Capital Structure and Sustainability Analysis

ESOP companies have a distinguishing feature from most non-ESOP companies – the need to continually fund the payment of retirement benefits to terminated ESOP participants.  This repurchase obligation creates a claim on the company’s future cash flow, potentially competing with other corporate initiatives such as capital expenditures, working capital investments and acquisitions.

Planning for this claim on capital is a critical element of an ESOP company's long term success.  The Department of Labor recognized this in their Proposed Regulation on Adequate Consideration which states one attribute of the fair market value of a company’s common stock is an assessment of a company’s ability to fund the ESOP “put option."  With many ESOP companies maturing, a heightened focus has been placed on accurately studying and planning for the ESOP repurchase obligation funding and its affect upon a company’s future capital structure.  

Traditional Planning

Historically, strategic planning, repurchase obligation and valuation analysis were, at best, closely aligned.  The strategic plan is a key factor in the valuation analysis.  However, repurchase liability planning is often performed without directly integrating the strategic plan and resulting valuation model.  By failing to connect the strategic plan, repurchase obligation and valuation, Boards of Directors and ESOP Fiduciaries may not be basing decisions on the most accurate claims to a company’s future cash flow.  A possible outcome may be the company lacking adequate resources to fund these competing capital claims.

A New Approach

Recognizing this problem, Chartwell developed a process to integrate the strategic plan, repurchase obligation and annual valuation to provide a more accurate picture of a company’s cash flow requirements.  By more accurately understanding these multiple claims on capital, the analysis determines a company’s ability to fund its competing interests.  Effectively planning can be accomplished by reviewing multiple scenarios and testing the impact various business decisions have on the company's ability to meet its goals.