Ep. 325 — Keith Apton & Miguel Paredes: ESOP Myths, 1042 Deferrals, Warrants, and How Executives Actually Get Paid

6 min read

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Episode Summary

You’re sitting on a company you’ve built for 20 or 30 years, and someone hands you two paths. Path one: sell to a strategic, take a check, pay the capital gains, and walk away from the culture you built. Path two: sell to an ESOP, defer the federal tax under 1042, keep running the business, carry a seller note with warrants that give you a second bite, and watch your key executives drive equity growth through stock appreciation rights. Most owners never get path two explained to them honestly, because their CPA, attorney, or banker has never done one and quietly steers them around it. This is part three of the four-part ESOP miniseries with Steve Storkin, and I brought on Keith Apton from UBS to break down 1042 (the ESOP equivalent of a 1031 exchange) and Miguel Paredes, founder of Prudent Fiduciary Services and a 12-year Department of Labor veteran who now sits on the trustee side. We got into how net proceeds on an ESOP can equal or beat a strategic sale over seven years, why warrants align the seller with the company instead of writing a guaranteed 12% interest check, and how stock appreciation rights (split between retention and performance) become the carrot that retains and rewards your key leaders. The honest caveat lands at the end: this only works if you believe your company has sustainable, predictable, transferable earnings and you still have fire in the belly to protect them.

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## Top 10 Takeaways
  1. Complexity isn’t a reason to skip an ESOP. It just means your incumbent advisors have never done one and are protecting their billing.
  2. On a $100M deal, the all-in transaction fees for an ESOP are usually equal to or lower than a third-party sale.
  3. An ESOP pays fair market value, not strategic value. A private equity buyer is also a financial buyer, so the gap is smaller than you think.
  4. Your net proceeds over seven years can beat a third-party sale once you add 1042 tax deferral, salary, seller note interest, and warrants.
  5. The trade-off is risk. A third-party sale de-risks you to 70% cash today. An ESOP pays more but back-end loaded over the note term.
  6. 1042 lets you defer capital gains by reinvesting into qualified replacement property, then borrow against it to get your liquidity back.
  7. You can flip an S-corp to a C-corp to elect 1042, then flip back to S after five years. Run the math both ways before defaulting to S.
  8. Warrants let the company pay a 6% coupon instead of 12% cash interest. The other 6% return only shows up if the company grows.
  9. Stock appreciation rights split into retention SARs (granted up front) and performance SARs (earned against targets). Both reward growth in equity value.
  10. None of this matters if your company doesn’t have sustainable, predictable, transferable cash flow and you don’t want to keep leading.

Sound Bites

“Complexity is resolved with clarity. The key is, before you make any big life decision, and selling a company is a life decision, we need to get the information.” (@TBD) — Keith Apton

“To do an ESOP, you need to believe that your company has sustainable, reoccurring, profitable earnings. And you have to have fire in the belly to want to continue to work to protect the profits.” (@TBD) — Keith Apton

“Let the math, let the modeling dictate the structure. Don’t let the simplicity or the ease dictate the structure.” (@TBD) — Keith Apton

“How is taking the keys from Jeff Bezos once we convert to an ESOP in the best interest of the employees? It just doesn’t make any sense.” (@TBD) — Miguel Paredes

“Warrants aren’t giving away 20% of the equity. All the stock is owned by the ESOP. This is a synthetic equity instrument that is purely an effective financing tool to provide an appropriate rate of return for a seller.” (@TBD) — Miguel Paredes

About This Episode

This is episode three of a four-part ESOP miniseries co-hosted with Steve Storkin, Executive Director of EOX (the Employee Ownership Expansion Network). Keith Apton runs the Capital ESOP Group at UBS out of Washington, D.C., and has built one of the leading ESOP advisory practices in the country on the sell-side. Miguel Paredes is the founder and president of Prudent Fiduciary Services, a national ESOP trustee firm based in Los Angeles. Before launching Prudent Fiduciary, Miguel spent 12 years at the Department of Labor’s Employee Benefit Security Administration overseeing ESOP enforcement on the West Coast, giving him a regulator-turned-practitioner perspective that very few trustees in the industry have.

Resources Mentioned

  • UBS Capital ESOP Group — Keith’s 10-person ESOP practice at UBS, based in Washington, D.C.
  • Prudent Fiduciary Services — Miguel’s national ESOP trustee firm based in Los Angeles. — prudentfiduciary.com
  • EOX (Employee Ownership Expansion Network) — Steve Storkin’s organization launching state centers to educate the U.S. on employee ownership.
  • ESOP Association National Conference (Las Vegas, November) — Where Miguel was speaking at the time of recording.
  • NCEO Conference (April 2023) — Where Miguel was scheduled to speak.
  • Internal Revenue Code Section 1042 — Tax deferral provision for ESOP sellers of C-corp stock, in place since 1986.

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