There is a serious lack of capital available today for private business enterprises, especially small to medium sized companies. Here is a typical example: ABC Brush Works is a manufacturer of paintbrushes that are distributed nationwide. The company has had a long, satisfying history in the industry and with its bank. The recent recession, however, has taken its toll on the financial statements although the company remains solvent and capable of sustaining at least minimal profits in a down economy.
Because of the bankruptcies of several of ABC's competitors, company management sees a unique opportunity to expand its market share and increase profitability. To do so, it needs to acquire $250,000 of heavy equipment for its manufacturing facility.
First Bank Request – ABC approached its bank on the basis of a typical five-year equipment loan. After analyzing the financial condition of the company and the cash flow required to amortize the debt, the bank declined the request, citing the company's recent lackluster performance. Collateral was not a problem. The bank refused to consider the planned increase in cash flow as a direct result of the new equipment and the increased manufacturing capacity.
Second Bank Request – ABC regrouped and approached the bank with an employee stock ownership plan. Under this new scenario, the bank would lend $250,000 to the company under an ESOP structure. The funds immediately would be loaned to the company's ESOP under the same terms and conditions. The loan would be amortized over seven years. (ESOP loans up to 10 years are common.)
The ESOP then would make an offer to purchase $250,000 of preferred convertible stock from the company. This stock is nonvoting preferred with a liquidation preference and convertible into voting common at the option of the plan trustee.
At this point in time, the company has the $250,000 back in the cash account. It uses these funds to purchase the needed equipment The company repays the loan to the bank by making fully deductible contributions to the ESOP in the amount of the periodic amortization. Next the ESOP uses the contributed funds to repay its loan to the company. The company takes the dollars it is paid by the ESOP and makes the periodic payment to the bank. As a result of these transactions, the entire loan is repaid with pretax dollars over seven years. Please note that not only was the interest tax deductible to the corporation, but the principal on the loan was deductible as well.
This particular structure changed the cash flow picture substantially for the better. Now the bank can consider the request in light of repaying the loan with $0.66 dollars and over a longer period of time, Often state-of--the-art financial structuring such as this will make the difference in obtaining much-needed capital for expansion.
Dilution – For those of you who noticed, this transaction did cause dilution to the extent of about 5% of total fair market value. Such a small amount of dilution, however, did not affect control and was a small price to pay to remain competitive in the marketplace.
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