Brewery ESOPs: Avoiding the Pitfalls | Brewing Industry Guide

Brewery ESOPs: Avoiding the Pitfalls

All things considered, ESOPs present a very compelling tax-effective exit strategy that can balance the change of ownership while maintaining control, but ESOPs are not without pitfalls. Here are seven of them that you should avoid at all cost.

Rocky Fiore 8 months ago

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It is almost inevitable that, at some point in time, craft-brewery owners will face the question: should we sell to big beer or preserve our independence and reward our employees? We all know about the stigma of selling out to big beer, but does that mean an Employee Stock Ownership Plan (ESOP) is the right ownership-transition strategy for every craft brewery? The answer is a resounding NO. Although ESOPs can be an effective strategy, they are not right for every situation. Here are seven pitfalls to carefully consider if you are contemplating an ESOP for your brewery.

Pitfall #1: Volatile Revenues and Earnings

ESOPs are typically paid for with cash on the balance sheet and/or loans from banks and other financing sources. As a result, ESOPs work best in businesses that have stable cash flows and the ability to meet debt-service requirements.

Breweries with unstable and unpredictable income streams should be very careful when implementing an ESOP. Your bank will require you to meet certain loan covenants to avoid defaulting on the loan. Failure to comply with these loan covenants can result in a technical default and/or an inability to meet debt-service payments, either of which may result in a series of actions by the lender that are less than desirable. The economy is uncertain, and the craft-beer industry is dynamic. Regardless, implementing an ESOP in a craft brewery with a volatile or poor financial performance track record is never a good idea.

Pitfall #2: Poorly Structured ESOP Debt

Just because a craft brewery has a successful track record of delivering strong financial results does not mean that an ESOP will be successful. Using all of the company’s debt capacity to finance an ESOP transaction without giving consideration to working-capital requirements and future expansion plans is a surefire way to run into financial trouble and negatively impact the brewery’s operations.

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In the initial ESOP feasibility and design stage, you want to spend time thinking about the future of the brewery. What is the growth strategy? Do you need more equipment? A new facility? Perhaps a new bottling or canning line? Evaluate and consider all of these when structuring an ESOP transaction so that you don’t end up strangling the golden goose. Also, working with experienced ESOP lenders will increase the likelihood that you can achieve the optimal financing package.

Pitfall #3: Poor Management Team

A successful employee-owned company has everyone working toward a common goal, and it all starts with great leadership. Effective managers of ESOP companies champion the concept of employee ownership, and that enthusiasm permeates throughout the entire workforce. Unfortunately, not all companies have great managers to lead the way. Managers who lack transparency, communicate poorly across the organization, and fail to lead by example negatively impact employee morale and contribute to a poor workplace culture.

In my nearly two decades of working with ESOP companies in various industries across the country, I have yet to see one achieve long-term success with poor leadership. If your brewery is lacking senior leadership or management depth, I suggest that you stop the ESOP process immediately and address these issues before proceeding down the ESOP path.

Pitfall #4: Lack of Financial Controls

If there is one common thread among businesses across all industries, it is the need to have good financial management. I’ve seen few situations where a company can thrive and succeed in the face of poor financial processes and controls. In situations involving an ESOP, it is even more important to have strong financial management. Consistent, detailed, and timely financial reports are paramount to running an ESOP company.

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In addition, the ability to budget and forecast financial performance is a great way for a business to anticipate bumps in the road ahead. Avoid the major pitfalls of poor financial management by investing in a talented finance manager and keeping accurate books and records of the business and its performance. This information is critical for the day-to-day management of the business. In addition, these books and records are important to help the leadership team assess performance and shape the strategy of the business going forward.

Pitfall #5: Poor Culture

I have always thought that craft breweries have incredible organizational cultures. These cultures are rich with passionate and energetic people who are proud of the company and their work. Their love of beer and their desire to create brew styles that are both traditional and evolutionary are infectious. ESOPs work best in companies with employees who are highly engaged and value teamwork.

Employees who don’t trust management and management that doesn’t trust the employees is a bad recipe for ESOP success. Companies that empower employees to make important decisions create a trusting environment where people feel valued and are an integral part of the success of the organization. A poor culture can lead to high turnover and a workforce that lacks motivation, the result of which is underperformance and a declining market position. Implementing an ESOP in a poor culture with the hopes of improving employee morale is a bad idea. First work on improving the culture; then focus on the implementation of an ESOP.

Pitfall #6: Too Optimistic

Business owners often focus intently on the opportunities in front of them, assuming that the successes they have enjoyed to date will likely continue into the future. Perhaps your always-successful brewery will continue its meteoric rise and avoid all competitive threats. However, known and unknown risk factors may surface at any time, and failing to acknowledge them in structuring an ESOP transaction can be a significant pitfall.

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Consider the scenario where a brewery is experiencing declining sales and margins in the face of growing competition and slowing industry-growth trends. Should the owner and management team disregard this new reality and focus only on the opportunistic return to historical levels of revenue growth and profitability? If they do so, it is likely that the company may find itself in a liquidity crisis at some point in the future due to overleveraging.

To avoid this pitfall, be realistic about the future and stress test various assumptions in order to provide the company with the relief it needs should it hit a rough patch in the road.

Pitfall #7: Lack of Management Incentives

ESOPs can provide meaningful and, in some cases, exceptional retirement-plan benefits. However, ESOPs are nondiscriminatory qualified retirement plans that are designed to provide benefits to a wide range of employees, not just a select few. Still, an ESOP alone may not provide a sufficient level of rewards to key members of the management team. For this reason, it is important to craft management incentive plans that attract, retain, and reward top-level talent.

These rewards, which are often tied directly to the performance of the ESOP stock value, are designed to align key members of management with ESOP participants. Unfortunately, I have, on many occasions, seen great managers and leaders leave an otherwise successful company because the proper incentives were not put in place to reward exceptional performance. Avoid this ESOP pitfall by designing a well-thought-out compensation plan at the time of ESOP inception.

Most successful craft-brewery owners have a multitude of ownership transition alternatives available to them. However, when all things are considered, ESOPs present a very compelling tax-effective exit strategy that can balance the change of ownership while maintaining control…if you can avoid the pitfalls. 

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