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99: CapEx, Real Estate, and ESOP Share Price

Recent episodes have contrasted EO and non-EO companies. Today we look at whether it's appropriate to make capital expenditures (CapEx) that result in a drop in share price, whether it's okay for an ESOP (the trust or the company) to own real estate, and what constitutes a prohibited transaction for ESOPs.

You can find the full, original version of this episode with a full transcript in our archives: Episode 40: Your ESOP Questions Answered.


Episode 99 Transcript

Bitsy McCann: 00:03 Welcome to The EO Podcast where we amplify and celebrate all forms of employee ownership.

Bret Keisling: 00:12 Hello, my friends. Thank you for listening. My name is Bret Keisling and as it says on my business cards, I'm a passionate advocate for employee ownership. In recent episodes of The ESOP and EO Podcast, I've been speaking about differences between employee owned companies -- ESOPs -- and regular companies. I've looked at WeWork and Grubhub and Under Armour and Casper Mattresses and have drawn distinctions between those types of businesses and employee owned companies. In my seven years as an ESOP trustee and in the time doing this podcast, we often get questions about whether an employee owned company can take certain actions or do certain things. One of the questions that comes up repeatedly is related to capital expenditures and share price. Another question that comes up quite frequently relates to whether ESOPs can own real estate and we draw the distinction between the trust that owns the shares and an employee owned company and then finally as a tie in Rich Heeter explains what a prohibited transaction is to get this episode. I've gone back to our archives. It was originally part of Episode 40 you can go back here the full episode there is additional questions and I remain grateful to my partner Rich Heeter at Capital Trustees and my son Brian Keisling who was producer at the time. He'll ask the questions. I hope you find this episode informative. Feel free to check the entire archive at Episode 40 which is available on with that we go about 18 months into the past with Rich Heeter and Brian Keisling and myself. Hope you enjoy.

Brian Keisling: 02:03 My company wants to make a $3,000,000 capital expenditure that we think will result in a lot of new business. But if we take on debt to finance the plans, the share price will decrease. Can management make certain decisions even though they know it will result in a decreased value?

Bret Keisling: 02:19 Yes. Brian, this is a question that comes up quite frequently and we think it is an important question. And where the confusion comes in is what is meant by the duty to preserve share value, or protect it, and that sort of thing. And generally speaking, businesses all the time are going to come up with expansion plans and where the confusion in employee owned companies seems to be is that if you take on debt and it's going to result in a reduction in the share price, is it appropriate or are you undercutting the share price among the employees? Further, it gets a little bit complicated. Let's say that you take, I think the question had a $3,000,000 example and you make this expenditure a year or two before someone's going to retire. The share price gets decreased as a result of the ongoing debt and someone just coincidentally is retiring during that decreased share price. Is that, quote unquote, "unfair" to that participant? And one of the things that we have to do is remember that before employee owned companies are ESOPs, they're companies, they're businesses, and there are all kinds of decisions that businesses are going to make that may have an effect on share price, but the share price is a temporary barometer to a long-term picture. So if you are a manufacturing company and you come to us as the trustee and you don't have to come to us as trustee, I'm just saying that if you did and said, hey, we want to make this $3,000,000 investment and over the course of 10 years we think it's going to bring us $10,000,000 worth of, of, of return on the investment through increased sales and increased productivity, etc. But there's going to be a couple of years share a price decrease because of the debt. Our response is going to be, by all means, make that investment. It's a solid business investment and the fact that there's a couple of years where there will be an increase in share value is necessary. Otherwise you avoid the decrease in share value, but also avoid the increase that comes from that capital expenditure. Rich, do you agree?

Rich Heeter: No, that's a very good point.

Bret Keisling: Where we come in and where we caution, and again, this is one of those outliers that I don't know that we've ever personally seen it with our clients, but management can't make a decision that is designed to decrease share price. So for example, if a management team is looking at a repurchase obligation problem or a diversification problem in terms of the costs of it and they say, hey, if we borrow $3,000,000, that will depress the share price so that we don't have to pay so much and repurchase obligations, we would shut that down in a heartbeat. That's not an appropriate use, but just decisions that are made in the regular course of business that are going to have an up and down effect. That's just business.

Rich Heeter: Right. There's a lot of decisions that because of as a result of the decision, it will impact share value, many times temporarily. It's a little different when, when the company decides to make a decision to transact with other, you know, for additional shares, let's say with the ESOP, because in that case the value will go down if they're going to incur debt to do it, but there's not a corresponding asset per se that that's going to increase value or revenue. Where in the example that was provided, it was a $3,000,000 investment of capital into the company for its operations as opposed to $3,000,000 of capital leaving the company.

Bret Keisling: For a retirement party for a popular upper management. That would be problematic.

Rich Heeter: Right.

Bret Keisling: That's not what we're talking about here.

Rich Heeter: Right.

Bret Keisling: Yeah. Excellent.

Brian Keisling: 06:29 Our next question asks I've heard at conferences that ESOPs can't own real estate. Is this true? And if so, why would there be such a rule?

Bret Keisling: This is one of the areas Brian, that is born from confusion and there are a couple of different components of the confusion. First off, we need to differentiate between "the company" and "the trust." There's - Rich, can you explain the qualified securities as it relates to what the trust can own?

Rich Heeter: So, in an ESOP the plan is designed to predominantly hold qualified employer securities, that is the common stock of the sponsoring company or preferred convertible stock sometimes. So, but many times the trust will hold other assets, as part of the plan, such as cash. Many times it will hold, it can hold, other individual stocks as part of the diversification of the trust's holdings once all the stock has been allocated in there and additional cash contributions have been made. you want to invest that cash so it will be invested in other stocks. It could be mutual funds, it could be insurance, just about anything that's an allowable investment of a retirement plan can be held there. And real estate is one of those assets. Whether or not it's a good idea is another question, and whether it should hold it or not versus whether it can hold it and whether it should be at the trust level or should it be at the company level.

Bret Keisling: And Rich, and I have a little bit of a different view at least until we meet in the middle. I happen to think that if a founder of a company or a sole shareholder at a company would buy the property that we often see - and they're often set up in a different entity for liability reasons, legal reasons, tax reasons, whatever - but if it was good for an individual who is an owner, then it's good for ESOPs as well. But there's a big caveat there. Let us say that you are a large insurance brokerage and we happened a couple of years ago to sell one of these. That was a fairly large company. And let's say that they had happened to own their real estate. Well, if they own a three or four story building that houses their company and the office has worked from there, to me, that can be a very prudent way to avoid rent, etc., etc. If on the other hand, this company that needs three or four floors worth of offices goes out and buys a 12 story building now they're a landlord, now the value of the ESOP could go down because they don't have tenants, they don't have, you know, things that are completely unrelated to traditional operations there, to me, it gets to be more speculative than would be appropriate for an employee owned company.

Rich Heeter: Yeah. I think in one case you're, you're, you're talking about, you know, the possibility of, of exchanging, having ownership in lieu of paying rent so you have an asset offsetting what you would've paid. So it's going to kind of wash in your value many times versus being as I think as you said, as a landlord and having it been primarily an investment property.

Bret Keisling: And we have, Rich, a couple of clients who have that scenario. Not prohibited and our clients do it as well as they can. We just point out if you take the example of the insurance brokerage, kind of taking you off your game, you know. Now you are a landlord with everything that entails. So there is no hard and fast prohibition from owning real estate. That is a misnomer from the conferences that does come up. However, just because it's permissible does not make it a necessarily a good idea or a good idea in every circumstance.

Rich Heeter: It comes down to a, say, like most things in life and in business, it's a facts and circumstances.

Bret Keisling: Yep.

Brian Keisling: 11:13 All right. Our next question is another one that gets straight to the point. What are prohibited transactions in relation to ESOPs?

Rich Heeter: That's an interesting question. So there's a number of what was determined to be prohibited transactions and there are certain exemptions as it, from the prohibited transaction rules as it pertains to ESOPs. The prohibited transactions are put forth, the rules are by the IRS, and the penalties associated with them, as well as the Department of Labor. So prohibited transactions in regards to ESOP include any direct or indirect sale exchange, lending of money, extension of credit, various other transactions between a qualified plan, which is what an ESOP is, and a quote "disqualified person," which is a person with any of certain relationships to the plan such as an owner, selling shareholder, company director that can be deemed to be a "disqualified person." So if you were to enter into a prohibited transaction, there's tax penalties associated with that. One of the prohibited transactions under ERISA is a qualified retirement plan can't buy its own employer securities to be held in the plan, however ESOPs get an exemption from the prohibited transaction rules which allows them to purchase those employers securities. Otherwise, it would have been - you wouldn't have ESOPs - because obviously a ESOPs are designed to hold primarily employer securities. The other thing that you, that would result in a prohibited transaction, and this is probably the one that we see the most of, is the overpayment of the purchase price to a party of interest in a transaction. So, the majority owner of a company that's going to do an ESOP transaction is determined, let's say in this case, that the company is worth $5,000,000, decides to do a 100 percent transaction. And during the course of that transaction based on the valuation that's on behalf of the fiduciary or the trustee, in this case, it's determined that the value is $8,000,000, and the trustee enters into that agreement and pays the eight, pays the $8,000,000 for those shares. And then ultimately upon investigation or audit, it's determined that they overpaid for those shares. There was, you know, there could have been any number of errors that were, that were done that the trustee relied upon to come up with that number and their valuation advisor. And it's determined that they overpaid by three million dollars in this case, that would result in a prohibited transaction. There would be penalties and fines and excise tax, and it could, could ultimately caused the plan to become a disqualified in extreme cases.

Brian Keisling: 15:17 And who are those penalties and fines paid to - is it the Department of Labor? If there was too much money paid in a transaction, does that get balanced out at all? How does that get dealt with?

Rich Heeter: 15:29 So there's a couple different provisions. So there's the excise tax is paid to the IRS in the prohibited transaction guidelines. There are also, depending upon what the, what the nature of that prohibited transaction is, can result in fines and penalties and charges by the Department of Labor as well. So it could be a multi-pronged penalty and fines being assessed, and it can be assessed against the trustee, can be assessed against the company. It depends who was involved in the transaction. So who the party of interest was that did the transaction. So prohibited transactions, not a good thing. That's why they're prohibited. Because they're trying to make sure that everything is done in solely for the best interests of the participants and the beneficiaries as it relates to an ESOP.

Bret Keisling: 16:52 All right, my friends with that, we'll bring this episode to a close. Again, I appreciate Rich Heeter and Brian Keisling of Capital Trustees. If there's questions that you have about ESOPs specifically or employee ownership, please visit I'm very proud, particularly with ESOPs, that we've covered almost every issue possible. And if you do a search, you should be able to find something there. We're starting in the last six months to be as robust on employee ownership, but that's going to take a little bit of time, but we hope if you have questions, you'll visit our website or reach out and pose the questions to us. We're always looking for new things to talk about on the podcast. Here's Bitsy McCann to tell you how to contact us and to give the closing credits. Thanks again for listening. Have a great day.

Bitsy McCann: 17:43 We'd love to hear from you! To contact us, find us on Facebook at KEISOP, LLC and on Twitter @ESOPPodcast. To reach Bret, with one "T", email, on LinkedIn at Bret Keisling, and most actively on Twitter at @EO_Bret. Again, that's one "T". This podcast has been produced by The KEISOP Group, technical assistance provided by Third Circle, Inc. and BitsyPlus Design. Original music composed by Max Keisling, archival podcast material edited and produced by Brian Keisling, and I'm Bitsy McCann.

Standard Disclaimer: The views expressed herein are my own and don't represent those of my own firms or the organizations to which I belong. Nothing in the podcast should be construed as guidance or advice of any kind in any field and the fact that I mentioned an organizational website or an advocate or a company on a podcast does not reflect an endorsement, but if you've heard your name or your group's name mentioned on this podcast, I'd love to have you come on and talk about it yourself.


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