Frequently Asked Questions
What’s difference between an ESOP and an IPO?
There has recently been some confusion about whether to advise a company to pursue an ESOP or an IPO.
Briefly, an ESOP is for owner exit, while an IPO is for company growth (and an owner exit years down the road).
Below is a very brief description of the points to consider when talking about these two financial products.
An ESOP achieves two objectives:
- It gives the employees ownership in the company; and
- It immediately pays the owner out of his equity through a bank loan (repaid through company earnings).
Negatives are that the dollars raised are limited by what the bank will lend (typically conservative compared to the market value of the company), fairly rigid structure (little room for customizing), slow (2-5 months), IRS oversight, pledging of company assets as security, negative covenants.
Benefits are the relatively low cost to structure an ESOP, a tax-advantaged way to lever the company, allows the seller to feel good about the sale (taking care of employees). Many banks are trying to expand their ESOP business, so the money is available.
An IPO achieves five objectives:
- Employees can get ownership in the company by earning or being gifted shares:
- An IPO sources capital for growth;
- Creates wealth (eg equity valued at 12 times versus 4 times multiple;
- Provides an exit strategy for the owner; and
- Allows huge financial flexibility (additional stock sales, stock buyback, issuing more stock, acquisitions, estate planning, and going private).
Negatives are: cost ($50-100K for the cheapest SB-2 filing plus underwriters’ fees; can reach 7 figures for a full boat IPO), regulation (very regulated), sensitivity to market conditions, dealing with underwriters, length of time to complete (6-12 months); unless the company has a profitable use for the money raised (eg an acquisition or a plant expansion), the money is expensive.
(Quick point – IPO’s are especially useful for acquisitions since using my multiple examples above, an acquisition can be made using 33 cent dollars to pay for the acquisition making even overpriced acquisitions reasonable. Additionally, the act of making the acquisition boosts the stock price, a self-reinforcing move. Lastly, paying with 33 cent dollars gives a cushion for those inevitable acquisition “surprises”.)
Positives are apparent from the five objectives – IPO’s are an incredibly powerful tool.
IPO’s only work when the following criteria are met:
- Charismatic CEO;
- Clear growth strategy;
- Strong corporate structure;
- Clear and sensible use of the funds;
- Confidence in rapid growth; and
- A good “story” to tell.