Individual Guaranties by Former Shareholders in an ESOP Owned Company

[Guest abrandw]

I am working with a construction company that is considering becoming 100% owned by an ESOP. The principal owners of the company have routinely guaranteed or individually committed themselves on performance bonds for the company. If we go the ESOP route, and these principal owners are no longer shareholders, there is a lot less incentive for them to do this. I would think that similar issues exist with other types of companies, i.e., a shareholder who, prior to the establishment of the ESOP, personally guaranteed the company's debt. I suppose that we could adjust the compensation of these individuals to take into account the risk that they are taking on behalf of the company, but are there other approaches to the problem?

[BeckyMiller]

Establishing a leveraged ESOP in a contruction company generates a number of critical issues, not just this important issue that you have raised. The ongoing availability of other financing when a company implements a leveraged ESOP and buys out existing shareholders has to be addressed at the front end. Frequently you see a new lender come in that takes the entire book of business - the ESOP loan and the commercial loans. You are correct that they will look somewhere for guarantees and the folks offering those guarantees will expect to get something in return.

The issue that I am most familiar with is the financial reportiing problem. Most construction companies are subject to bonding and the bonding companies require GAAP financial statements and a significant positive net worth. The ESOP accounting rules tend to plunk a huge negative number into the equity section and totally mess up net worth....bonding capacity....staying in business.

The ESOP Association www.esopassociation.org has several construction company members. I suggest that your client look at that membership listing to see if they know any of these companies and chat with them about ways to make the ESOP work.