After successfully implementing an ESOP at Computer Protection Technology, Inc. (“CPT”) in 2018, Acuity was approached by the leadership team at CPT about potentially selling the business. A leading critical power service organization on the West Coast, CPT was approached by their most significant vendor who was looking to enter the service and maintenance end of the business. With no clear management succession plan having emerged post-ESOP and an already strong regional market share, the proposition of becoming a platform acquisition of a larger organization with deep financial and human resources was worth investigating. Based on trust developed during the ESOP’s initial planning, feasibility, and sell-side advisory process, the company turned to Acuity Advisors to help navigate the complexities of selling an employee-owned company to a strategic buyer.
Background and Challenge
Founded in 1986 and ESOP-owned since 2018, Computer Protection Technology, Inc. served as Southern California’s leading critical power service organization. Throughout its history, CPT continually and successfully grew a large list of customers seeking preventative maintenance of existing uninterruptable power supply systems, comprehensive installations of new systems, and 24-hour emergency response service to critical backup power issues.
During the fall of 2020, management was approached by their largest vendor and equipment supplier, Mitsubishi Electric Power Products, Inc., a wholly owned subsidiary of The Mitsubishi Group, regarding making CPT a potential platform acquisition that would provide them a strong penetration into the service market while also gaining invaluable access to the decades of industry knowledge present within many of CPT’s employees.
While it was apparent that Mitsubishi was the most logical buyer, we recognized that numerous challenges would be posed by selling to Mitsubishi that would not exist with other buyers. As a result and to maintain negotiating leverage while also satisfying the board of directors’ fiduciary obligations to ensure that the transaction they were recommending to the trustee was the best overall transaction that was possible, we ran a limited auction by contacting a limited number of other buyers. Two, in particular, were private equity-backed companies that were active in the space, but did not meet the financial parameters that Mitsubishi ultimately met. In the summer of 2021, a letter of intent was signed by both parties.
As a result of the pandemic and other factors, the power supply business, like many others, was experiencing uncertainty. New sales are usually the result of approved capital spending, which naturally stalled as companies attempted to safeguard cash as the COVID-related effects rippled through the broader economy. Preserving purchase price during due diligence was a critical issue in light of the fiduciary duty of the ESOP trustee to the participants. At the same time, we could not close the transaction prior to December 2021 due to a significant excise tax that would have been due if the company sold prior to the 3-year anniversary of the formation of the ESOP.
The negotiations and financial considerations became more difficult due to the possibility of the loss of certain business where CPT offered a competing product to Mitsubishi. The obvious fear was that by being owned by a competing manufacturer, some of CPT’s other vendors would no longer choose to sell through them. At the same time, supply chain issues throughout the industry put CPT’s results under increasing pressure. Through shrewd negotiations, we convinced the buyer to exclude any shortfall that resulted from their inability to deliver product from the earnings derivation and also omit any of the standard representations from the purchase agreement around supplier and customer issues.
Adding to the complexity of the transaction was the election of code section 1042 (tax deferral/elimination) by the selling shareholder in the 2018 ESOP transaction, which resulted in the seller and his children and brother being excluded from participation in the ESOP. In light of their key roles within the company, but exclusion from the ESOP, they were granted stock appreciation rights with the intention of providing commensurate benefit levels with their hypothetical participation in the ESOP. Given the short time that the ESOP was in existence and the requirement that they continued to be employed by the company post-transaction, we had to ensure that their long-term incentives were consistent with the original intent of the plan. Having served as a trusted advisor during the implementation of the CPT ESOP, Acuity Advisors was a natural fit to help the CPT management team address these questions while still delivering a great outcome for the employee-owners.
As will happen with the sale of most companies, unforeseen challenges presented themselves throughout the transaction, which without an assured and steady guide such as Acuity, could derail a transaction process. Understanding the buyer’s desire to vertically integrate and make significant inroads to the equipment maintenance and servicing business, Acuity strategically negotiated key terms, which ultimately limited escrows, representations and warranties, and downside purchase price adjustments from the buyer.
To illustrate this, although an LOI had been signed with the intent of closing the transaction during 2021, rigorous due diligence on the part of the buyer eventually required a delayed closing. This presented a challenge for CPT, as global supply chain disruptions during 4Q 2021 and 1Q 2022 significantly impacted trans-pacific transportation of equipment resulting in delayed installations. Having previously agreed to a trailing 12-month adjusted profit metric in the LOI, a critical issue quickly arose when the trailing 12-month was at risk of being shifted from the delayed closing. Acuity Advisors aggressively argued on behalf of the client that the fundamental value of the business was not compromised by the temporary impacts of the supply chain issues and as a result, a modified measurement period was agreed to along with various adjustments that further benefitted the company. Ultimately, this proved to materially improve the transaction economics and resulted in a headline multiple of trailing 12-month earnings well in excess of expectations.
Further complicating the transaction where Acuity leveraged its unique ESOP knowledge, the transaction required conversations with the trustee of the ESOP as well as third-party vendors to help ensure the eventual winddown of the ESOP would happen with limited complication and exposure. Acuity was able to navigate the needs and interests of the various parties to bring about favorable outcomes for CPT, incumbent company management, the ESOP trustee, the ESOP participants, and the buyer.
Over the remaining months until closing, Acuity Advisors coordinated the diligence process and participated wherever needed, which minimized distractions and let CPT management focus on running the business during the turmoil of supply chain disruptions. By the beginning of April, the transaction closed with the ESOP participants realizing significant proceeds considering the relative infancy of the ESOP.
Selling an ESOP company carries a number of challenges ranging from valuation to deal structure to the dispensation of the ESOP itself. In the current environment, these challenges are compounded by an unprecedented global pandemic and rapidly changing business conditions. Given the complex landscape and the many possible outcomes in the transaction, ultimately, the right result was reached for the employee-owners with the help of Acuity Advisors.