100 | How to Maximize Value, Maintain Influence and Preserve Your Culture: ESOP Power Play with Gary Gray

Patrick: [00:00:00] Have you ever thought what it would look like to sell your business? Still keep control, protect your team, and walk away knowing the culture you built will live on. Welcome back to another episode of the Vital Wealth Strategies Podcast. I’m your host, Patrick Laden, and today we’re diving in one of the most powerful, yet least understood exit strategies available to entrepreneurs, the ESOP or employee stock ownership plan.
My guest today is Gary Gray. Partner at Tenor ESOP Partners. Gary isn’t just an advisor, he’s lived it. He built his own company, sold it through an esop, stayed on to lead it for years afterwards, and grew it to three times larger after the initial sale. Now he helps other owners do the same. Build real wealth, protect your people, and create legacies that last.
If you’ve ever wondered how to cash out without checking out, this episode is going to give you the roadmap. And as you listen, you’ll start to see how powerful the right [00:01:00] strategy can be, not just at an exit, but for everything you’re building towards. So when you’re ready to start mapping out your own tax plan, head over to vital strategies.com/tax.
There you’ll be connected with our team to help you design a tax strategy that lets you keep more of what you earn and build a business that truly works for you. Alright, let’s get into it. Here’s my conversation with Gary Gray from Tenor ESOP partner. I’m excited about this conversation today. We’ve got Gary Gray on the podcast from tenor ESOP partners, and we’re gonna be really talking about, uh, selling our business and how to maximize the value and doing that through an esop.
Gary, thank you so much for, for joining us here today.
Gray: Yeah, well, thanks for having me, Patrick.
Patrick: Yeah, I think it’s, it’s awfully interesting when we think about the challenges that owners face when they’re thinking about exiting. They’re worried about losing value, losing controls. The culture that they’ve built, you know, falling apart with this, this new buyer, traditional exit paths, traditionally, you know, thinking about like private equity or strategic buyers might [00:02:00] not align with the entrepreneur goals.
And then we also think about being overwhelmed by the complexity of succession planning and the fear of making the wrong move that could harm the people and their, their legacy. You know, I think of employees, it really is, uh, can be like family members. You know, you spend so much time with these people and you care a lot about ’em, and you don’t want anything to go.
Sideways there. And then ultimately we think about, you know, the entrepreneur, uh, believe their people and culture deserve to, to share the value that they’ve been a part of building, and they want to transition that, um, reflects that as a goal. So thank you very much for joining us here today. Can you give us a little bit of your background and how you got started in the ESOP world?
Gray: Yeah, no, I, I appreciate that and uh, I’m excited that we’re actually able to do this. We’ve been talking about this for some time. Yeah. You and I had an opportunity to. Talk with a mutual client together and mm-hmm. And that’s where the introduction came. So it’s, it’s good to, that we’re finally kind of circling back.
Yeah. Spending some time together. So, yeah, it’s kind of, uh, how I landed at tenor. [00:03:00] Uh, first of all, most folks that do what I do come from a finance background or a legal background. Mm-hmm. Uh, I come from a business background. I actually led a business, sold a business into an esop. Continued to lead that business for seven years after the sale, um, all the while executing on a succession plan.
In fact, the succession plan that we had in place was a really, it was a five year plan, executed on it, um, named the next CEO. Was able to work with ’em for a couple of years, make sure the business was ready for the CEO and the CEO was ready for the business before I finally exited and, and started with tenor ESOP partners and.
Now as a give back, I’m actually helping other business owners to, to basically do the same thing I did. So I come at it, you know, obviously with a completely different approach than mm-hmm most of the folks that do what I do. Um, very practical. I understand what’s going on in the owner’s mind. They’re thinking [00:04:00] about whether or not to, to sell this business, keep this business and help them, you know, guide them to make good decisions.
So I get to be, uh, you know, I get to be the quarterback and the coach at the same time, I guess.
Patrick: Yeah, I, I love that. And I also appreciate your humility. You know, uh, just a few highlights. You, you grew the business three x after you transitioned it to an esop. So the, the cool thing about that is. The team and the, the employees all got to participate in that growth as you, you stewarded that and then ultimately you were the number two ping and coding specialty contractor in the US when you were done.
And so that’s, um, uh, I, I think it’s important to highlight your business chops just from the perspective of somebody that’s been there, done that, lived it can walk alongside and owner and they know exactly what they’re going through. So I do appreciate, uh, all of that expertise and, uh, excellence that you’ve, uh, demonstrated in your career.
So. I think this is gonna be a lot of fun.
Gray: Yeah, absolutely.
Patrick: So let’s, let’s think about the, the owner that’s considering, [00:05:00] it’s interesting the number of businesses out there that, uh, are, are small businesses, but very healthy cash flow revenue. Um, and the, the number of the opportunities to transition don’t, you know, I think a lot of business owners are struggling with, what do I do with this next, you know, I like my business.
I’m not trying to. Sell it today for top dollar. I do wanna maximize my value, but I wanna do it sort of on on my terms. Can we, can we start with helping the entrepreneur just understand, uh, an esop, what they are, how they work, and when the right fit would be?
Gray: Yeah, absolutely. You know, so probably the best thing to do is, you know, what is an esop, you know.
Before 2017, uh, when I did my transaction, I had no idea. I didn’t even know how to spell the esop. Uh, you know, so, uh, what we needed to do first is figure out what it is, and, you know, first and foremost and what we should know about is it’s a qualified retirement plan that invests solely in [00:06:00] the sponsoring business.
So, uh, what that means to our entrepreneurs and business owners is that. We’re doing is we’re creating a, uh, what’s gonna ultimately become an employee windfall at retirement. Uh, but it’s a retirement plan that only invests in that company stock in your, in your company stock. And for the employee, it means, uh, that they have an opportunity for ownership and, and they have an opportunity to, to, uh, own a piece of the business that they help to build and, and help every day to create value.
They actually get a piece of that. And, uh, from the owner’s perspective, uh, you know, you’re able to, to capture fair market value for this asset that you’ve created. And, uh, you know, and everybody’s short 20 year, 30 year career, uh, to build this business. You know, obviously that’s, you know, first and foremost.
And you would think by, uh, doing such a, you know, great thing for your employees and, and what feels like almost a [00:07:00] charitable act to your employees that you might have to take a haircut. It’s absolutely not the case when it comes to esop, and that’s one of the things that was really kinda the eye-opener for me as a business owner is, um, all those same challenges that you, you rattled off at the beginning.
Value control, uh, closing risk, uh, you know, going through a process to sell to a third party with, with no guarantee of success. Uh, and, and the disruption that it caused in a business. And what do I do once the deal is closed and trying to integrate cultures, and then how do I take care of my, all of these things mm-hmm.
Are rolling through your head As a business owner and a foundry, you wanna maximize the value, but you’ve also, you know, you’ve also got your manager hat on it. You’re, you’re, and almost, you know, where these guys and gals are, they’re family.
Mm-hmm.
Gray: And, uh, what, how do I, you know. You almost feel guilty, I guess, as an owner.
Patrick: Yeah. Uh,
Gray: being able to extract that value and then still take care of your, your team and ESOP’s an opportunity to be able to do that.
Patrick: Yeah. Yeah. And [00:08:00] I, I think this is really interesting. So I, I wanna, I want to pause on the value side of things for just a second. ’cause I, I want to tie two things together that we’ve discussed.
Um, the first is maximizing the value to the, the owner when they sell, right? Like getting a fair market value. Um, and then I wanna, I wanna connect that to the fact that when you execute, executed your ESOP and left your business, the business grew at three x of what happened at the, the transition. So I, I wanna, I wanna think about that, you know, ’cause maybe we can get into a few of the details there, but I’m thinking about when I, when I sell.
Okay. Typically, the, the employees, now there’s some debt that comes into the equation. That, that the debt is going to be a little bit of a burden on the business. And so too much, too high of a valuation could be a problem from a debt point of view, but clearly to grow at three x in a pretty short period of time, um, there couldn’t have been too many restraints on the business.
So can we walk through like a [00:09:00] maximizing value for the seller and then how, how the business can continue to accelerate value over time?
Gray: Yeah. So, um. Maximizing the, the value to the seller. I mean, that’s, we wouldn’t have the opportunity to create employee owners if we weren’t able to, to get the owner what they deserve.
Mm-hmm. Right? That’s the bottom line. So, um, you know, part of our job as transaction advisors is to unlock that value for the owner and really maximize it for ’em. But the second objective of a transaction advisor, and equally as important, I hate to call, call it out second, because it’s just as much a first priority as it is, as the other one.
Is that I have to have a sustainable esop. I have to create an ESOP that doesn’t overburden the business. To your point, with debt that’s gonna, you know, uh, cause it harm later because that’s not gonna do any of us any good. So, um, you know, a good transaction advisor is somebody that creates, you know, structures a proper transaction.
Is gonna walk through all those things. Mm-hmm. And it, but it [00:10:00] doesn’t necessarily mean taking a haircut on value. It could mean that it just takes a little bit longer to get that value off the table.
Patrick: Yeah.
Gray: And, and, and one of the key ingredients of a successful ESOP is patients, uh, we’re gonna get into, you know, which companies make sense of which companies don’t, because not every transaction is for every company.
Yeah.
Gray: But one of the things I can tell you is if, if you have a little bit of patience, we can create more value in an ESOP than you can, and, and. Really, and I hate to say, but any other mm-hmm. Uh, third party transaction, we can create more value, more wealth for the selling shareholder with a little bit of patient.
But back to your original question, how, how does that translate into the growth that we created at, at the company that I founded? I would love to say that the ESOP caused the growth, but the ESOP didn’t necessarily cause the growth. Mm-hmm. What caused the growth was that we had a really good business plan, we had a really great culture and a really great team.
What the ESOP allowed me to do is to keep all three of those things together. And then create alignment amongst those three things that I was really able to [00:11:00] drive value into the business that I, that I wouldn’t have been able to do had I sold to a third party, I might could have done it, uh, status quo and did nothing.
But, you know, here again then, you know, I wasn’t necessarily, you know, I wasn’t de-risking at all. Uh, I wasn’t moved some of my personal wealth out of this business into something else and diversifying some of my own personal wealth. I was able to do both. Yeah. That’s the beauty of an esop. I was able to diversify de-risk a little bit, but still accelerate growth in my business because I kept the team together, I kept the kit culture together and I had a really good business plan that I was able to execute on.
Yeah. Um, so what I like to tell people is that ESOP didn’t create that growth. Mm-hmm. But the e-stop, let me keep everybody together, attract really great people to be able to take advantage of that growth and do it without putting each other.
Yeah. I
Gray: love it.
You know?
Gray: It, it was kind of a, it’s all about the people and that’s just any,
Patrick: yeah.
Uh,
Gray: getting ready together.
Patrick: I think this is great and, [00:12:00] and I wanna get back to, to some of the things you talked about, but you also, I, I think we should lay the foundation for what businesses this makes sense for, you know, maybe if there’s particular industry or revenue or EBITDA figure that, uh, we should be paying attention to that this aligns with.
So can you walk us through. You know, who does this make sense for?
Gray: Yeah. So, so great question. I would tell you that, uh, an ESOP works really well with companies, uh, where the owner or the founder still has some gas in the tank. Mm-hmm. Because, again, as I mentioned it, it takes some patience. That’s one of the ingredients for a good esop is that the.
The founder or a leadership team, some, you know, it doesn’t necessarily have to be the founder, but it has to be something that the founder has already set up is, is in place and is willing to run this business because the way the, the owner is gonna maximize value and the only way the owner’s gonna get all of their chips off the table is through future profits of the business.
And, and, and we could talk a little bit about the structure, but just know that. [00:13:00] The business has to continue for you to get all your money off the table. This is a multi credited event. It’s a, you know, multi-event, uh, transaction. And without a team in place or an owner that’s willing to stay on for a period of time and execute a succession plan with good leaders, those are the ones that are gonna be the most successful.
So I would tell you, it’s a company that’s, that’s still growing. It’s not on the decline.
Mm-hmm.
Gray: Uh, that’s got a decent leadership team either in place or a or an owner that’s willing to stay on and execute on that succession plan. Companies that have great cultures or or good cultures, this is gonna pour gas on a good culture.
Mm-hmm. But it doesn’t fix bad cultures. It doesn’t fix broken businesses. If you have a bad business plan, doing an ESOP’s not gonna do any good. Uh, if you have a bad culture, this isn’t gonna fix it. But if you have those two things, then an ESOP is, is literally gonna [00:14:00] pour gas on that.
Mm-hmm.
Gray: And really give you an opportunity to attract even more really great people to your team.
Uh, create alignment that, that, you know, you would never be able to do if you were to remain status quo. Because everybody is kind of rowing in the same direction. They understand what creates value Yeah. In the business. And they’re all driving that same number. Which, um, as any of us know when we’re leading a business, that that’s the, the secret sauce.
It doesn’t matter, uh, what business you’re in, what type of business, um, you’d ask what types of businesses. Um, we see a lot of momentum right now in construction. No doubt about it. That’s probably the largest segment of new ESOP transactions every year is always construction. The next one, uh, is gonna be professional services businesses.
Then the next one right behind that’s gonna be manufacturing. And those three trade places every year is the top three. But I would also tell you that at tenor we [00:15:00] do transactions for all types of businesses, retail, restaurants, um, we do engineering and architectural engineering firms. We do construction, we do manufacturing.
Um, there’s not necessarily a business that it doesn’t work for a business type, but. It needs to be, they don’t make very good turnaround tools. So it needs to be a business that’s our, that’s got a good business plan and a good culture, and, and they wanna keep all that together. Yeah. If not, then maybe one of the other alternatives may be a better option for you.
Mm-hmm.
Patrick: Yeah. No, that’s, that’s great. And then, then thinking through, is it a, is there a top line or a bottom line number that we should really be. Focused on before we even start to consider an esop?
Gray: Yeah, that’s also a really good question. The way we we answer that is, um, you know, rule of thumb is we need about a a million to a million and a half dollars in profit or ebitda.
Mm-hmm.
Gray: For it to start. Make sense now? I tell you that, but I tell you that [00:16:00] kinda with a caveat. You know, the, the reason we use that is not because there’s a regulation that says that, or, uh, that we haven’t done, uh, transactions with smaller businesses. But what we find is that businesses of that size are substantial enough.
To be able to, to, uh, execute the transaction.
Mm-hmm.
Gray: But then also the tax shield that we put over, it will almost subsidize the transaction when you get to that point.
Patrick: Yeah.
Gray: The, you know, um, we’re gonna hit on the tax benefit at some point because that’s kind of the. You know, the, the, the, the, the punchline of an esop, so to speak.
There’s, there’s really a couple of them, but I tell you that that’s one of the big ones. Um, and when you hear transaction advisors say, let’s do a feasibility study, I tell you there’s, you know, I can ask you two questions and decide whether this is feasible or not. And the first one is, uh, are we a million dollars or, or better, and net income.
Mm-hmm. And then the second one is, do we have an employee base that’s greater than 10?
Patrick: Yeah. [00:17:00] Yep. Yeah, because we have
Gray: to have some payroll Yep. For this to be Yes.
Patrick: Yeah. No, and I’m excited to tease people on the, the, the tax benefits. So we will, we will save that for, for later. Yeah. I think that’s, uh, that’s a lot of fun.
But I also wanna highlight one thing that you, you keep. Talking about in a, in an interesting way. Uh, and I, I wanna bring it all together. You just mentioned 10 employees for payroll. I think that’s good, but I also just think about you, you’ve mentioned the team, you’ve talked about the owner having gas in the tank, and, uh, I think one of the most valuable things, and you said this, but the, the value of having a tremendous team to continue to run and build the business is, is so important and, and putting the right people in place.
And I, I also think about the. You highlighted that the ESOP won’t fix broken culture. Uh, which is absolutely true, but an ESOP can be very attractive to somebody that, especially on the leadership side, that can come into the business and, uh, really drive [00:18:00] change and see the business grow and, uh, ’cause they get a benefit from that as.
As a, an owner of the business now, and so I, I don’t know if there’s anything to say about, you know, attracting top talent, but at the end of the day, when we think about what grows a business and what makes the biggest difference is. Having the great, great people in place, right? And, and some people they have a, a ceiling like, okay, we’re gonna, we’re gonna take this business.
We can, I’m capable of taking this business to here. And hopefully there’s four or five years of runway before they get there. And maybe they expand that capacity. Maybe not. Maybe it’s time to bring in new leadership. But we think those things are important. Like having a team that has, uh, a higher ceiling than where we’re currently at is, uh, is critical too.
Uh, getting some of the results that you’ve highlighted here. So I don’t know if there’s anything to talk about in regards to like, attracting top talent with an ESOP or not, but, uh, I think that’s a, an interesting, well, I think,
Gray: I think there is one, uh, one of the big, uh, misconceptions of an ESOP is that when you do [00:19:00] an esop, now everybody has to be treated exactly the same.
Mm-hmm.
Gray: And, and that’s true. In a qualified, in the qualified retirement plan that we’re creating when we create an esop. Uh, what’s untrue about that is that there is also a separate plan that we’ll put in place, a non-qualified plan, and all the transactions that we, we structure there is always a non-qualified piece to the plan that allows us to do equity awards to attract that really great talent that you’re talking about.
Yeah.
Gray: So, um, in all of the transactions that we structure, there’s always that tool and the trustee who represents the employees in this transaction, understands the value of, of being able to offer those equity incentives and attract the talent that you’re speaking of to be able to keep this business running and actually ultimately create a sustainable esop.
Mm-hmm. Because, um. One of the, the things that I would tell you in an ESOP transaction that really makes it different from third party transactions is, uh, when [00:20:00] you have enter into a third party transaction, the buyer has their own agenda. Uh, always. Mm-hmm. Right? But in an esop, the buyer’s agenda, the buyer’s, really their mission is to create employee owners.
Mm-hmm. That we hire and we assemble the team and their mission and, and their objective agenda is to create employee owners. And that doesn’t happen unless this transaction closes. Yeah. So it’s a much different negotiation and process that, that if anybody, any of our owners that are listening to this and ever have gone through a third party process and seen it fall apart, is gonna, you know, they don’t even want to talk about it anymore.
Most of the time it’s such a different experience. Uh, so much less disre disruptive. Mm-hmm. And, uh, with a completely different agenda, uh, for both parties that it almost eliminates closing risk. I’m not gonna say it eliminates it all together. Yeah. But it minimizes closing risk.
Patrick: Mm-hmm.
Gray: So I think that’s also another, another point to just kind of, yeah.
Bring up here.
Patrick: Yeah. No, [00:21:00] this is fantastic.
You know, one of the biggest takeaways from today’s conversation is that the right strategy changes everything. Whether you’re thinking about selling your business, creating an exit plan, or just trying to keep more of what you earn. It all comes down to strategy. And that’s exactly what we do at Vital Wealth.
Our team works one-on-one with entrepreneurs to build out personalized tax and wealth strategies designed around your goals, your business, and your lifestyle. So if you’re ready to stop reacting at tax time and start being proactive about your future, visit vital strategies.com/tax. When you go there, you’ll be able to connect directly with our team and start building out your own customized strategy the same way most successful business owners do.
That’s vital strategies.com/tax where your next breakthrough starts with the right plan.
So, Gary, you’ve alluded to this a little bit, but it sounds like, [00:22:00] uh, as I think about this, as a, an outside party that could be considering selling my business to the esop. That sounds like it might be like cookie cutter, like it’s just the same every time. Is this a, is this a customizable transaction? Can I structure this different ways?
Um, yeah. Can you talk a little bit more about the flexibility that we can, can or can’t build into an esop?
Gray: Yeah, absolutely. Uh, you know, like we talked about before, in a typical third party transaction, the buyer comes in an agenda, the seller has an agenda and it’s a much different type of transaction.
Well, one of the benefits of an esop. That we are, these transactions are highly customizable. Um, and they all have one objective, and that’s to create employee owners. But what we also recognize is that every single business, every single owner has a different, you know, uh, different objective for the business.
They have different personal objective, they have different tax situations, and we can customize transactions to meet any of those. Hmm. Um. [00:23:00] Whether it be the, the timing of the transaction, the amount that’s sold into an esop, you can sell 1% to a hundred percent into an esop. We’ve got different financing customizations we can do.
There are a set of rules that every ESOP has to, you know, to qualify. Ultimately, at the end of the day, we’re creating a qualified retirement plan for our employees, and that plan has to follow a certain set of rules. You know, it’s, it’s all established in the ERISA law of 1974. In fact, ESOPs have been around, believe it or not, for 50 years.
51 years this year.
Patrick: Yeah.
Gray: So that it’s the same law that put 4 0 1 Ks into existence is the same law that put ESOPs into existence and just like a 401k, it’s got certain requirements that we have to meet. We have the same thing with an esop. However, we can customize these plans to meet the. The business objectives, maybe the workforce is, we have a transient workforce in one business and we’ve got a really stable one in another one, but we can, you know, there [00:24:00] are, there are things we can do to customize that plan for each business.
Yeah. The trick is, is that whatever we do, we have to do for everybody, right? We can’t discriminate from one employee to another. That’s really the biggest, biggest rule in the, in the plan itself. But then the structure of the actual transaction, uh. We’ve got a lot of, of, uh, customizations that we can, with the right transaction advisor, we’re gonna really be able to dig in and figure out what it is we need to do to meet those objectives.
Patrick: Yeah, this is, this is great. So can we talk a little bit about the transaction itself? Can we talk through, um, you know, I could see the employee team going, man, am I gonna have to show up with a bunch of cash to buy the owner out? That’s clearly not the case. We’ve already talked about debt a little bit, but can we talk about debt and.
Um, you know, maybe how the owner, ’cause uh, you also talked a little bit about, um, uh, I’m, I’m gonna use my own terminology here. This isn’t what you said, but I think [00:25:00] we can recapitalize maybe a, a couple times and I think the owner can maybe benefit through, through that process as well. But yeah. How, how does this, how does the owner get compensated?
How does the lender feel comfortable in the transaction that there’s enough equity in this deal to. Make sure that, uh, you know, the debt service and everything else is gonna turn out okay. Yeah. I’m just ge generally curious how these deals come together, uh, where everybody starts to win like we’ve been talking about.
Gray: Right. Let me back up because you made a, uh, a comment about the employee. Do we have to have a bag of cash to buy the owner out and, and. I don’t know that I, um, really hit that, uh, hard enough to an employee. It, it’s a windfall at retirement. It’s a qualified retirement plan that kind of, kind of looks like a 401k, but the two, two big differences is one, to invest only in the stock of, of the business.
The second one is there’s no money out of the employees check, so the employees don’t actually buy the [00:26:00] business owner out the future cash flows. Of that business is what is what we’re gonna channel to this debt. Not, not anything outta the employees salary, bonuses. And, uh, you know, we would never be able to create the alignment we do if we were taking something away from these employees, turning around, giving it to the owner.
That’s a, something I really wanted to make sure that we drove home, that it, uh, it’s really a, from the employee’s perspective, it’s the best way to own a business. Uh, no money out of pocket, no liability. You’re simply beneficiary owners. You get the financial benefit owner of the business without those two things, cash out of pocket, no liability.
Yeah.
Gray: On the employee side, truly the best way to own a business. Absolutely. Let, let’s fast forward now to the, to your second comment, talk about how the transaction works. Um, it is a, uh, multiple credit event to get the owner paid. When I say that, let’s just say we negotiate, the transaction amount gets [00:27:00] negotiated with a trustee, and our job as a transaction advisor is to again, be the, the coach and the quarterback in this transaction.
From the quarterback’s perspective, we’re gonna go out and introduce you to the trustees, to to hire, to represent your employees in this transaction, and that becomes the buyer. That’s the first job. The first job is to, to bring on an attorney. Second job is to bring on your, your trustee. That represents the buy side.
Mm-hmm. And once we do that, then we enter into a negotiation with that trustee. And our job then is the coach to coach you through that and represent you to be able to maximize that value. So now, uh, kind of we’ve got the transaction value set at that point, once that negotiation. Ends, we have all the financial terms of the transaction.
Mm-hmm. Kind. Mm-hmm. We’ve got the transaction value set at that point. Once that, again, dollars, [00:28:00] well, now the or her business, it’s gonna, uh, conceivably be.
Paid over time through cash flows that we’ve created a tax shield over, we’ve lowered the tax burden of this business and now we’re channeling all the cash flow from the business over to this $10 million debt. Well, uh, in the case, if it’s a $1 million EBITDA business, it would basically take 10 years to pay this business off, assuming.
Just simple math, right? Yeah. Uh, we can accelerate that by bringing in a lender, and a lender is gonna provide financing to the company that they will use to, in turn pay it down that seller note and accelerate the cash to the selling shareholder. In general, we can probably do this in three events. So the first tranche will be [00:29:00] about a third.
Mm-hmm. And the, the, uh, the selling shareholder will receive a third of their money. Then to have a note for two thirds, the business would pay down the bank and just before we paid it off, then we would go back and reload for a second truck. Yeah. And we would do this three different times, a third at a time until the business owner has been completely paid.
And then the business would continue to pay off that senior loan to the lender.
Mm-hmm.
Gray: And. Continue to enjoy those tax benefits, which mean now we’ve got unencumbered cash of a million dollars a year, assuming the business didn’t grow at all, a million dollars a year that we’re just stacking cash that we can use really for any business purpose.
Mm-hmm.
Gray: And that could be growing the business, paying GR better wages, expanding, opening offices, whatever pieces of equipment, whatever it might be.
Patrick: Sure, yeah. This is, this is great. Now I’ve got a question and, um. I, is there an [00:30:00] opportunity, I’m thinking about those, those opportunities to recapitalize the business to, as time goes on, is there for the owner, is there, is there any way to participate in some of the upside of the growing business?
Like, uh, when I do recapitalize, can I, can I get bought out at sort of today’s value? Um, if that’s, if that’s a fair question. I don’t think I’m. Positioning that, that properly, but I, I think there’s some opportunity in their life.
Gray: Absolutely. I think I, I think I know where you’re headed now. First of all, uh, one of the benefits to the owner is once we establish that transaction value, that transaction value set mm-hmm.
Uh, if the business continues to grow. They still have the same value they sold for, you know, a year or two earlier. Yep. And then, you know, uh, and adversely if the business declines a little bit, the, the value still set. So from a business owner’s perspective, it’s a way to, to really de-risk and, you know, put a flag in the ground.
This is what the value of the business is, and they’ve got their deal set so they can start making some plans around that. Then [00:31:00] you also bring up another point. How can that business owner participate in the future upside of that business while they continue to operate it? So in my case, over five years, I grew the business, you know, three times the size that it was when I sold it.
Well, I was highly motivated to do that because there’s another benefit in it and a properly structured transaction. ESOP transaction, we’re gonna create what we call the second bite of the apple, and this is a non-qualified plan that I spoke about earlier as a management incentive plan. There’s also a second bucket of equity that we’re gonna create, that we’re gonna use as a seller finance warrant.
Mm-hmm.
Gray: And this is gonna allow us immediately after closing to hand back that business owner, a portion of that equity to hold onto and then liquidate it at some point in the future, at a future value,
yeah.
Gray: Of a business that’s paying much less in taxes and in in, in many cases, if we structure it right.
Nothing in taxes. Yeah. Folks, I keep [00:32:00] saying that I’m gonna keep, we’re gonna eventually get to the punchline on this because we have to. But, uh, for you to really understand the value that we’re creating, you have to understand that what we’re, what we’re creating is a business. Mm-hmm. That is, uh, has a competitive edge over there, uh, over a non-ESOP business.
Yeah. Because you have a lower tax.
Patrick: Yeah. Yeah. This is, this is really fascinating. So I, I love that we’ve got these, uh, we’ll call ’em warrants alongside the, uh, the esop and everybody’s winning in this scenario, you know, as the owner, that blood, sweat and tears into this thing, got it off the ground, turned it into something, uh, with real value.
The employees are getting to participate in that. And then as we continue to grow together. I get to continue to participate in, in a small, smaller piece of that. Uh, I think that is fantastic. So I have questions now about some of the tax side of the equation. ’cause I think there’s, there’s two, two things I wanna touch on.
I’m curious how the seller can sell, [00:33:00] uh, by deferring some of the capital gains. I think that’s, that’s pretty interesting on what our opportunities are there. And then, uh, I also want to touch on, uh, there’s, there’s two tax-free entities in the United States. We’ve got. The credit union and ESOP’s not a credit union.
And then we’ve got an esop. And, uh, I think about the competitive advantage that, uh, I’ve got some friends that own banks and they’re, they’re consistently, um, bemoaning the fact that the credit unions have an unfair advantage, don’t have to pay tax. I think about the esop and I’m like, wow, that’s a fantastic competitive advantage.
Uh, can we touch on those, those two tax pieces? Can we start with the capital gains opportunity for the owner and then we’ll, we’ll move into the tax free nature of the ESOP after that.
Gray: Yeah. Ab absolutely. Um, in a, uh, esop, there is a, a particular code in the IRS code book IRC 10 42. Mm-hmm. And in that code, it allows the business owner to avoid capital gains if [00:34:00] they sell their stock to an esop.
The way that works, it’s gonna work very similarly, like to a 10 31 exchange in real estate where we have to reinvest the proceeds, uh, into another investment, uh, real estate investment. In this particular case, in a 10 42, we will need to reinvest the proceeds into what the IRS calls qualified replacement property.
And by definition, uh, kind of a, a layman definition of that is it’s gonna be a US owned business, uh, or equity, uh, and. When you do that, then it allows you to defer that capital gains tax. And if it’s structured properly, we can permanently defer the capital gains on that. Now, the first thing that people think of is, well, I want something, I wanna be able to, you know, I want some liquidity that I can go buy, you know, boats or Ferraris with when I sell my company.
Well, nobody would do this if there wasn’t a way to get, uh, some liquidity out of it. So there are products out there that you’ll be able to, [00:35:00] to point folks to. That they can actually margin back and be able to create liquidity for themselves. And, uh, in general, what we see is there’s typically 10 to 15% of the total proceeds that’ll be tied up into this, in this product during their lifetime.
But it’s 10 to 15% that are invested in a, you know, uh, a very, uh, valuable, highly marginable blue chip stock, likely equity or, uh. Floating rate note for a, A similar type of business
Patrick: Yeah.
Gray: That they hold onto, and that at some point when they pass their estate would get a step up in basis and then ultimately eliminate.
Capital gains tax on this transaction. So again, it’s complicated, but it mm-hmm. But there are, you know, folks like you are the ones that guide people on that. We, we introduced them to you and then you walk ’em through on how do, how do we execute on this?
Patrick: I love it. Yeah. This is fantastic. And uh, just yesterday I recorded an hour and a half, uh, [00:36:00] long webinar for, uh, one of our planning partners, uh, Lineberg.
And it was all about how to defer the capital gains tax and, uh. ESOP is a fantastic tool to, to be able to do that. So, uh, thank you for that, that overview. That is good stuff. Okay. Now, now I’m excited about the tax free nature of an esop. Can we, can we talk a little bit more about that and the competitive advantage that it creates?
Gray: Yeah, absolutely. So, uh, the NA esop, if. Were to structure the transaction where the business remains an S Corp. Mm-hmm. Then ultimately the business will become a for-profit, tax free entity. And, you know, it seems like this is too good to be true, but I’m here to tell you, uh, I’ve done it, I’ve seen it. I had a front row seat to this.
And what that ultimately does for you is this is a permanent tax advantage that allows you to subsidize the transaction, the exit transaction. Then because this benefit is permanent, once the transaction debt is [00:37:00] paid for, then we have this cash that we’re able to use for any business purpose now. Mm-hmm.
First one is the liability for the retirement account that we’re creating, which is one piece. But there, you know, what we’ve done is we’ve essentially freed up 30 or 40% of the cash flows of this business to stay in the business. Uh, the liability that we’re creating on the retirement. We’ll leave a lot left to be able to use for growth of the business.
Um, expansion acquisition, again, it’s, you know, whatever business purpose, whatever the board of directors of that business chooses to use that cash to do.
Mm-hmm.
Gray: Um, so, uh, in the case of an ESOP and, and it really creates a competitive advantage over all of your competitors, your non-ESOP competitor. And we’ve done so many transactions.
I’ve, I’ve done some podcasts with some of our previous clients and one of our clients, uh, mentioned OnOne says, I don’t know how non [00:38:00] ESOP firms are gonna compete in my industry with ESOP firms. Mm-hmm. Uh, is this, you know, with the momentum that’s being created and the fact that we’re able to operate, uh, uh, under a different tax structure, uh, just gives us a competitive edge that we don’t even know how they’re gonna compete.
Patrick: Yeah.
Gray: But I would, I would just tell you. Um, the way this works mechanically, ’cause everybody’s sitting, they’re going, how is this even possible? Right? So the way this is possible is this, uh, the first thing that we’re gonna do in a transaction. We’re gonna create a trust, a, a retirement trust, an ESOP retirement trust, and we’re gonna sell, uh, for this example, a hundred percent of our shares into the trust.
Now the, all of the income that flows through that business and typically would flow through to a personal return through a K one. Now that K one is directed to the retirement trust, well, the retirement trust is exempt from taxes. Mm-hmm. So there [00:39:00] is no tax, uh, burden being created. By the profits of this business any, any longer.
So is all of us business owners where we, you know, we, we work all year and then all of a sudden we get a, a k one at the end of the year for kind of the, the game is, is that we, we run our business to, to, to be tax efficient. Less about, you know, the timing of our purchases mm-hmm. And all that are all ’cause of tax reasons and not ’cause of when we need things.
Right. Well,
Gray: all that stuff out the window, now we can operate the business and do it under a timing that makes sense for the business rather than making sense. To, to, to, uh, a avoid or, or be more tax efficient. Maybe avoid is not the right word, we Yeah. To be more tax efficient.
Yeah. Uh,
Gray: and, and this allows you to forget about all that kind of thing and then just work directly with, you know, what makes sense for the business.
Patrick: Yeah. This is fantastic and I, I do think you’re absolutely right when you. Uh, or we’re talking about employee or former clients that, uh, or clients that had exited with an esop. Just [00:40:00] the competitive advantage they have when I don’t have to give, depending on the state, I live in 40% of my profits to the federal government.
It’s federal and state government, uh, or more. 50% of ’em in California. Like, uh, that’s unbelievable, right? Like it allows me to build the team, invest in the machinery and equipment and all of those, those factors at the right time, right? Not. Not looking at my tax bill going, okay, I might need this next year.
I better go make that big purchase now so I can, um, get deduction for the, uh, the current tax year instead of waiting to when I actually need it. So, yeah, it’s a fantastic opportunity. And then we think about that with, we start layering these ideas together, tax free nature with potential warrants, you know, that allow me to, or warrants that allow me to, to be able to, uh, grow the business.
Right. You know, participate in the upside. It’s like. Wow. You know, I am, you’ve said this few times, I’m pouring gas on the fire with this, uh, this structure because it allows me to, uh, just go farther faster. So I think that’s a, uh, [00:41:00] beautiful thing. All right, Gary, we’ve talked about, uh, all sorts of things with the esop we’ve talked about.
You know, really we should probably be at about, uh, a million dollars of bottom line ebitda, uh, for this to make sense with about 10 employees. Uh, we’ve talked about all of the benefits of, of ESOP and how we can take advantage as an organization, the benefits for the owner, uh, the tax benefits all the way around.
It’s a beautiful thing. Is there anything else that is, uh, important for us to touch on before we we move on to the next, next phase of our discussion?
Gray: Yeah. Um, we talked about the size that it, uh, that it starts to make sense to, to be an esop, but let’s talk about the top side. Mm-hmm. Uh, you know. We do transactions, um, you know, beginning at that million dollar, million and a half dollar net profit.
Um, but then we also do transactions for businesses that are so much larger than that. So there’s, there’s not a, a business [00:42:00] that’s too large for this, you know, at tenor, uh, we work with, uh, businesses that are, you know, that sort of 10 to $15 million enterprise value up to. A billion dollars in enterprise value.
So there, there is no top side that’s too large. Mm-hmm. Uh, in fact, what I would tell you is that some of the larger businesses can really create some extraordinary outcomes for their employees, uh, and really attract. A lot more people to the business. You know, let’s just face it, the velocity of hiring is much bigger than those businesses, and we need those advantages.
Yep. Uh, so even the larger businesses, I would even say that there’s, there’s a lot to gain. Yeah. Even more to gain. Sure. The bigger the business.
Patrick: All right. This has been fantastic. So I think, uh, everybody should go check out tenner esop.com or contractor esop.com. Those are both. I’ll say tenor website, um, domains that you can learn more.
You know, you talked about professional services, [00:43:00] uh, manufacturing and contractors being sort of the top of the, uh, heap. They’re all taking turns there. So, uh, if you’re in the contractor space and considering an ESOP contractor, esop.com is the place to go. Everybody else, uh, can check out tenor esop.com and we’ll have links to those in the show notes.
Um, but I, I think about the, the stakes, right? Um. If, if people are considering an exit and they don’t put the right plan, plan in place, you know, the owner’s risk losing, control of their legacy, undervaluing their business and harming them employees and morale that, uh, they’ve spent so much time and energy, uh, building.
And then we think of the opposite side of that. With the ESOP strategy, owners can achieve a profitable exit, preserve culture, reward employees, and drive ongoing growth. And we also didn’t touch on this, but I think it’s an important piece too. So many owners. Are depressed, they’re, uh, dissatisfied with their exit because they sort of lose their purpose and the fact that they can stay engaged, like you, you talked about earlier.
You know, they’ve got, [00:44:00] they’ve got gas in the tank to keep going with the business. I, I think is an important part. Uh, you know, personally, I, I think about my, my dad was an attorney. You look at the statistics around attorneys and CPAs when they, they retire and it’s not good. Within two years, a huge percentage of them are, have, are dying.
Right? And it’s ’cause they lose their purpose. And so I think about that and it’s like, let’s, let’s keep our purpose going. And I think that ESOP is a way to stay engaged and sort of make that transition from a succession point of view in a, uh, a healthy way. So, um, yeah, this has been, this has been great.
Anything to add to that Gary?
Gray: Yeah, I’d love to share just, you know, give you just some real world perspective on that. Mm-hmm. Because obviously I lived this and, uh, uh, before I, uh, got on with you today, I was actually at the office of the business that I founded meeting with my CEO of the business because, you know, he had a situation that he wanted to run by me.
Mm-hmm. And it allows me, you know, I, I still am on the board of directors for the business, so I can [00:45:00] still, uh, have some involvement in the business that I found. Um, you know, now, you know, so before my, uh, my objective was to grow the business and, you know, make it successful, now my objective is to help my new CEO be successful.
It’s like the measure of my leadership now is on how successful he is. So it does, it keeps a purpose as you, as you talk about. Mm-hmm. Uh, so my purpose might have changed a little bit. Uh, but it’s, it still gives me purpose. I still get to be involved as I want be. Um, I still get to spend time in, in the, in the business that I founded, but I don’t necessarily have to deal with the day-to-day, uh, you know, firefighting and so forth.
So, uh, yeah, you, you, and you could keep that as long as you want. Uh, as long as you’re willing to do it and willing to spend the time on it. You can, you can keep that as long as you want. So,
Patrick: yeah. Yeah. No, I, I think that’s, that’s fantastic. And I, I think. Uh, there, there’s a [00:46:00] few things I wanna highlight. The fact that you’ve run a successful business, you’ve exited personally from an esop, you’ve also helped, uh, countless number of folks also go through the process.
You’ve been on both sides of the, the, the equation, and I think that. That brings a level of connection that, that somebody that’s only lived on the finance side can’t bring to the, the discussion. So I think that, um, that is so valuable and I think it’s one of the reasons people should reach out and, and connect with you.
Gary, what is the best way for people to connect? Is it, is it emails, is it phone? Is it just through the website? How, how would you for people do that?
Gray: Yeah, so, so certainly through the website, um, but you can also just reach me via email, uh, Gary at tenor esop, T-E-N-O-R-E-S-O p.com. Also on LinkedIn, uh, Gary Gray, uh, Lieutenant ESOP Partners.
Uh, you can actually look back and kinda see some of the, the history in my and some of the things that we’ve done. Uh, we also have a ESOP for Contractors page on LinkedIn where we share an awful lot of information. So even if [00:47:00] you’re not ready to have the one-on-one conversation, I urge you to go out and visit both of our websites, tenor ESOP partners, and contractor esop.com.
Just see some of the information that we provide out there. Yeah. Uh, if nothing else, it’s just gonna open your eyes up to the possibilities. Um, and then, then maybe let’s have a conversation and talk about how we can customize it and meet the objectives that you actually have for your own business.
Patrick: Yeah, I think that’s great.
I think it’s, um. I think of websites now and all the, uh, social content you’re putting out on LinkedIn is a, is a great way to go on a few dates right before I, I call you up and, uh, figure out if we should, uh, you know, take this relationship to the next level. So yes, all of those things are, are fantastic.
There’s, uh, tons of information out there. And, uh, Gary, I just wanna say, you know, we’ve got a, a mutual client that, uh, we’ve been working with that uh, it’s just been fun to sit front row and just see how you interact with, with clients and. Level of professionalism you bring to the game. And so, uh, [00:48:00] thank you for, for all of that.
I appreciate it. Thank you. Yeah. This conversation has been wonderful. Thank you so much. We’ll have links in the show notes to, uh, how to get in touch with Gary plus LinkedIn, plus all the, the websites. But this has been fantastic and, uh, thanks so much for joining us here today.
Gray: Yeah, well thanks for having me, Patrick.
Look forward to, to, uh, our next conversation with our mutual client.
Patrick: Very good. Thanks so much for tuning into this episode of the Vital Wealth Strategies Podcast. I hope you found real value in today’s conversation with Gary Gray and that it opened your eyes to what’s possible when it comes to exiting your business on your terms.
If this episode resonated with you, share it with another entrepreneur who could benefit from it. You never know who might be trying to figure out their next steps in their business and needs to hear exactly this message. If you’re ready to start building your own strategy, whether that’s for minimizing taxes, setting up your exit, or just getting more intentional about how you grow and protect your wealth, head over to vital strategies.com/tax.
You’ll find tools and insights to help you [00:49:00] take the next step toward financial freedom and long-term impact. And remember, you’re a vital entrepreneur. You’re vital because you’re the backbone of our economy, creating opportunities, driving growth, and making an impact. You’re vital to your family creating abundance in every aspect of life.
You’re vital to me because you are committed to growing your wealth, leading with purpose, and creating something truly great. Thank you for being a part of this incredible community of vital entrepreneurs. I appreciate you and I look forward to having you back here next time on the Vital Wealth Strategies Podcast, we help entrepreneurs minimize their taxes, master wealth, and optimize their lives.