Dividends

Dividends correspond to the portion of earnings available for distribution after paying all taxes and accounting for all net reinvestment in the business. Mature FinTech companies and banks that are generating earnings consistently will want to consider their dividend policies. Below we list a few common dividend policies for companies and the types of companies that most benefit from having those policies.

1. No Dividend Paid at All. Companies paying no dividends include those that pay no dividends ($0 in dividend payments) and S corporations whose shareholders/members/partners receive no economic dividend as they only receive distributions sufficient enough so that they can pay their pro‐rata share of the taxes owed.
2. Sporadic, Onetime, or Special Dividends. Companies with this type of dividend policy typically pay a dividend for specific reasons applicable at the time the dividend is paid. For example, the company may have volatile earnings depending upon the business cycle or an extremely profitable period or unusual, nonrecurring income that results in a special or onetime dividend.
3. Targeted Dividend Payouts. Companies paying targeted dividend payouts typically have either a target dividend payout ratio (e.g., 40% of after‐tax earnings), a targeted dividend yield (2% of the concluded value of the business), or a constant‐dollar dividend (i.e., $2 million dividend per year).
4. Spinout or Spinoff of Subsidiaries or Assets. Companies that spin out or spin off subsidiaries or assets take some subsidiary or division of the company and create a separate operating company. Interestingly, there have been a number of famous spinoffs of FinTech companies. One FinTech example is eBay and PayPal, but there have been others, including a number of payments companies that have been spun out of retail banks.
5. Some Combination of Items 1–4.

For banks, the question of whether to reinvest in the business or distribute cash is often uniquely different than for those FinTech companies. Often, banks are mature businesses that tend to have more limited growth prospects compared to FinTech companies, which leads them to often return cash flows and capital to shareholders in the form of dividends. For FinTech companies, the growth prospects are often higher than their traditional bank counterparts, and thus they often have more opportunities to create value through forgoing dividends and reinvesting earnings in capital projects that generate returns in excess of their cost of capital. However, mature banks do have the opportunity to take a portion of the cash flows generated and invest in these FinTech companies, or in their own technology groups to develop platforms that can capitalize on the potential growth within FinTech and ultimately create value for their institution.

Share Repurchases

Share repurchases may be a more favored use of capital than shareholder dividends when shareholders have diverse preferences in terms of what they desire for their shareholder return. For example, share repurchases allow those shareholders looking to sell their interest for whatever reason to be able to sell and then the remaining shareholders can benefit from capital appreciation following the repurchase. In order to facilitate repurchases, though, there must be a price that is deemed fair to both those selling shareholders and the remaining shareholders as well as cash flow available from the company to repurchase. Should the price paid for the repurchases be too high, then the selling shareholders benefit at the expense of those who remain after the repurchase. If the price paid is too low, then the remaining shareholders benefit at the expense of the sellers.

Employee Stock Ownership Plans (ESOPs)

Another potential alternative to enhance liquidity is by selling a portion of the company to managers and employees through an Employee Stock Ownership Plan. ESOPs are often an important omission in the boardroom as a number of companies lack an understanding of the possible ways that an ESOP can solve a number of strategic and liquidity issues. ESOPs provide one option to maintain independence and enhance stock liquidity absent an outright sale or an IPO. ESOPs are a written, defined contribution retirement plan designed to qualify for some tax‐favored treatments under IRC Section 401(a). While similar to a more typical profit‐sharing plan, the fundamental difference is that the ESOP must be primarily invested in the stock of the sponsoring company (only S or C corporations).

ESOPs can acquire shares through employer contributions (in either cash or existing/newly issued shares) or by borrowing money to purchase stock (existing or newly issued) of the sponsoring company. When compared to other retirement plans, the ability to borrow money to purchase stock is an attribute that is fairly unique to ESOPs. Once holding shares, the ESOP obtains cash via sponsor contributions, borrowing money, or dividends/distributions on shares held by the ESOP. When an employee exits the plan, the sponsoring company must facilitate the repurchase of the shares, and the ESOP may use cash to purchase shares from the participant. Following repurchase, those shares are then reallocated among the remaining participants.

While ESOPs or some variant of them may be prevalent in other countries and their tax attributes will vary depending upon the country, ESOPs can potentially provide significant tax benefits here in the United States and we will discuss those briefly. Similar to other profit‐sharing plans, contributions (subject to certain limitations) to the ESOP are tax‐deductible to the sponsoring company. The ESOP is treated as a single tax‐exempt shareholder. This can be of particular benefit to S corporations, as the earnings attributable to the ESOP's interest in the sponsoring company are untaxed. The tax liability related to ESOP plan holder's accounts is at the participant level and generally deferred similar to a 401(k) until employees take distributions from the plan. When leverage is involved (i.e., the ESOP borrows money to purchase shares), the potential tax benefits can be extremely large as the ESOP is able to effectively deduct (and get the associated tax benefit on) both principal and interest payment.

Both publicly traded and privately owned companies (C or S corporations) can sponsor ESOPs, but the benefits are often more profound for private institutions that are not as actively traded because the ESOP can promote a more active market and enhance liquidity more for the privately held shares.

An ESOP can help to solve a number of strategic issues, including the following:

• Facilitating Stock Purchases and Providing Liquidity Absent an Outright Sale/IPO. ESOPs can help create an “internal” stock market. By creating an “internal” stock market, the transaction activity between existing shareholders and the ESOP, which serves as a buyer, can promote confidence in stock pricing. For C corporations, the selling shareholder may even have the ability to sell their shares in a tax‐free manner subject to certain limitations.²
• Providing Employee Benefits. ESOPs can provide a beneficial tool to reward and attract key employees. ESOPs offer the benefit of stock in the company absent any direct cost to the employees by providing them with common stock. The structure of ESOPs varies, but ESOPs typically tie rewards directly to the long‐term performance of the company. A recent study by Ernst & Young found that the total return for S corporation ESOPs from 2002 to 2012 was a compound annual growth rate of 11.5 percent compared to the total return of the S&P 500 over the same period, which was 7.1 percent.³ The measure of S corporation ESOP returns considers cumulative distributions as well as growth in value of net assets and the net of those distributions (i.e., growth in the underlying value per share).
• Creating Long‐Term Shareholder Value by Properly Aligning Incentives between Employees and Shareholders.
• Augmenting Capital. While it typically occurs more slowly than through a private placement or a public offering, an ESOP strategy can provide certain tax advantages that can help to build capital and/or pay down existing debt.

Despite the potential benefits to an ESOP, there are some potential negatives to them. Here we have listed a few:

• Plans are regulated primarily by the Department of Labor and also the IRS (Internal Revenue Service) can review plan activities.
• The sponsoring company will need to have sufficient cash flow to be able to provide contributions to the ESOP so that the ESOP can manage its repurchase obligation as the ESOP participants receive cash (not stock) for their vested retirement plan payouts.
• There are some administrative costs with setting up and maintaining the plans.
• An ESOP can spread ownership/transparency to the employee base, which for some companies can be viewed as a negative.
• There can be some dilution to the existing shareholder if newly issued shares are purchased by the ESOP.

For those considering an ESOP, the first step is a feasibility study of what the ESOP would look like once implemented at your company. Parts of the study would include determining the value of the company's shares, the pro‐forma implications from the potential transaction/installation, as well as what after‐tax proceeds the seller might expect. This will help to determine whether the company should proceed, wait a few years to implement, or move to another strategic option. There are typically a number of parties involved in implementations, including, among others, the appraiser/valuation provider, trustee, attorney or plan designer, and administrative committee.

Initial Public Offerings (IPOs)

Initial public offerings offer another way for shareholders of private companies to achieve liquidity. Typically, the private company transforms to a public one after completing the public offering as the shares are sold to institutional investors and then to the public after being listed on an exchange. The motivation for initiating an IPO is not always to achieve liquidity for shareholders. Other motivations can include raising capital or expanding access to capital for the company. One offset to these potential advantages for shareholders is that IPOs can be relatively costly to undertake the process and public companies are often required to disclose greater financial information to the public on an ongoing basis (which can also be costly to provide and comply with disclosure requirements).

The IPO of Netscape, a computer services company that was relatively well known for a web browser that it created, in the mid‐1990s was a seminal moment in the technology industry. Netscape was founded in April 1994 and in approximately 18 months had an extremely successful IPO despite not yet being profitable. The IPO was initially priced at $14 per share before being offered initially at $28 per share and then closing at $58.25 per share, which implied a valuation for Netscape at roughly $3 billion, at the end of the first trading day.

Due to its rousing success, Netscape's story received widespread attention and generated significant proceeds for many of its early investors and employees, including a book written by Michael Lewis entitled The New New Thing (W.W. Norton & Company; January 6, 2014). Netscape's story provided a template for many technology entrepreneurs and investors to follow. Netscape's template basically became the playbook for a number of technology companies, and its strategy was relatively straightforward: develop a blueprint for a technology solution that can be applied to a large potential market, pitch the blueprint to the venture capitalists, raise money, gather the team, execute the business plan and develop the product, and then prepare for an exit in the form of either an IPO or strategic sale. Ironically, though, this template seems to be met with resistance by some entrepreneurs today. Even Marc Andreessen, one of Netscape's founders, has been on record downplaying the role of the IPO in today's market environment.

A number of technology companies and entrepreneurs have attempted to follow Netscape's track and develop their technology platforms and business models, including a successful IPO as their primary exit strategy. However, that has started to change somewhat in recent years as technology IPOs have faced increased levels of scrutiny and many private companies are staying private longer as ample funding has been available, limiting their need to undertake the time‐consuming and costly process to access capital and liquidity in the public markets.

While FinTech is an emerging and growing industry, there are examples of FinTech IPOs. Table 12.2 provides the largest FinTech IPOs of all time. Payments companies (Visa, First Data, and MasterCard) represent the largest FinTech IPOs in terms of proceeds raised. Insurance/healthcare solutions are also relatively well represented. Interestingly, some of the areas that receive most of the media attention, like alternative lending, blockchain, and wealth management solutions, have yet to raise enough proceeds in a public offering to make the list of top FinTech IPOs.