Optimism should be in sight. As spring has set in, COVID-19 infection rates are dropping dramatically and recent variants have proved less devastating.
Unfortunately for the skilled nursing industry, there is no time for celebration, as the industry faces the harshest staffing headwinds in its history. Nearly 238,000 employees, or almost 15% of the total workforce, have left the industry since the start of the pandemic, according to Bureau of Labor Statistics data. The recently proposed reform package from the White House, with a focus on minimum staffing requirements, will not ease these pressures.
Accordingly, skilled nursing owner-operators are increasingly seeking differentiators that may enhance their employee recruitment and retention efforts. One alternative that is becoming increasingly popular is the use of employee stock ownership plans (ESOPs) – a creative financing solution for owner-operators, particularly those considering legacy planning or strategic alternatives such as a sale.
The concept of an ESOP as a strategic alternative transaction structure for skilled nursing owner-operators started to gain in popularity prior to the pandemic. Even then, the merits of an ESOP were clear – a fair market valuation, a path to liquidity, estate planning and tax advantages, and management and employee retention.
The element of employee ownership inherent in the ESOP structure is especially conducive to the skilled nursing sector, as the labor-intensive profession requires staff be fully committed emotionally and physically, and the ESOP can further that commitment with a financial incentive. As staff commit to driving the success of the business, they will be rewarded with healthier investment accounts.
How it works
The existing shareholders sell to a newly formed ESOP – if the sale includes the real estate, outside debt can be used to assist in funding the transaction; if the sale is only the operations, seller financing is often used. Each participating employee receives an allocation of equity shares as the debt from the company is repaid. The employee’s shares will vest over a certain period and the share value tracks the performance of the company. As the value of the company increases – which occurs as the equity value grows as the debt is repaid, and cash flows of the company increase – the value of the shares increases.
The recruitment and retention benefits of an ESOP span virtually all employees, from C-suite executive leadership to management to facility-level employees. For key executives, it is typical that a robust incentive compensation package is negotiated and structured as part of the ESOP.
Changing lives
In a recent sale of an ESOP-owned skilled nursing company, a mid-level employee planned to retire following the sale. She was expecting to receive approximately $10,000, but ultimately received more than $50,000 due to the appreciation of the share value – a “life-changing event” she described it, coupled with tears of joy.
As a result of the ESOP, employees and management begin to think and act like owners. Studies suggest that employee engagement, motivation and retention increase in ESOP companies, as employees focus not only on their daily tasks but also on the top and bottom lines of the business.
Benefits beyond staffing
In addition to the employee retention benefits, the ESOP structure provides more certainty of close while still providing a fair market valuation, especially for companies that do not own the real estate. Further, the ESOP structure is flexible and customizable based on the objectives of the current owners. The structure can be a minority, majority or full sale. The transaction can also occur in phases over time. This is particularly useful if shareholders have different objectives (such as some desiring liquidity and others desiring continued equity upside), as not all shareholders must sell.
In addition, there are corporate and capital gains tax advantages. S-corporations that are 100% owned by an ESOP are fully exempt from federal income tax. Further, sellers may elect a Section 1042 rollover allowing them to defer capital gains by reinvesting the principal proceeds in a qualified replacement property (i.e., stocks and bonds), which will receive a stepped-up basis and completely avoid capital gains tax if certain conditions are met. Philanthropic gifting can be structured with an ESOP as well.
The pandemic has exacerbated the challenges of an already tight labor market across the industry, with the most difficult operating environment in history prompting providers to search for creative solutions to drive employee recruitment and retention. In this environment, the ESOP should be considered one of the most compelling financial and strategic solutions available.
Laca Wong-Hammond, Managing Director & Head of M&A for Lument, is in charge of business development and management of the firm’s sell-side, buy-side, and strategic advisory services to owners and operators of senior care and seniors housing, as well as across the healthcare, housing, and commercial real estate continuums.
Dominic Porretta, Vice President – M&A for Lument, works in tandem with the firm’s healthcare bankers for both sell-side and buy-side transactions, providing transaction oversight, maintaining buyer and client relationships, and creating and improving processes and analytical models.
The opinions expressed in McKnight’s Long-Term Care News guest submissions are the author’s and are not necessarily those of McKnight’s Long-Term Care News or its editors.
