Employee Stock Plans See Rebirth as Market Stumbles.

ESOPs are back.

The employee stock ownership plan was something of a hit a generation ago. And even today there are certain giants, such as rental car giant Avis, that employees own under an ESOP.

The plans have some interesting attributes, the basics being that an ESOP provides an exit strategy for sellers, while incentivizing and providing a modicum of job security for employees.

But with the high market valuations on Wall Street and elsewhere for the past decade, ESOPs had fallen out of favor.

"It's tough to do an ESOP if an owner can go public, or sell to a public company willing to pay 25 times earnings," said Larry Hurwitz, chairman of the downtown Los Angeles-based national business valuation firm Marshall & Stevens Inc. But now, the IPO market is dead, and public company currency - stock - is getting cheaper. Moreover, banks are chintzy today when lending to leveraged buyout firms, so the LBO market is a snail, too.

"But banks are more than willing to lend to an ESOP," said Hurwitz. "We expect to do about 25 to 30 ESOPs in the greater Los Angeles market in the next year. We are doing one right now."

(On such deals, Marshall & Stevens does the valuation work, while Hurwitz hustles up bank financing through his Lawrence Financial subsidiary, he said.)

ESOP deal sizes start at $7.5 million, said Hurwitz, although the brokerages -- especially UBS Warburg-PaineWebber - tend to move in when values get much above $50 million.

Banks will lend to finance an ESOP buyout and not an LBO due to the unique structure of the employee plan. First, the ESOP deal is taxfree, so owners can sell for about 30 percent less, noted Hurwitz. In general, an ESOP will buy a company for about seven times earnings, or 10 times EBITDA (earnings before interest, taxes, depreciation and amortization). And banks like financing cheaper deals, with less leverage.

Second, the proceeds of the ESOP sale are typically invested in government securities and doled out by the bank at a measured pace to the seller, if the company performs. That gives the owner a reason to not sell a dog-in-the-making. If the business craps out, the banks, seize the seller's collateral -- the government bonds.

Third, some academic studies have shown that ESOPs do well, probably because employees do realize their stake in the outcome. There are some advantages for owners as well.

"They can sell only a minority, such as onethird of the company, if they want to," said Hurwitz. 'They can keep control, but monetize some of their wealth."

ESOPs tend to work better when employees are routinely kept informed about their ownership and the value of their stake in the company.

"It's not enough to just give them (employees) a paycheck," Hurwitz said. "A monthly statement, showing their shares and values, is important."

An annual independent evaluation of the value of the company - and thus the value of employee shares - also helps workers feel their stake is meaningful, not esoteric.

In general, employees "cash out" either when they retire or leave the firm, if they have been vested.

Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal.