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Apparel firms searching for liquidity might want to consider transferring a portion of company ownership to an employee stock-ownership plan.
This story first appeared in the April 14, 2008 issue of WWD. Subscribe Today.
Companies such as R&M Richards, Briefly Stated and Nicole Miller have all done ESOPs.
“The ideal candidate for an ESOP is a company where its owners want to take some money off the table, but not lose control of the company to an entity that doesn’t know the business,” said Andrew Jassin, managing director at Jassin-O’Rourke Group LLC.
An ESOP is a vehicle owners should consider if they are looking to partially cash out of a company, he said. Owners who do the transaction can use the money for any purpose and, under existing law, receive some favorable tax advantages, as well.
Certain apparel firms are ideal candidates for the ESOP vehicle. “These are companies that have great businesses, but the trademarks aren’t of the type that would attract a top buyer willing to pay a premium,” Jassin said. “Many are private label businesses where they have great customer distribution, but can’t be sold for the multiple that the owners expect.”
ESOPs were first enacted by Congress in 1972. An estimated 20 million American workers own stock in their companies through some plan, either an ESOP, 401(k) or via a grant or option, according to the National Center for Employee Ownership. The largest study on ESOPs in public companies was done in 1999 by Hamid Mehran, then of Northwestern University. He found that ESOPs in 382 publicly traded companies increased the return on assets 2.7 percent over what would otherwise have been expected.
The group said that companies utilizing the vehicle perform better post-ESOP than pre-ESOP. Annual sales growth averages a 2.4 percent gain, with the annual increase in sales per employee up 2.3 percent. Although the growth figures might seem small, the national center said an ESOP firm with the same differentials projected out over 10 years would likely be a “third larger than its paired non-ESOP match.”
Typically, a plan is set up through funding from a bank. The bank lends money to the company, which then lends the money to the ESOP. The ESOP, set up as a trust, takes the money and buys stock from the selling shareholders. The stock is then distributed to the employees at no charge, provided certain plan guidelines are followed.
While there are variations to how those shares are allocated, as well as vesting rights, the real benefit to the employee shareholders is when they leave the company, such as a retirement or subsequent whole company sale. Over time, the value of the ESOP to the employee is in the growth of the stock shares.
The company has an obligation to purchase back the stock when an employee leaves. The theory behind the ESOP is that the employee hasn’t paid anything for the stock, but can realize a substantial value later on when those shares are bought back by the company.
Doing an ESOP doesn’t prevent the company from being sold. According to industry sources, sleepwear firms Briefly Stated and American Marketing Enterprises Inc. each put in ESOPs at their firms. Subsequent to those transactions, a subsidiary of Li & Fung acquired the firms in separate deals. In each case, the employees were immediately vested and at the sale of the company walked away with a substantial nest egg, which could be placed into their individual retirement accounts, the sources said.
Larry Kaplan, founder and managing director of Corporate Solutions Group, a financial advisory firm, said that during the last few years his company has seen a steady increase in the number of ESOP transactions. ESOPs account for 40 percent of the firm’s business. It is working on as many as 10 that are expected to be completed this year.
Kaplan worked on the R&M and Nicole Miller ESOPs. He said most transactions involve 30 to 49 percent of the stock of the company, and that the minimum is 30 percent in order for the deal to be cost-effective. The average sale size is $40 million, and the average annual volume of the apparel firms doing the transactions is $10 million to $500 million.
One major reason for doing an ESOP is the tax break a company gets from the federal government. “It’s a way for companies to defer and potentially eliminate capital gains on transactions,” Kaplan said.
Companies can get tax deductions to offset against future income. Moreover, the loan is paid down first before any taxes are allocated to the government.
Given the current weak economic environment, companies straddling the fence on whether or not to do an ESOP might want to make a decision soon.
So far, banks such as J.P. Morgan Chase & Co. and Israel Discount Bank are still willing to lend money for ESOPs, but that window might not be open much longer.
Jay Silver, an accountant at Mahoney Cohen, which counts many apparel-related firms among its client base, cautioned that as banks tighten credit, loans for an ESOP could be tougher to get.
“Banks are willing to fund ESOPs as long as there is good cash flow,” Silver said.
The accountant explained that often firms eyeing ESOPs are maturing companies, and might face cash-flow demand issues when the economy slows.
Essentially, when a company does well, it can pay down the loan faster. But when there is a cash-flow struggle, a company could find itself with an overleveraged balance sheet.