Harpoon, Breakside, Deschutes, Modern Times, Left Hand, Alaskan Brewing – other than consistently cranking out delicious products, what do these craft breweries have in common? They’ve implemented employee stock ownership plans or an ESOP. It’s highly likely that you’ve heard lots of buzz about employee stock ownership plans as an alternative to selling a company to one of the beer titans or a private equity firm, but what exactly does an ESOP transaction entail? We’re going to break down what this complex deal looks like, including the potential benefits and risks, and why it’s critical to have a strong team in place to successfully guide you through the process and to the finish line.
What is an ESOP?
When a brewery reaches a certain maturity point, an ESOP can be an attractive substitute to an outside sale. If majority owners are weighing the possibility of an exit strategy, typical options include selling to a competitor or private equity. However, within the unique realm of craft brewery culture, this can often seem taboo and even potentially harm the brand and perceived reputation of the business. Remaining independent proves to be a high priority, which is why employee stock ownership plans have gained traction as a new form of ownership structure amongst breweries. An ESOP is essentially a highly customizable leveraged buyout that enables brewery owners to partially or fully sell their shares and also enables the brewery employees to own part or all of the company that they work for – yet the stock they own doesn’t cost them a penny. In simple terms, this is how an ESOP works: untaxed earnings of and loans to a company are used to purchase shares of the company from the owner(s) on behalf of the brewery employees. However, the employees don’t have the funds to make the purchase, so the brewery typically borrows all or part of the funds from a lender like Live Oak Bank. Then, the brewery lends those same funds to an ESOP trust which then purchases the shares from the owner and distributes those shares to the employees over a pre-determined vesting period.
Who are the key players involved?
If you’ve made the decision to do an employee stock ownership plan, the single most important thing to do is assemble a group of experienced professionals who can lead you down the right path. Typically, that begins with a financial advisory firm, who will architect a solid blueprint for the deal, and then implement that plan from start to finish. Michael Harden, senior managing director at Ambrose Advisors, lends his expertise and insight into the ESOP buyout structuring and transaction process. “Once we’ve facilitated due diligence and laid out plans for how the ESOP is structured, we then play the role of ‘general contractor’ and pull in the ‘subs’ at the appropriate point in time. First comes bringing on company legal counsel to assist us in implementing the Transaction. Next, comes the trustee team who will act as the buyer who will conduct due diligence on the business, negotiate the price and terms of the transaction with the sellers’ representatives and oversee the legal entity that holds shares on behalf of employees. Then we help the brewery secure financing to fund the transaction. It’s crucial for the lender to have institutional, in-depth knowledge of how these breweries work. Working with Live Oak is always a collaborative effort,” says Harden.
Scott Lawrence, founder and owner of Breakside Brewery in Portland, OR, recently made the decision to do an ESOP. Ambrose Advisors and Live Oak Bank were involved in his transaction. “Mike and his team at Ambrose did a phenomenal job at orchestrating the entire deal, which was no doubt a complicated process. He brought in the right people at the right times, including Randall and the Live Oak team. I heavily leaned on Mike and trusted in his guidance and knowledge. It’s been an awesome experience and we’re continuing to enjoy all of the benefits of an ESOP at Breakside.”
Who’s a good candidate?
Another imperative point when considering employee stock ownership plans is that it is not a “one size fits all” approach to taking some chips off the table. By no means are we convincing you to run out and decide to do an ESOP – many businesses are not good candidates for this type of transaction, be it financially or culturally.
“We weighed all of our options, including selling to a large beer company or private equity. An outside owner would’ve focused solely on profitability, and we’re more than just about that at Breakside,” says Lawrence.
To be able to support the added leverage required to execute an ESOP, the brewery needs to have strong cash flow and a strong balance sheet. The breweries who have been most successful in implementing an ESOP are those that did it for reasons other than financial gain. The primary goal should be to create a legacy for its employees and to bolster an ownership-minded culture.
Your brewery must possess certain attributes to be set up for a successful ESOP. During an ESOP roundtable discussion at the 2019 Craft Brewer’s Conference, one of the participants made the astute comparison of “not getting married because engagement rings are on sale.” Like a marriage proposal, an ESOP decision should not be made lightly. If implemented incorrectly or prematurely, or if it doesn’t align with company culture, it could be catastrophic. Harden states, “When qualifying a brewery for an ESOP, consider four critical factors. First is full-time employee count – we like to see a minimum of 15 employees but closer to 20 is ideal. Next, they must have a positive cash flow. Then, the business must have the capacity for debt, since they will likely be leveraging the acquisition with third party debt from a lender like Live Oak or the selling shareholders or a combination of both. And finally, uncover what’s ultimately driving this transaction – this is the ‘why’ that really speaks to whether this decision is a good cultural fit.”
Pros and Cons of an ESOP
There are considerable benefits to going the route of an ESOP but also significant risks. Above all else, you stand to gain enhanced internal culture, as well as deeper employee engagement and retention rate. There are studies that were completed by the National Center of Employee Ownership connecting ESOPs to improved financial performance (sales and employee count growth post-transaction), and empirically we also know that many businesses experience a tremendous upswing in operating efficiencies and net operating results once they gave ownership to their employees. The term “run it like you own it” holds true when your employees are actually co-owners. Harden adds, “Most people do not wash a rental car before returning it. However, people do tend to take care of their own vehicles. You’re empowering your most valuable people by giving them equity in the companies they work for without having them pay a thing.”
There are also substantial tax and financial benefits. Under IRS Tax Code 1042, the owner can defer all of his or her taxable gains from the sale. Further, the corporation will have ongoing tax benefits post-transactions and if 100% of the company is ESOP owned, you pay no federal income tax and no state income tax (in most states.) It goes without saying that the financial implications of that could be a game-changer. With an ESOP, you also retain the distinction of independence, a status that we all know is highly regarded in the world of craft breweries.
Where there are so many advantages, it only makes sense that there are also potential drawbacks involved in an ESOP. Harden says, “In order to do these transactions, you must take on debt. It’s essential to be mindful of any impending or future debt needs of the business. It’s well-known that brewing is a capital-intensive industry.” Another possible peril is not structuring the deal properly on the front end. The ESOP trust should negotiate a reasonable period of time required to buy back shares of employees who leave the company, as the liquidity may not always be readily available, especially if multiple employees exit simultaneously. This underscores the importance of having an experienced team of professionals, including a financial advisor and lender, by your side throughout the ESOP process.
An employee stock ownership plan is not the appropriate ownership transition strategy for all breweries. However, when executed at a suitable moment in time for the right business and with the best support team in place – an ESOP can exceed all expectations, as evidenced by Breakside’s experience.
“You know, I didn’t start Breakside to then one day sell it all for a profit. I do this every single day because I love the lifestyle of owning a brewery, and I love my employees. We are a family. It has been great for me as an owner, but also great for our culture. An ESOP was an ideal solution to meet everyone’s needs,” concludes Lawrence.
Randall Behrens is a Vice President for Live Oak Bank’s Wine and Craft Beverage Lending Division. In 2014, he joined the bank to help found this new group, which has been ranked as the Top SBA Lender to wineries & vineyards, craft breweries and distilleries nationwide since 2015. Randall works from the bank’s office in Santa Rosa, California, but travels across the country to meet with craft beverage producers seeking expansion and advise them of their best loan options for their growing business. Randall has been a top-performing SBA Loan Officer since 2001.
Michael Harden is a senior managing director at AmbroseAdvisors. He leads Ambrose’s Investment Banking division. He has more than 24 years of experience in accounting, mergers & acquisitions, financings, ESOP buyouts and valuations. He is a specialist in ESOP buyouts and therefore has experience in a wide array of industries, including craft breweries, energy, technology, government contracting, manufacturing, distribution, business services and construction.