Stocking Up

You get more than financing when you tap your 401(k) to buy stock in your business.
Magazine Contributor
8 min read

This story appears in the April 1997 issue of Business Start-Ups magazine. Subscribe »

After nearly 20 years in sales and for a large manufacturer of printed forms, labels and electronic systems, Jim O'Brien was getting antsy. The he was writing in his head was getting more and more detailed. And when the future of the company he was working for began to seem less than certain, O'Brien, along with five fellow salespeople--Paul Hoffman, Jeff Porter, Mike Ryan, John Talaga and Sue Sharkey (pictured, left to right)--made the jump to form Print Management Partners Inc., a Des Plaines, Illinois, company that, not surprisingly, brokers printing services and also offers electronic printing and forms-management services.

O'Brien's business plan showed the company needed about $500,000 during the first year of operation for office equipment, an of forms, and to fund receivables. In theory, Print Management Partners was ready to roll, but O'Brien wasn't ready to hold the grand opening until he knew the business could be funded.

"I thought it would be a big mistake for us to launch headlong into the business without any funding," he says. "At the time, the biggest asset I had was the 401(k) plan from my previous employer, so naturally, my first thought was to see what could be done with that." In fact, all the newly minted Print Management partners had 401(k) plans, and, in the aggregate, these had more than enough assets to fund the business. The trick was unlocking the funds.

"The way I saw things was that a 401(k) plan can buy stock in any company," says O'Brien, "so why not directly from my own--or, better yet, through an Plan [ESOP] established by Print Management Partners? This was the safest investment we could make because we understood the business inside and out and had control over its destiny." But everybody O'Brien talked to, including investment bankers, brokerage firms, attorneys and financing consultants, said it couldn't be done because 401(k) plans are restricted to purchasing shares in publicly held .

Of course, O'Brien and his partners could have liquidated their 401(k) plans. But, he says, there's a steep penalty right off the top, and the distribution from the liquidation must be reported as income in the year in which it is received. A good-sized distribution will push the recipient into the higher end of the thirtysomething-percent tax bracket. No, thank you!

The litany of no's gnawed at O'Brien. After all, an ESOP was the most democratic way possible to run a company. How could laws be on the books to prevent employees from furthering the cause of their own company?

But one day, instead of hitting the brick wall, O'Brien walked right through it when he talked to attorney Greg K. Brown, an ESOP specialist in the Chicago office of Oppenheimer, Wolff & Donnelly. With little fanfare, but a great deal of confidence, Brown said the deal could be done.

Draft Picks

Brown counseled O'Brien that while the transaction could be done from a legal perspective, it would require assembling a highly specialized team of financial professionals for all the moving parts. Looking back on the transaction, O'Brien says putting this team together took no small amount of time and skill.

The first decision--which attorney?--was easy since Brown was an ESOP specialist and the only lawyer who had assured O'Brien the transaction could be completed. Brown's task was to serve as the architect of the ESOP. He not only had to draft the documentation that created the ESOP but also had to define and engineer the relationship of the ESOP to the 401(k) plans held by each of Print 's founders.

Next, O'Brien needed an evaluation specialist. Specifically, if the ESOP was going to purchase common shares from Print Management Partners, it needed a qualified opinion about what those shares were worth. For public , this is not an issue since the shares are valued every day by the trading that occurs in the market. But with a private company like Print Management Partners, it's not so cut and dried.

O'Brien selected Greg Heebink of Brownstone Associates Inc., a financial consulting company in Milwaukee. While competence is certainly a factor with any evaluation specialist, so too is chemistry because the valuation consultant must rely on input from the company's officers and shareholders to do his or her job correctly. If they can't see eye to eye, the job can't be done. With Heebink, the chemistry was good.

Next, O'Brien needed a brokerage firm to act as the custodian for the ESOP stock. O'Brien chose Smith Barney. For this old-line brokerage firm, O'Brien's deal represented a perfect way to make some money the old-fashioned way. After all, Print Management's current and future employees would need to either establish or roll over their 401(k) plans somewhere--and if Smith Barney was already the custodian of the ESOP, it would have an edge in getting Print Management's 401(k) , too.

Finally, O'Brien needed a good accountant. "Who doesn't?" you say. But with an ESOP in the picture, the tax issues are even more complex. "We wanted a partner on board who could help us think through the strategic issues on an ongoing basis," says Brown. Incidentally, O'Brien also needed a 401(k) administrator to keep track of employees' stock purchases. Accountant Jeff Weidner of The Accountants Group Inc. in Lincolnshire, Illinois, also an ESOP specialist, filled both roles.

By April 1996, about four months after Print Management Partners was incorporated, all the pieces were in place and the transaction could be executed. O'Brien and his partners then instructed Smith Barney, the custodian of their 401(k) plans, to purchase shares in the Print Management Partners ESOP, for which it was also custodian. As a result, cash ($427,000 in total) went from each 401(k) to the ESOP and from the ESOP into Print Management Partners' bank account. Then stock certificates in Print Management Partners were issued to the ESOP in the names of each employee making the investment.

Tricky, yes, but when it was all done, O'Brien and his partners had successfully tapped their 401(k) plans without any tax consequences, funded their new company without giving up equity or bringing in outsiders, and kept the balance of their savings intact.

Pros And Cons

When reviewing the transaction, O'Brien is quick to point out that the structure Print Partners and its team engineered had merit well beyond the initial financing.

First, with an ESOP in place, Print Management Partners now has an effective tool to attract, retain, give incentives to and reward employees, with several options for accomplishing any of these objectives. For instance, Brown says, "commencing in 1997, we are issuing ESOP stock to everyone in the company so everybody has a stake in what the company is doing." That's the incentive.

As for the reward, says O'Brien, "we have the option, for example, of passing profits to stockholders via 401(k) matching [contributions], without it being taxed. There are now several options we have to manage profits and pay a fair tax."

Second, O'Brien points out that the ESOP delivers built-in liquidity for company shares. "The reason most private businesses rarely last more than one generation is because there is nobody to buy out the founders or other stockholders when they are ready to retire or move on," he says. "But the ESOP means the exit strategy is already in place because when shareholders leave, they have the option of selling their holdings to the ESOP at a fair price."

Third, O'Brien says, Print Management Partners was able to fund its start-up operations without searching high and low for outside investors who would extract a high price in terms of ownership in the company. In the end, Print Management Partners didn't give up any equity--no small feat for a start-up company.

All of this esprit de corps seems to have paid off for Print Management Partners. After its first full year in , the company reported profits on sales of nearly $4 million. And for 1997, O'Brien anticipates double that.

But in addition to Print Management's future success, O'Brien hopes the company's trail-blazing technique will help other would-be entrepreneurs cut loose from corporate America with nothing more than a pat on the back, some severance pay and a 401(k) investment. For these people, finding seed capital for a new venture is akin to being Dorothy in Oz. Their solution is always with them--they only need to click their heels twice.

David R. Evanson, a writer and consultant, is a principal of Financial Communications Associates in
Ardmore, Pennsylvania.

Contact Sources

The Accountants Group Inc., 101A Schelter Rd., #202, Lincolnshire, IL 60069, (847) 634-3990;

Brownstone Associates Inc., 250 E. Wisconsin Ave., Milwaukee, WI 53202, (414) 225-5860;

Oppenheimer, Wolff &Donnelly, 180 N. Stetson Ave., 45th Fl., Chicago, IL 60601, (312) 616-1800;

Print Partners Inc., 640 Pearson St., Des Plaines, IL 60016, (847) 699-2999.


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