A Strategic Solution for Transitioning Your Business
I recently attended a conference in Atlanta on strategic solutions for high performing companies, where I met Ken Baker. Ken is the CEO of a family business in PA valued in excess of 9 figures.
The story of how he is transitioning the sale of his business held me spellbound. He began with a presentation on Employee Owned Stock Option Plans (ESOPs). His message was how effective they can be as strategic solutions for improving the performance of a company and as exiting your business. Now, before you move on thinking this will be an esoteric rant, bear with me.
I was introduced to ESOPs by way of the Employee Retirement Income Security Act of 1974 (ERISA) early in my career. But honestly, I hadn’t given it much thought until Ken brought it up. OK, it’s a little esoteric, but only a little. The meat is up ahead.
Most sellers of successful large businesses focus on four major questions when considering how they might transition out of their business. These questions are: What’s the number I walk away with? What’s the risk of not closing? What are the social issues related to the sale? And what is the sustainability of the business that remains--whether folded into another company or simply taken over by a new owner?
Selling to an ESOP as a Strategic Solution
I have taken the following advantages of ESOPs from the November/December issue of the NCEO Employee Ownership Report as they relate to each of the four major questions.
Price - What’s the number I walk away with?
S Corporation ESOPs can realize higher after-tax cash flows from target companies and can thus pay more
Sellers to ESOP companies can receive competitive value for their shares while providing future benefits for their employees as ESOP participants
Sellers can receive higher after-tax proceeds through special IRC ~1042 elections uniquely available through an ESOP as an acquirer
Tax-shielded target cash flows enhance the acquirer’s credit profile providing marginally more support for financing commitments
Closing - What is the risk of not closing?
Strategic industry knowledge should imply fewer due diligence “outs” vs. private equity and family office bidders
Social Issues - What are the Social Issues Related to the Sale?
ESOP companies are less likely to relocate operations overseas
Employees at ESOP companies receive 5%-12% higher wages and were 4x less likely to be laid off during the last recession
ESOP companies have 25% higher job growth over 10 years
Sustainability - What is the sustainability of the business?
Productivity improves by 2.5% per year in years immediately after ESOP relative to the competition
The average improvement in return on assets of +2.7%
Increased sales of 2.3%-2.4% per year observed on average
ESOP companies are 25% more likely to stay in business for over 10 years
The Beginning of ESOPs
The story of employee ownership is an interesting one. It was championed by Louis O. Kelso, an attorney, and economist, who felt that free enterprise would work better and for more people if capital was more widely available. If more people owned the fruits of their production, they would earn a wage as well as capital appreciation in the stock of the company they owned. This isn’t a foreign concept to anyone reading this article. Back in the day, however, this type of strategy was a foreign concept to anyone without the wealth to invest directly into stocks.
Kelso came up with a variety of ideas for encouraging the wider distribution of stock. He wrote books. He gave speeches and interviews. He lobbied politicians. But Kelso was more than a thinker, he was a doer. He created a way for employees to buy a company at no cost to themselves – a form of a leveraged buyout, much like today’s ESOPs. He then helped companies implement several of these solutions.
The going was slow, and skepticism was high. That was until Kelso explained the concept over dinner to Russell Long, a Senator from Louisiana. Kelso explained that employee ownership, the kind he was talking about, could make the “have-nots” into the “haves” without taking anything away from the “haves”.
ESOPs Gain Acceptance as a Strategic Solution
Senator Long inserted provisions relating to ESOPs in the Employee Retirement Income Security Act and Congress passed it in 1974. Later he helped persuade lawmakers to provide tax incentives for setting these ESOPs up. Over the years more incentives have been added and a few removed.
Now, 44 years later, many lawyers, bankers, and business advisors have become very familiar with how ESOPs work. They provide companies considering an ESOP with expert advice. In PA, Mr. Baker, who I introduced at the beginning of this post, has created PACEO (Pennsylvania Center for Employee Ownership), a non-profit that provides guidance to anyone interested in learning how to pursue creating a plan or selling to one at little to no cost.
You’ve spent your career building something wonderful. What you’ve built has contributed to the support of many families who, in turn, have put their shoulder to the wheel in helping the business grow. This strategic solution is an elegant way to ensure your legacy and your future.