it is in a different standpoint, is that the ESOP transaction is a regulated transaction by the Department of Labor, because an ESOP is a is a retirement plan. And unlike, you know, like an m&a transaction without they don't have any of that type of, of limitations. So there's no regulations technically, on that transaction on this type of transaction, the buyer can only pay what we call adequate consideration for the ESOP. So if they're buying it out from a privately held owner, they can only pay the fair market value price. So what does an investment banking firm really do they, they try to pitch a larger or higher price a higher multiple, in an ESOP transaction, that's not really even appropriate, because it's not like you should take the lowest price, it's just that the buyer can only pay fair market value. And the Department of Labor is watching that to make sure it's been done correctly. So that's where my role is very distinct from an investment banking firm.

Got it? So what So we're seeing a kind of rise in popularity of of Aesop's in the architecture industry, both in the US and in the UK. There. They're kind of a very, it seems like it's quite a modern thing. I don't know that I don't know much about the history of Aesop's whether it's kind of an acquisition process that has got a long, a long path, what are some of the benefits? Why, and why specifically, why does it suit an architecture practice? Yeah. Is it kind of tax benefits as well? And

Oh, for sure, yeah. And especially if we're, if we're focusing primarily on the US market, and the UK, I think it works a little different, although there are some overlapping benefit benefits in the UK. But for the US, there's a couple of major tax benefits that and this is going to be pretty much for any business. So whether you're an architectural firm or not, the the main benefit for the selling shareholder is that they can sell the shares of stock and defer the capital gains tax on the sale, that is going to happen only if the company isn't existing C Corp. Or if they convert the company from an S corp to a C Corp at the time of the closing. Now, that's a pretty big benefit, because the state of federal rate for capital gains tax here in the US is around 20%. So I can defer a 20% differential on the sales price that was going to go to be paying taxes on I can I can hold that money as a seller and use that for something else. Right. There's a there's a lot of I wouldn't say a lot. But there's complexity to that there's it's called a 1042 exchange where you have to set up a qualified replacement property. And so there are some things to creating a 1042. But but in effect, that's a pretty strong benefit for somebody to sell their company and not have to pay that that tax. And in addition to that the states have capital gains tax, too. So those would be in addition to the federal rate. So there it can be for some states that have very high tax rates, capital gains tax rates, that can that can add a significant amount to incentivize them to do to do that as a 1042. So keep in mind that Aesop's there this in the US, that's the only way you can do this. Like there's there's tax provisions that are only available to ESOP companies just right.

Yeah. Well, so I mean, perhaps it's worth stepping back a little bit here and kind of explaining Well, what are the main differences between your regular kind of acquisition of a company versus and an employee initiated acquisition? Like we're talking about? Sure. Hey, what are the main mechanisms that we need to be looking at? And it's a

great question. And so one of the things that's really significantly different, and this is one of the things I think are attracted to an architectural firm is that the transaction for an ESOP will allow the owner who sold their shares to still be a very fundamental part of that company going forward. And so they can serve and they may be ready to kind of start exiting the company, but they can serve on the board or we can create a, they can stay in the position they were at before, there's no, there's no real requirement for them to change what they were doing before that happened to after the transaction so that for some people, that's pretty a pretty attractive aspect because there's a lot of flexibility on on the way that they go about their transition. And so small, closely held companies, especially like architectural firms, there, they've just kind of as you've done it for 20 years, or 30 years, you're just kind of used to it, and it's just part of your lifestyle. So do you free to sell to a company and have to be walked out the door in a year or whatever. And it's a whole new company, that's hard for some people. So I think that's an attractive idea when it comes to why it would be a good beneficial thing. The other part is, is that the people that helped you build the company, your employees are going to get to participate in this, you know, now, a straight up transaction, you know, the owner sells, they get their money, the new buyer comes in, and they run the company and ever they move on and you kind of leave in the ESOP environment, you're gonna sell your shares. Now, the employees in this environment, are not buying your shares, you know, this is a benefit plan for them, the shares are going to go into what we call an employee stock ownership trust. So you sell the shares, the company buys those shares, and leverages the company with debt, those shares go into the ESOP trust, and then the they're going to be allocated to the employees over what we call a long term benefit plan, where over a period of time, and so that's going to vary a lot. But essentially, the employees, though, aren't paying anything for these shares, they're, they're just part of the company as employees, if they stay there, then they're going to have the benefit. We call them beneficial owners of the shares of stock and actually become, you know, connected stakeholders to the future of the company.

So it's not like the employees can actually put their own money into buying stock from the current owners, there's like a deferred compensation.

Right there, they're not putting anything like in a 401k, though, in the US, you do put your own money in that. And then in some cases, the company matches that. And so that's a nice, nice benefit for you, as an employee, in an ESOP, you don't put any of your money in at all companies actually allocating new shares every year. So there's a there's a stronger and if you look at the typical 401k match, it's usually something around three or 4%. For an ESOP, it's typically around like a 12% benefit. So it's a significantly higher benefit. And I think the main difference is, is that you're going to participate in a in when you think about stock appreciation, like if you think about a small closely held company, the the the ability to participate in the appreciation of that company's stock value, is a pretty big benefit. Because if I just buy in my 401k, a lot of you know, mutual funds in very diversified equities, I'm probably not going to have a a very strong growth rate in my retirement plan, most people aren't going to look for that they're gonna look for diversification. But when you think about where wealth is created, in the US, and I'm sure this is true in the UK, it's really, in these small, middle sized, closely held companies where the owner start the company and they and the value of that business has gone up so significantly over 2030 years. And this is the opportunity that the employees have is to participate in that kind of major appreciation of value, just simply by doing their jobs. Now, meanwhile, the company now most of the time, now, we're going to be able to put that company into a tax exempt environment. So the company is no longer gonna have to pay any income tax either. So that means for most of these companies, let's just say 30% of that cash that was going to pay taxes is now coming back into the equation that's going to help them repay the debt faster. And then once the debts all paid off, we're accumulating more value because the company is accruing cash. And so we talked about valuation. There's several terminology, definitions that are important enterprise value, and equity value. So enterprise value is the value that we talk about when a company sells as a multiple of cash flow, you just sold by, you know, 10 times EBIT or whatever the number is, that's what we call enterprise value, but equity value is that value plus the other aspects of the balance sheet which include my my accrued cash in excess of working capital, minus my debt. So in the future, what happens is my equity value in an ESOP company is going to be affected by paying down debt, dollar for dollar increase in equity value, and by the accumulation of cash, not just the cash. The EBITA targets are the multiple view to Those are going to be a factor. So what an ESOP company gets to what an ESOP employee gets to do is participate in, in the accumulation of equity value, which, if the company is paying debt down pretty fast, the value can go up really fast. And so it's a tremendous

benefit. So when does when does the to the employees then start to get a kind of dividend like this in a similar sort of way that they would do if they owned shares of another, like publicly listed company? For example? That's a

great question. No, they don't get a dividend. There, they're what they're going to get every year as a participant statement, showing the shares that they got in this plan. Every year, they're going to get new shares. And so it's going to accumulate. So if I had 100 shares, the first year, I might get 200, or 300, the next year, those shares typically get allocated to the employees based on their compensation. So what hopefully is fair about that is that if somebody is compensated more than maybe they have more value, in terms of contributing value to the business, right. And if they get paid last, there might be a relationship there is really just a good, easy way to do it. And that's really how most plans are designed. But what's it we're gonna get? We're not going to get a dividend, but they are going to accumulate value in this retirement plan. And then when they do leave, that is going to have to get paid out.

Right. Okay. So when they leave somebody or the business buys the shares back from the employee, or who, how does that transfer?

Yeah, exactly. So the business is going to start to accumulate what we call repurchase liability. And the repurchase liability is what the company is going to start to owe. So the first step of this, we they pay off the owner, like they bought out the company, or they bought out the shares of stock from the owner. So they got debt on the books, and the company pays that debt off, again, with the tax benefits, then, individual employees are starting to gain value in their shares, and then eventually, they're going to leave. And then in the plan, document, the ESOP plan document, there are provisions for them to get bought out. And so right at say, they're ready to leave, let's just say that they're retiring at 65, they've been in the plan for 20 years, whatever the value is, at that point in time, they're going to get that value. So if the per share value goes up every single year, it's not like an average, it's like the day they they leave that year, that value is what they're going to get paid out. So whatever chairs they have, that'll be the number now, most the time, they're going to get paid out over a five year period. So they're not going to get all their money immediately. But they are going to be able to get that paid out. Or maybe they leave the company before retirement, they're going to be able to take that money, get bought out and roll that into a retirement plan, like an IRA or something like that. So

let's say okay, so it gets transferred, it gets transferred. So they don't actually get to have the cash. But they're it's kind of their pension. So part of the the ESOP mechanism, then really is it's like a long term investment, wealth building device for the employee. What happens if what happens if, say, the company has to make a lot of layoffs all in one go?

That's a good question. Because it's, it's very similar to any other benefit there, they would have to calculate the vesting schedule. So like, who's vested in the plan, if they were going to have to lay them off, that is their asset, and the company would have to buy that out. And that's going to be a business decision from the board of directors as a part of the layoff is we got to unwind some of these retirement plans that we've that we've built up. Now, that really does infer that the company is probably not doing as well, right. So that could also be the value of the business could be coming down a little bit too. So if that's happening, then the value of what they're buying those shares out might be worth, you know, not as much as it was before. And so what's nice about an ESOP for an employee is they do get to participate in the upside if things are going up, and they haven't had to put their money in it. But the reality is, they're also participating just like owners, if the company goes down in value, the value of their retirement is going to go down. And so now they should still have a 401k, they should still have other retirement planning means. But if the company is well run, and they're able to do that, then then most of the time, we're, as we do planning, we're gonna get into this a little bit deeper. But as we do ESOP planning, that is definitely something that's on our minds. Is this company, stable enough in its cash flow historically, to do the transaction? Well, I think it may not work,

you know, when it becomes interesting as well, when when the employees have this kind of responsibility and the sharing in the ups and downs of the value of the business that I can imagine that, you know, one of the advantages of the SOP is that it creates that culture where people are literally their vest, they're invested into the business themselves. This is ours. So they've got a responsibility to be like, Okay, well, the something's happening. thing here, like, what can I, you know, what's what's my role? You'll be contributing to ensure that we're not we're not we're not doing this. So everybody becomes interested in the business side of it. And for an architecture firm, that's, that's massive. That's really important. Yeah.

Yeah. It's like, it's like the like, let me put my ownership hat on for a second and really think about, if this is my company, what would I do like, and a lot of times, if people have never owned a company, they may not understand what I was gonna say, but it put but most business owners that I know, if things get rough, they're kind of like, alright, well, we're gonna, we're gonna do this, this and this, and they've got a game plan, they're normally not going to say, Oh, it's just too bad, I'm going down in value, they're normally going to meet, meet the challenge, like any business is going to have and figure it out. So possibly, like for an architectural firm, it just may mean that, hey, we know we've lost a couple of big clients, we all got to do more BD, we got to do more business development, we got to get more business, or we've got a lot of business coming in. We don't have enough staff to take care of it. We all need to go recruit some really good people build the talent. And so you're going to have people that will where more responsibility in the company. And this is why an ESOP company statistically, is going to outperform a non ESOP company. And, you know, the numbers are always being calculated there. But it's it's I think, ESOP companies outperform non ESOP companies by 65%, statistically. And so that comes through the NCO which is the National Center of employee ownership. But but it's, it's it just makes sense, though, intuitively, because you are affected, hopefully, you are affected, if you're if you're an employee of an ESOP company by Wow, this this really does matter now. It's not just a clock in clock out job, I have the opportunity to, to really build some wealth, and and in what you do want to do is take a good culture and make it better with an ESOP. You know, I have a company that has a good culture, everybody likes to work in there. How do we take an ESOP and make that better? And this is where it gets better? Because people now can be connected to that all of them, you know, because they all win.

So what what kind

of companies would you recommend are suitable for Aesop's and what kind of businesses are not? Yeah,

it's probably mostly not as much the industry. But I do think so architectural stuff, as we go through there. There's some reasons architectural firms are a good fit. It's to me more of some other factors. So the first is, is the employer is the owners mindset, the owner of the company right now is their mindset one where they want to plan their if we call it Exit Planning or succession planning, all this kind of happens conduct connected, are they thinking on a bigger picture on a bigger scale in in the factors that they might consider? Of course, the valuation is going to be important to them, but other parts and pieces are going to be important if they're a good candidate for an ESOP. And that is, do they care about how the employees are going to be treated in the future? Do they care about the future legacy of the business that they built? And is that going to be important enough for them to build into what what the deal might look like for them? So some some owners that I talked to, and it's nothing, there's nothing wrong with this, I'm just kind of pointing out that they're probably not a good fit for you. So the only thing on their mind is I want to maximize the valuation, and I'm waiting for the next big wave of private equity group deals to come through or the next big strategic buyer to come make me this big old offer. And if that's the only thing on their mind, I usually just tell people, you're probably not a good fit for an ESOP, because you're you, you want to have the connectivity have a very holistic picture in your brain, like, how do we do this and also help the employees? How do we connect with it's not either in the other side of it's not true, either. I'm not just thinking about the employees, there's a balance to it. So that's the first thing. The second thing I would say is, people do wonder about this, like the size of the company, will it matter when you go through an ESOP transaction. Now, I would say very, very small companies, I would say less than a half a million dollars of net income probably aren't a good fit for an ESOP. Anything above that probably could could work as an ESOP. There are people in our industry that would say, they don't even touch it if it's not $5 million of EBITA. But the problem with those goes people are they're more, they're more thinking of of having an investment banking firm do the transaction. And so the way that we have gone about it as a sell side advisor is a very cost advantage advantageous way, because we're not charging a success fee. And we're not charging a transaction fee or we're not charging a contingent fee based on the purchase price, which I think philosophically it doesn't really make sense to me because we are dealing with a regulated m&a transaction. So guys, size is going to be important. If you're too small in a number of employees. We may have to To shift you to a C Corp, as opposed to an S corp. I have one one transaction I'm working on right now that they're a great company, but they're just they're 10 people. And so instead of being an S corp will be a C Corp because an S corp has to follow the there's a 409 P ruling from from the IRS. So there's disqualified persons. So a company that has very few employees can be restricted that way. So I think it's it's the mindset of the owner, and it's kind of the size of the company. And then it's also a matter of predictable cash flow. So if I have a company that's losing money every year, or maybe they they lose money every three years, and it's just very volatile, probably not a good company to do an ESOP, because you're gonna have to structure this around cashflow. And if the cash flow is not there to do the buyout, there's really no tax benefits, because it could you could have losses, that's probably not going to be a good fit. But I think those are probably good for just in general, for business. Businesses that work or don't

you touched upon kind of a briefly a little bit earlier about the valuation process of a business and preparation for for an ESOP. He talks a little bit more about about that, and, and how, you know, what, and you know, people considering going on to this journey to becoming an ESOP. What sorts of things should they make sure that the business has got in place to to get a solid valuation? Awesome, fair for? For everybody?

I think that's a good, that's a good question. And you mentioned the journey to an ESOP. And I think we you probably are, put this in your comments, but I do my own podcast called the ESOP guide journey to an ESOP. And you know, wanted to put that in there, just because I think it's important for people to, if they do listen to this, or like, Hey, I've got more thoughts, I want to know, I want to learn more, go to that podcast, because there's a lot of information there. The valuation is something that the very beginning of the process like, we were going to want to nail down what we believe the company will sell for. And so if you back up a step, a lot of times when people are thinking about an ESOP, they're conceptualizing, like, how does this work kind of stuff that we're talking about, like, you know, if you conceptualize the way, it's gonna work for my employees, and it's gonna work for me as a shareholder and financing. The very next step after that is like, Okay, you, you think 90, you know, you're, you're at a high probability of saying this might work for you, you're gonna have to get into the valuation, because you're gonna have to nail down, you know, for the business owner, what's this going to actually reap you when you actually do sell it. Now, without getting into too much detail, the valuation that we work with is a model that anticipates the way that the trustee and their valuation firm on an independent level are going to come up with the number. So I mentioned this is a regulated m&a transaction, but it is an m&a transaction, there's, we are the sell side advisor, eventually, we'll be hiring and with the client, we'll be hiring a trustee and their valuation firm, to do very formal work, we're going to do some informal work, but it's more modeling. And what we're trying to model primarily in the valuation is, is how is the forecasted cash flow going to impact the value? Now, that's a really tough thing for people and, and as we get started, I've got a lot of projects I'm working on right now, helping someone build a five year forecast is really difficult. Nobody knows the future in five years, nobody does. And even in one year, it's tough, because

even in six months with many practices,

so but but but I, you know, oddly enough of most of the emphasis in valuation for Aesop's is going to be placed in the discounted cash flow, which is a income approach valuation method that is going to lean towards forecasted cash flow. And so the forecasts do need to be worked, where they're, they've got integrity to the models, they make sense from a business plan perspective, if the company has a history of, of say, you know, 5%, growth in the forecast is showing 50% growth is probably not going to work. Right. So there's, there's there needs to be a very reasonable forecast. And the other piece of information in the valuation model that needs to be built is that is the working capital targets. Because I've seen this where I've actually picked up some clients that actually working with other advisors, and then they hired me, and I look at their stuff and they don't do anything to estimate working capital. So one thing is true about any small closely held company, is the amount of cash they keep on the balance sheet can vary. Now, some smaller companies that that do business, this is architectural firms, too, they can keep a lot of cash on the balance sheet. Is that going to affect the valuation? Absolutely. Now how much it will affect will be based on the target working capital. And so if you don't estimate those, those very Don't estimate them appropriately, then you could really be either under estimating or overestimating your valuation. And you're coming out of the gate with bad information. So So we're, we're going to build a model that will help do that. And also, we're going to build a model that help update through the entire transaction, because you're looking at about six months from when we first start doing evaluation model to the closing. So how a lot can change in six months.

So how would the evaluation process differ from say it was a private acquisition? Yeah,

very good question. So a private acquisition, if you come in, and you're the buyer, very, very traditional approach to doing this is you have a meeting with the owner or the board, hey, we really like your company, we're the suitor, we're going to issue you at the very front end, after some some very small information that's gathered like financials and stuff like that, we're going to issue a letter of intent at the front end. And the letter of intent, the buyer is going to issue is going to have to be proven out through their negotiation. So they're going to start with some number at the front end, and then they're going to work their way through a transaction. Now the basis of that number is going to vary widely based on the strategic nature of the of the suitors interest. So if they're really looking at, it might not always be cashflow, they may want the technology, they may want the customer geography, they may want something in there that's, that's very strategic in nature, their evaluation may be very geared towards the market approach like and in an ESOP transaction, although that's in there a bit, most of its geared towards cash flow, and the the what we call the discount rate, or the capitalization rate of that cash flow, which is basically the risk rating of the business. So certain industries are going to have higher risk ratings than others. So a construction company might be higher than, say, a doctor group, you know, and so if you're, you're, you're gonna want to understand that, you know, good valuation theory, but also practical approaches to doing a model. That's going to make sense. And so our job is to predict that number and make it reliable is for somebody to plan the rest of the ESOP transaction around it.

Right. And so, as you're moving along this this process of becoming an ESOP, who were the other? What's the kind of team that you need to be creating? What kind of what kind of professionals need to be on board?

That's a great question. So the way the way that you know what my first approach to this is, I don't, I don't want to encumber the company with a lot of costs at the front end, right. And so I want to help them to what I would call prove out the ESOP concept. So they could say, you know, my, my tagline is the ESOP guy, right? And it is, and I've branded myself that way. But I'm not I always tell people, I'm not trying to create you to become an ESOP company, I want to help prove it out first. So the first part of it after we get done with our work, we're going to nail down before we hire anybody else, this is this is, first off, our plan is 100%, we've done all the cash flow modeling, we've done all the warrant modeling, we know this is going to work and the clients collaborating on it, their confidence level is very high. And so we're not going to buy we're not going to hire anybody. But the very first person we will hire, or institution is the trustee. So the trustee is going to represent the buy side the buyer. And so to do that, we're going to interview the trustee, make sure that they're going to fit, we're going to interview multiple trustees, so that the seller who's selling their shares, has done the fiduciary responsibility of making sure that they haven't just picked anybody. Now, the trustee is going to hire a valuation firm. So they're going to be an independent valuation firm, they're going to be part of the buy side team, and then they're likely going to hire an attorney. And so all of those people are going to be paid with those respective roles by the client. And then on our stature

was that two valuation teams then so the kind of current owners has their own valuation team and then the trustees have their own valuation team.

Technically, I'm their valuation team on the sell side, like that very first step of doing the valuation model is is the sell side advisor will be the valuation consultant to the client as part of what they do. Go and that's where we were talking about the skill sets of, you know, being like me, being a banker, CVA, certified valuation analyst, doing m&a work, having some legal background, all of that I think is an essential skill set for somebody to do sell side advisory. Right because they do need to be able to consult on the valuation going through the process. And so now on the trustee side, they need somebody that's because the department labor that is completely independent, is a firm has to be have nothing to do with the company had never worked for them. Have any at all, it's very important because that's there's a lot of any ESOP case you're going to look at ever illegally. The problem always comes back to the valuation.

And does that regulation exist? And in a private acquisition, or can you use one value? Well, but it would kind of be a bit crazy if you only had one value. All right,

yeah. And I think the rules of, of truly not trusting people are going to exist in that, like, I think the buyer is going to the seller is gonna be like, I don't want to I don't care about what your buyer thinks I'm going to get my own person. So I think that'll play out. And there's no, there's no technically regulations. You couldn't it's just you'd be kind of silly to accept something. Yeah.

Well, I mean, it's interesting, when I'm when I've seen kind of deferred compensation plans or ownership transfer, from an existing partnership team to a new partnership team, not as an ESOP. I've seen it many times where they've they've had the architecture practice has only ever had one valuation. And often the new partners, you know, they're not, they're just accepting whatever the valuation is that that the people who were selling it is this is kind of based on a lot of trust. Yeah, yeah. And that that can break down after a few years, when everyone kind of starts to get a sense of actually how the business is operating. And sometimes people who are now becoming business owners or becoming partners, or they were architects, they didn't have an interest in business. They were just, they didn't know how the business side of it works. They weren't, they didn't know what to

look for. Yeah.

And I think with that, too, I think it's a good point, a lot of the consulting I've done, that's not necessarily ESOP, but it's just like internal Buy, Sell consulting, with internal agreements, is, if you've been through this with a, maybe a minority partner suing a majority partner over these kinds of things. It does happen and what I try to do with, you know, if somebody has helped if I'm helping somebody structure something, I'm trying to educate the whole group on on valuation, because you do see a lot of confusion in the professional world, like with architectural firms about what should this be valued? What's, you know, for instance, like, what's my book value? How does my balance sheet translate to the actual real value? How do you keep it, if you're going through the appreciation of like somebody signing a shareholder agreement, and then 10 years from now, what's going to be that value now, and a lot of these agreements, they're, they're built around, hey, if we're gonna, if we're going to separate, or you're going to leave, we're going to go out and get some valuations at that time. But that's always kind of a recipe for, for a some type of lawsuit, because maybe you're not okay with that valuation. And maybe they're, you know, and so now you have this potential problem, or someone dies, and the spouse says, No way, this company is worth way more than your shame saying on this agreement, so they sue the partner. And it's like, that's a mess. So it's way better to nail this stuff down. And that's really one of the byproducts of doing valuation models. They may not even do an ESOP, but they could probably use our model to help to build that buy sell agreement to really strengthen the company's understanding of what it really what valuation really is. So that everybody is treated fairly, whether you're a minority owner, or

what happens if you're

on the kind of the sell side advisor position, you've come up with a valuation of the of the company, then there's this, then the the leaders of the trustee of or the trustees. They've got their independent valuer. And the two are kind of wildly different. Because I happen.

It's a great question. And that that gets asked like, almost every time I take on a new client, to be honest with you, and it sounds crazy, but no, it actually never happens. The work that we're doing is to create some scenarios. But what I mean, really, it comes back to the skill set, like I'm filtering the information that they're giving me. And once we get really close to finishing the valuation model very at the very beginning, I'm actually just going to play devil's advocate, like I'm going to act like I'm the trustee evaluation team. And I'm pinging them with questions about your customer concentration. How does you know management depth affect your risk? How does you know your geographic limitations, your boundaries, legal, you know, legislative risk, all these things that I know are going to come? I'm pinging all that. So I'm already filtering that. And then so it's that's why the modeling isn't just putting numbers into, say, a spreadsheet, it's a lot more of 30 years of experience bringing coming into that, you know, and, you know, so I think that's important. And that's, I think the say, this is like, what's really important, is you find an advisor, who knows how to do that. You know, one of the things I think it's interesting like I don't want to be demeaning at all, but a lot of times the investment banking firms they're just putting together a PowerPoint and there's like some multiple view but I'm like, Well, you know, it that might be the multiple that they to negotiate, but there's no roadmap of how they got there. So what I'm doing is I'm going to give somebody a roadmap, and I'm going to help them understand. And then I'm getting their assistance collaboratively to make sure that all of my assumptions are done correctly, as opposed to, I'm going to back in on something I think already exist, and then just kind of say, hey, that's what it is. And then trust me, let's move on. We don't, we don't do that it's too important of a thing as you've identified, it's too important of an issue to wait or worry about later.

So when we've got this transfer of ownership happening, into the ESOP, and let's say that the existing partnership team retires and disappears, and there hasn't been a transfer of skills, for example, there hasn't been a proper transfer of, of the ownership, the owner skills that are needed, like winning work, for example, or, or, or dealing with the actual mechanisms of running a business. And now you've got a group of architects, amazing designers, amazing architects, but they haven't got a clue on how to win work. Now, all of a sudden, the company starts to diminish in value. What do you recommend to make this kind of this transfer effective? And like what sorts of education is needed for the for the trustees? Do they've got a new responsibility now?

Yeah, good. Good question. And let me quickly back up in this process a little bit because what what we're you're getting at is there's I always call it like, there's two transitions happening, ownership and management. And what's cool about Aesop's is we can we have a lot of flexibility on timing. Now, in some cases, when I come into play, the ownership transition is or the management transition is 100%. Done, the owner tells me, Hey, I'm not even coming to the office anymore, I'm out golfing every day, I still own the shares. So of course, that's easy, because it's already being run, the company is already being run right now. So that's a piece of cake. Now we just have to do we have to focus on ownership transition. Now the other extreme exists as well, the owners like I am working 70 hours a week. And I want to do the ESOP, so I can get out of here. And I'm like, and so so part of that that beginning is like I'm going to kind of give them some advice on look, the ESOP transaction is not going to free you from the bondage of your job. It'll free you from the ownership, and all the things you might be feeling, but you know, that's not going to do it. So. So we're going to have to build in a management Transition Plan, you know, and that's something that if people are listening to this, I'm like, You can't start that soon enough, right. I mean, whether it's a very, you know, can happen in small degrees, it's better that it happens in small degrees. You know, it's better when you when you recruit talent, and you bring them up slowly, as opposed to bring somebody in from the outside culturally, trying to get them to fit. So. But there are cases where, like, I did 100% ESOP, for a company, that the guy was in his, like, early 70s. And he's like, I, I just want to do the ownership transition, I still want to manage the company, I want to be the president. And he's he's 76. Now we did 100% ESOP. And he's completely fine with it, like he works 12 hours a day. Now he has people behind him that can do his job, because we've worked on that over the last several years. But going into the ESOP transaction, we were still him, 100%, President and everything, and we did 100% transition. So that's kind of an extreme example, what I was trying to what I'm trying to say is like, there's a lot of flexibility, though, and the ESOP can be a great tool to be the catalyst for a management transition plan. So sometimes we're like, Alright, we're going to kick off this, and you're going to, you're going to still do the same thing, but we're going to get you from in five years, from being 100% to 80, to 60, down, all the way out, and we're going to, we've got to these people in place, they're going to take on more, you're gonna take on less. The reason that's very successful is because sometimes the owner can't let go until they actually don't have the income from this anymore. If they still have the income and the cash flow, they're gonna want the influence and all that. So once they lose that piece, then their inability, their mindset is like, Okay, I'm always I'm ready to release the control thing I had, like I had. So and honestly, I love management, transition planning, because it gives the people that have talent, an opportunity to do the thing that they really want, and if you don't give that to them, you could really jeopardize the whole company. So now in addition to the ESOP, we're going to use other tools to incent a management transition plan. Those are going to be things like SARS stock appreciation REITs programs that will be kind of built into an ESOP transaction that are that can be used separately. So they're not necessarily just an ESOP creation. They're they're, they're created as a legal contract, but the company to the employee, but we use them, you know, with with an ESOP transaction as synthetic equity for people that because because the big question that I think is stirring around, too, is, if I am working as the new owner, not the new owner, but the new president, and I'm putting in 12 hours a day, and I'm, and I might be getting more shares in ESOP than somebody else. But I should get something more than that, because I'm just like, you know, I'm working my brains out, I'm like, on the frontline. So we're going to build in an incentive plan to affect that strong transition for them, because a president to stay rewarded, and to be motivated to build the future value, which is going to help everybody and, and that's a key, that's a key ingredient, ingredient for any architectural firm, or any other company where you have to have the leadership in place, you know, so this becomes

interesting kind of talking back to the the question of valuation, and the obviously, the value of the value of the company is kind of issue can be shifting over the process of the ESOP transition. And if you're moving from say, like a single person owner, who's led the business for this part of 3040 years, for example, and everything's in their head, I would imagine, as soon as that there's this man, this management transition plan, that happens, actually, the value of the business suddenly rises, because now now the business is a business, as opposed to being one person.

Yeah, you kind of like that. The terminology we use here is like, this is a lifestyle company. And the lifestyle company analysis is like, the business is basically an take on the person's lifestyle, their, if their whatever they owe, a single owner does, it's like that company revolves around that. And it can be dysfunctional sometimes, or it can be very dysfunctional. In a, as we transition to a management team, with a, you know, a board of directors, and then these, these more professional people that are running the company, we move into more of the business, like a more normal business setting of management, business management, as opposed to a lifestyle company. So it can be more, it can be more valuable in the future that way. And it really is part of the valuation in the in the first part, so let's just say I have a company, same exact type of company. But they've advanced their management plan in the ESOP transaction they've gotten, maybe they're down three or four steps, or they're 100%, through the management transition plan, they should be worth more dollar for dollar, then the company that has a single owner that hasn't done any transition planning. In fact, they will be. And part of the part of the way we prove we use that is we'll we'll end up doing a management presentation to the trustee and evaluation for him as one of the steps along the journey to an ESOP. And that is called a sim or a confidential information memo that we put together as part of the site visit. And so in that we're going to dig into Who are these people? Like, what were the resumes? Why are they qualified? How long have you been here? What are their roles and responsibilities? How effective are they, you know, what are their KPIs? How do they manage, you know, how do we they come, they take the company more from a business process to, you know, just managing it by the by the hip or whatever. So those things are absolutely going to be enhancing the value of the business. But if we don't get there too later, then the value can go up later, as well. Got it.

Is it reversible? An ESOP? Yeah. Yeah. And after people have done that,

it happens, it does happen. And I think some of it happens, because they, you know, they've they've gotten into it, let's just say there's a, there's a scenario where they, I was going to pick on the investment banking firms, they overvalued the company, they went through this process, a bunch of money, the company has way too much debt, nobody did the right planning for feasibility to figure out if this was sustainable. And so now they're like, they're, it's not working, like it's effectively not working, because the company can't meet the demands of the of the cash flow that's required. So what they would have to do is the owner could just buy it back. Or it could get a no, if it goes down in value, of course, it can go through some transition, so then it could be unwound. But, you know, my my biggest thing on that is if you would want to plan accordingly to not ever have that happen, because you've wasted your money on the transaction, the time and you've steered the employees in a wrong direction from a culture standpoint, and so it's, it can be super disruptive and confusing. Another reality, though, for a lot of ESOP companies is that they get to a point through the ESOP that the they're succeeding so much that they get bought by a strategic buyer. Right? Okay, that's a positive thing, because now everybody that works there, they get their shares, they get the money, and they everybody's going to benefit if they do if we do that an ESOP company would have to sell above fair market value to an outside buyer, in order for the trustee to say, Yeah, we're, we're good with the sale.

Right. Right. Yeah. In terms of culture shifts that you typically see within an ESOP company from going from privately owned to Isa, what culture shifts? Do you typically see happening? What cultural shifts must happen? For it to be successful?

It's a great question. Let me let me bring this back to the context of architectural firms to because I think that would be kind of helpful. So for a for any company, you know, I think the first step in part of what I'm trying to assess is what is their culture. So for an architectural firm, a lot of times, you know, when we, when we define the culture, going into the transaction, we're looking for certain elements of say, say, a culture of teamwork, a culture of people, there's an atmosphere of, you know, people like their job, they like the environment, there's a friendliness to it, maybe maybe a work ethic, but there's a balance where it's not like they're, they're not in the slave driver situation where everybody's just killing themselves and I, so that those are kind of, I would say, cultures that I've seen with architectural firms and other companies that I think are super positive going into it. And, and that's probably one of the reasons that the owners are stop and say, you know, what, we don't want to lose what we have here. The last the firm I was telling you about earlier, the architectural firm, we just did their their ESOP, for, they had they had somebody come in and kind of help them build a culture over the last several years. And it just energized everybody, like they're just so excited, right. But meanwhile, they were left with this issue, they had the two oldest founding members, were at a place where they were ready to retire, they had six other partners. And because the companies, not just their culture was great, but their value started to go up significantly. They had they ran into an issue of affordability, how could the other shareholders look to buy them out? That was gonna that was starting to become an issue. So ESOP became a very good avenue for these guys to to understand the connecting points that they can keep the culture they built, keep the same people in place, bleeding the company, and at the same time now enhance the culture with Aesop's. So it's, now these are going to be things that they're going to start working on. But the things that I think are really important is to connect the dots and educating people on what this thing how this thing actually works, how it works for them, how what they get out of it, you know, and what they're going to have to do on their side to, to build their own value going forward. And so those things can really resonate in a culture that's already good. And they can kind of give kind of the a little bit more connectivity to the meaning behind it. All right. So good culture without an ESOP is like, Hey, we love working here. You know, we probably would love to work in somewhere else, too. They have a good culture, too, right? The difference now is that I've got a stake in the work I'm doing every single day. So whether that's Monday through Friday, or whatever I'm doing with this client, I can see that work sticking into my future in a way that's that's meaningful. So we did I did another architectural firm about a year ago, this was about a year ago from now. And there were they were under from a culture standpoint, they were in a program called Great Game of business. Have you ever heard of that? No, not that one specific. So great game of business is a business management, philosophy and program that that fosters open book management. So open book management is when you literally open the books to everybody in the company. And in their company. They, they'll have like weekly huddles, everybody knows their number. Everybody understands what you know, what has to get done. So like in their case, it was interesting because they already had a very edge financially literate, employee base because they are already educated on the financials. And so doing the ESOP has made that even better right because now not that, not just are they literate? Are they connected to the understanding of how that really translates to the value so so these are just kind of like what I would say culture is so is so important. But what I would say on the other side of things is though, if you guys have if the company has a bad culture, and nobody's gonna say they have a bad culture, by the way, but it's not going to be the answer. It's like to say the The indicators are there, that the turnover is high. The the people are putting on job vent and social media, how much they hate this place. You know, I mean, there might be signs that the culture is not great. I would say Aesop's are not going to fix that. Right? Yeah, it's not it's not gonna be like, Oh, great. I'll plug an ESOP in. And, you know, you got a business management problem. There, you got a communication problem, you got other things that that need to be figured out for so. So people that come in the door and say, hey, I want to think about an ESOP. I'm never going to tell them, it's going to be your answer to a culture, it's going to be an enhancement to that culture.

Amazing. I think that's a perfect place to conclude the conversation there. If people listening to this podcast, they're interested, they you know, they're in partnership, just conversations about becoming an ESOP. And they want to speak with you what's the best way for them to connect with you?

It's a great point. So I would say go to my website at journey to an esop.com. And then there's a there's a contact me file there, you can say, you can just ask me a question. And I'll and I'll, that goes right to my email. If you wanted to email me directly, Hayes at Berman hopkins.com. would work and right. So either way, be great to connect with people that are thinking about this. So I think to leave off with, I think it's perfect for architectural firms, for a lot of reasons. I think that architectural firms have the employee base, that can definitely understand the connectivity between ownership and what they do. Not that other companies can't I just think that that fits well, a lot of the ways architectural firms are structured, they're much more team oriented. And I think that works really well for ESOP companies. And then just like we've been talking about, I think cultures really work well. So that type of environment is a great, a great fit for an ESOP company. So, but I'm actually

gonna pull those details into the information in the podcast and Philip, that was incredible. So thank you very much for sharing your expertise and insights there into the journey to an ESOP.

Ryan, I appreciate it. Thank you for having me. And that's

a wrap. And don't forget, if you want to access your free training to learn how to structure your firm, or practice for freedom, fulfillment and profit, please visit smart practice method.com Or if you'd like to speak to one of our advisors directly follow the link in the information. The views expressed on this show by my guests do not represent those of the host and I make no representation, promise guarantee, pledge warranty, contract, bond or commitment, except to help you the unstoppable