ESOP Growth Presents Market Opportunity for Retail Agents

There are also regulatory risks. ESOPs cannot pay more than “adequate consideration” for company shares. Between 2007 and 2017, the Department of Labor’s Employee Benefits Security Administration (EBSA) found ERISA violations, mainly valuation and loan term issues, in over 1,000 cases. The EBSA’s ESOP National Enforcement Project investigates ERISA violations in connection with ESOPs, and additional scrutiny can come from the IRS and the Pension Benefit Guaranty Corporation.

Risk Management

Retail agents can help clients manage ESOP-related risks by recommending best practices and appropriate insurance coverage.

An ESOP Trustee must obtain an independent valuation for ESOP purposes. While it may be tempting for companies to use C-suite members as Trustees due to their business familiarity, this can lead to conflicts of interest. Independent ESOP valuation firms have the expertise to objectively assess financial data, including financial statements, cash flow projections, customer and geographic concentration, and management depth.

Independent firms also bring the objectivity and independence that internal staff cannot, conducting in-depth interviews with management to establish credibility around projections and generate necessary transparency. These firms analyze not only value but also the entire transaction, considering interest rates, synthetic equity, and deal structure.

Insurance Coverage

Both the existing company and the acquiring ESOP need comprehensive liability insurance protection, primarily through Fiduciary Liability (FL) and Directors & Officers (D&O) insurance.

• Fiduciary Liability Insurance (FL): This protects plan fiduciaries against claims of mismanagement, including improper management of plan assets, misrepresentation, or failure to provide required information to participants. It covers legal defense costs, settlements, and judgments. As per ERISA and court decisions, the ESOP plan itself cannot indemnify fiduciaries, putting their personal assets at risk without fiduciary liability insurance.
• Directors & Officers (D&O) Insurance: This protects the personal assets of directors, board members, and other managing members if they are sued for mismanagement. In an ESOP transaction, directors may have fiduciary responsibilities to both existing/former shareholders and ESOP participants, complicating their role.

Other recommended coverages include:

• Employment Practices Liability (EPL): Protects against claims from dissatisfied employees during ownership and cultural transitions.
• Crime Insurance: Covers theft, including employee theft, which may increase during ownership changes.
• Cyber Insurance: Addresses potential control vulnerabilities during systems and access changes in ownership transitions.

Potential Coverage Gaps

• Coordination of Coverages: Fiduciary liability and D&O are claims-made forms requiring coordination between ESOP and former owner policies. This can involve Prior Acts Coverage, Extended Reporting Period endorsements, and Waiver of Change in Control clauses.
• ESOP Coverage Language: Existing fiduciary liability and D&O policies must be evaluated for their treatment of newly formed ESOPs. Some policies cover them, while others exclude them, necessitating awareness of policy differences.

Partner with an Expert

ESOP liability coverage is complex, the market is specialized, and underwriting scrutiny is intense. Expect to provide detailed and company-specific ESOP applications, multiple financial statements, and thorough documentation of ESOP valuations. Underwriters will deeply analyze share price volatility, financial condition, reputation, ownership structure, and more.

Retail agents are best served by partnering with experts in the ESOP space. DOXA has extensive expertise, strong underwriter relationships, and access to specialized resources to help agents succeed. By aligning with a knowledgeable partner like DOXA, retail agents can effectively navigate the complexities of ESOP coverage and capitalize on the growing market opportunity.