Author Archives: Timothy Schmitt

Alternative Liquidity Options: Leveraged ESOP

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Market Dynamics

M&A activity and public company valuations across the Defense and Government Services industry have rebounded from 2013 lows. Trump-related spending tailwinds in the DOD and IC sectors, in particular, should drive similar if not increased buyer interest in the sector in 2017 and 2018 once a more definitive spending plan is established. In many cases, however, the prevalence of small business set aside or other preferential contract awards for a government contractor negatively impacts their valuation or even eliminates the available buyer universe in a sell side process. This is especially true for companies that operate in historically small business friendly markets (e.g., Department of Education, Department of Energy) or lack differentiated capabilities and provide more commoditized service offerings with minimal barriers to entry. These firms typically have two options: (i) invest in business development resources, make strategic hires and attempt to transition the businesses into a full and open competitor over a 3 – 5 year time horizon, or (ii) evaluate alternative liquidity options, including a leveraged ESOP transaction.

Leveraged ESOP Overview

A leveraged ESOP enables the existing shareholders to sell all or a portion of their ownership to a trust and receive partial liquidity. The available cash at closing is driven by the amount of senior debt the Company can borrow to finance the ESOP. Certain tax attributes of ESOPs, as outlined below, can enable the Company to borrow more at closing from a senior lender than under normal circumstances. In a 100% ESOP transaction, the selling shareholders typically hold interest-bearing seller notes for the difference between the total Enterprise Value of the Company and the amount of senior debt available at closing. The Company acts as a plan sponsor, repays the senior debt and shares are allocated to employee accounts each year. Over time, as the senior debt is repaid (typically over 3 – 5 years), the Company can then repay the seller notes, often by refinancing the senior debt. After the ESOP transaction, the Company will retain its small business status (if it still applies in the relevant NAICS code) and will have the opportunity to pursue set aside awards in the future.

An example of the closing consideration for the shareholders of a $5M EBITDA company in a 100% leveraged ESOP scenario is summarized below:


Pros & Cons of a Leveraged ESOP

A carefully designed and executed leveraged ESOP provides partial liquidity for selling shareholders while increasing the ownership participation of management and employees. In a highly competitive government services recruiting environment, the opportunity to entice new hires with an ESOP retirement plan can often times be a distinguishing factor. There are extensive tax savings opportunities with ESOPs that are more thoroughly described below. The ESOP also allows for preserved operational autonomy, a greater certainty to close, and the opportunity to continue to bid on small business set aside procurements. The challenges with an ESOP transaction include partial liquidity at closing, a leveraged balance sheet, and the incremental costs and compliance requirements associated with an ERISA plan.


Tax Savings Opportunities

There are three primary tax attributes associated with ESOPs. The availability of these attributes depends on the entity’s tax status as summarized below.

  • Shareholders of C Corporations that sell at least 30% of their equity to an ESOP have the opportunity to defer capital gains taxes if they invest in qualified replacement property (“QRP”) 3 months prior to or 12 months after a transaction.
  • Corporations that have elected “S Corporation” status are flow through entities and there are no corporate level income taxes. All income and related tax liabilities reside at the shareholder level. Since an ESOP trust is a tax-exempt entity, there is no tax liability for the ESOP’s pro rata share of the income. Therefore, 100% S Corporation ESOP companies do not have any income tax liability, and can therefore typically service the debt borrowed in connection with the transaction in a more rapid manner.
  • Contributions to ESOPs are tax deductible for the Company making the contribution, up to certain limitation. This tax shield is particularly beneficial to C Corporation ESOPs and S Corporations partially owned by the ESOP trust.


An ESOP may be a good alternative if an outright sale is not achievable for a government contractor with a heavy reliance on preferential contract awards without a transition strategy to F&O status. Businesses with steady cash flows, strong management teams, large contract backlog and healthy borrowing capacities are ideal candidates, as outside financing is usually required to facilitate a shareholder liquidity event. Certain tax attributes of an ESOP-owned company can expedite the debt repayment and accelerate a selling shareholders full liquidity. The Company should have a sizable workforce and utilize direct labor (as opposed to subcontractors or 1099s) for a meaningful piece of the overall level of effort. Lastly, the opportunity for employees to be shareholders in their company can create a competitive edge in the highly competitive recruiting environment in the government services marketplace.

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Aronson Capital Partners Advises Force 3, Inc. on its Sale to Sirius Computer Solutions, Inc.

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force3-sirius-shadow-webAronson Capital Partners is pleased to announce the acquisition of Force 3, Inc. (“Force 3” or the “Company”) by Sirius Computer Solutions, Inc. (“Sirius”), a portfolio company of Kelso & Company. ACP served as the exclusive financial advisor to Force 3 in this transaction.

Founded in 1991, Force 3 is recognized across the federal sector as a leading cyber security and networking solutions provider. With approximately 170 employees and $260 million in annual revenue, Force 3 will strengthen Sirius’ solutions portfolio in the areas of information security, software-defined networking, secure collaboration, enterprise networking, and data center solutions. Mike Greaney, Force 3 CEO, remarked, “Combining forces with Sirius helps Force 3 take the next step in accelerating our vision. Together, we will extend our geographic reach, solution offerings and networking capabilities in an industry that is very dynamic and fast-paced.”

Sirius Computer Solutions was founded in 1980 and is headquartered in San Antonio, TX. It has approximately 1,700 employees and more than 5,000 active clients across the United States. As a national IT solution provider, Sirius partners with many of the same strategic technology leaders as Force 3, including Cisco, Citrix, Dell, EMC, NetApp, Palo Alto, Splunk, VMware – and is also IBM’s largest solutions provider worldwide. Sirius was acquired by Kelso & Company, a New York City based private equity firm, in 2015.

We believe this transaction illustrates several key trends in the government technology market:

  • The evolving cyber security threat continues to drive M&A interest in targets that have cleared engineering talent focused on securing the network;
  • There is renewed interest in federal acquisition targets by commercially focused buyers as the government accelerates the adoption of next generation technologies; and
  • Vehicle-rich targets with access to key IDIQs and GWACs command significant buyer interest, particularly as a platform investment to rapidly scale a federal business. Specifically, Force 3 is a prime contractor on NETCENTS-2, SEWP V, NIH ECS III, CIO-CS, and ITES-3H.

Aronson Capital Partners has served as a trusted strategic advisor for Force 3 for many years and has helped the Company navigate its growth strategy. Force 3 CEO Mike Greaney commented, “The Aronson team provided senior level thought leadership from start to finish and identified a large, commercially focused strategic buyer that will allow us to accelerate our growth strategy. Aronson’s insights, experience, and hands on style were invaluable to our success”.

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Aronson Capital Partners Cited – Harris makes $4.75B deal for Exelis

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Harris Corp. is buying Exelis in a $4.75 billion cash and stock deal that the company is calling mandatransformational.

The deal will significantly increase the size of Harris, adding $3.25 billion in revenue to Harris’ $5 billion in revenue. Headcount will grow to 13,000 to 23,000. The transaction is expected to close by June.

Adding scale was definitely one of the factors the drove the deal, according to Harris executives and industry analysts.

“The combination of the two companies’ highly complementary core franchises creates a competitively stronger company with significantly greater scale,” said Harris CEO and chairman William Brown.

Much of that scale will come in the defense market, where Harris adds Exelis’ strong position to its own. Sixty-one percent of Exelis customer base comes from defense customers. About 75 percent of Harris’ revenue is DOD and intell related.

Exelis and Harris also both have significant international and commercial sectors. Pre-acquisition, the

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Evaluating Contract Mix in Government Services M&A: SBSA & Subcontracts

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The majority of the completed Government Services transactions involve targets with annual revenue of less than $50M. This sector is incredibly fragmented, largely due to the government’s preferential awards, and it usually takes significant reinvestment and commitment of the shareholders to grow their business beyond this threshold. Therefore, most transactions involve targets with a contract portfolio comprised of (i) prime, F&O work; (ii) prime, small business set aside (“SBSA”) contracts or other preferential awards; and (iii) subcontracts.

We are often asked if it is easier to market and sell a business with prime, SBSA contracts or subcontractor work. Unfortunately, the answer is not clear-cut and is largely case specific based on the target company’s solutions and relationships.

All things being equal, a target with prime, F&O contracts will command greater buyer interest and a higher valuation than a firm with SBSA contracts and subcontractor work. These targets have proven that they can compete and win against the larger primes, which validates their future growth prospects, capabilities, customer relationships and competitive positioning. Moreover, there

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Key Observations from FireEye’s ~$1.0B Acquisition of Mandiant

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FireEye’s $1.0B acquisition of Mandiant marked the 2nd cyber security transaction in the past four months with a publicly disclosed valuation in excess of 9.0x TTM revenue. However, unlike Sourcefire, which Cisco Systems acquired in October 2013, Mandiant has more extensive ties back to the federal sector and a greater composition of services work (vs. products). Therefore, it is more relevant to take a detailed look into the drivers of this valuation and the implications for the government contracting community.

Mandiant was founded in 2004 and is the undisputed leader in security incident response management. The company received significant publicity in February 2013 after it published a report directly implicating China in recent cyber espionage attacks. However, prior to its publicized reports, the company was recognized across the cyber security community as the “Navy seal team” of cyber security breaches, and had secured equity investments from prominent private equity firms Kleiner Perkins Caufield & Byers and One Equity Partners LLC. Mandiant

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