I enjoyed this article from Middle Market Growth on the intersection of private equity investing and ESOPs. As the article points out, most people think of ESOPs as fully employee owned enterprises, but in fact there are partially employee owned companies where there is room for private equity investments elsewhere in the ownership structure and outside of the part of the company owned by the employees. The article speaks very favorably of these types of scenarios and notes that these types of transactions can greatly benefit the investment itself and the investment target, as well as the employees. I find this proposition wildly noncontroversial. As I have written elsewhere with regard to employee ownership, turning employees into stakeholders is beneficial to the particular company’s employees, to (as the article also points out) the company’s prospects and performance, and, in my view, to society as a whole.

However, one point not noted in the article is the need to ensure that these types of transactions treat the employees fairly and bring matching – and depending on the transaction identical – benefit to the employees as it does to the non-employee owners. I have litigated cases where that was not the case, and this is a quick route to expensive litigation involving the ESOP. For instance, in one of my cases, private equity bought the company through a structure in which both the employee stock holdings and the shares of the company’s other owners were acquired. Although the discrepancy, and the impropriety of it, was not obvious as it was buried within the nature of the transaction and obscured by the timing of different steps of the transaction, the buy out resulted in a higher purchase price being paid to the majority, non-employee owners than was paid to the employees for their share of ownership. This eventually led to litigation intended to rebalance the funds paid to purchase the company so as to eliminate the discrepancy.

It is important to pay attention to these types of details when private equity becomes involved in investing in an ESOP. Unlike a classic private company transaction, complete freedom of movement in designing the terms of a deal doesn’t exist with an ESOP, due to the obligations running to the ESOP itself and the employee owners.