Sustaining Employee-Owned Firms Over the Long Term
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Transcript Sustaining Employee-Owned Firms Over the Long Term
Sustaining Employee-Owned
Firms Over the Long-Term
Vermont Employee Ownership Center
2012 Conference
Burlington, Vermont
June 8, 2012
Alex Moss | Praxis Consulting Group
Judy Kornfeld | ESOP Economics
Peter Paquette | Tarndale
What is “Sustainability”?
Meeting present needs without compromising
the ability of future generations to meet their
needs
World Commission on Environment & Development
(Bruntland Commission), 1987
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Employee Ownership Sustainability
Being employee owned
(through an ESOP, coop, or other form)
in perpetuity.
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The Historical Record:
Something Interesting is Going on Out There
Shared ownership in the US: predates the American
Revolution
Coops
Mutuals: e.g. Franklin’s fire insurance society
Cooperatives: Rochdale, England, 1844
ESOP
Economist Lou Kelso & Senator Russell Long
37 years: part of 1974 ERISA
11,400 companies, 13.7 million participants, 10% of workforce
(NCEO)
Wide range of industries, structures, & experience
Shared ownership, ESOPs and beyond (GSS)
45%+ of workforce
Highly valued by workers
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ESOPs Are An Exception Under ERISA
An ESOP is an ERISA retirement plan…
…that owns your company = shareholder
ESOPs are an exception to key pension rules
and philosophy
Technical: prohibited transactions
Philosophical: diversification
Likely source of current DoL discomfort: this isn’t
how “pensions” are supposed to work
Why? Lou Kelso + Russell Long
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Different Models & Expectations
For some, long-term aspirations, e.g. Silver
ESOP Awards and taking public position of
long term employee ownership
For others, transitional aspirations: natural
life-cycle of ESOP, including sale of company
or termination of ESOP
Overall # of ESOPs has been relatively flat for
many years; however, there continues to be
lots of activity, into and out of ESOP form
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Data: ESOP Formation & Termination
% of
ESOPs
# of
ESOPs
The company was performing well financially but could
not manage its repurchase obligation or expected not to
be able to do so in the future
13.2%
60
The company could handle its repurchase obligation,
but received an attractive offer it could not turn down
51.2%
233
The company was dissatisfied with the ESOP for
reasons other than repurchase Problems
15.6%
71
The company was in financial difficulty and needed to
cut costs
13.1%
60
The company never intended the plan to be permanent;
it was just used to buy out an owner with the intention
of terminating the ESOP at a later date
2.2%
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Other
5.3%
22
Reason for Terminating ESOP (source: NCEO)
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More Often Than Not…
Business *failure* is not our challenge
The market is pretty good at handling this (!)
How will we handle business *success*?
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Core Question
Can you run your business better under
ESOP ownership?
If yes
Your company & ESOP will thrive
Public policy & opinion will support employee
ownership
If no, ESOPs will be a temporary ownership
vehicle
until the operating burden outweighs the valueadded in your firm
until Congress changes its mind
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Should Your Company
Remain ESOP Owned?
Does ESOP ownership generate return in excess
of costs?
What’s your “Return On Ownership” (ROO)?
Costs
Direct $ expense + staff time + hassle + regulatory risk
Benefits
Tax savings + operational performance improvement +
intrinsic value of independence
What’s your alternative?
Repurchase obligation is universal, ESOPs give it a name
and shape
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Two Inter-Dependent Discussions
Can we manage the *ESOP*, as a benefit and
ownership plan, sustainably?
Can we manage the *company* sustainably?
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Judy Kornfeld
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Peter Paquette
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Challenges to ESOP Sustainability
1.
2.
3.
4.
5.
6.
7.
8.
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Hostile legislative / regulatory environment
Business model fails
Repurchase obligation is too great
No consensus view of shareholder value
Succession discontinuity
Business is not run like an ESOP
Plan design time bombs go off
Purchase offer is “too good to ignore”
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1. Hostile Legislative / Regulatory
Environment
ESOPs are creatures of the federal tax code
and ERISA
Potential efforts to curtail ESOPs
Tax reform
DoL aggressive enforcement
Advocacy efforts
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2a. Business model fails
ESOPs can not overcome a flawed business
model, e.g., Polaroid
ESOPs cannot overcome a poor
implementation, e.g., United Airlines
ESOPs cannot overcome management fraud,
e.g., Enron
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2b. Business model fails
Sustainability of the ESOP, as previously
defined, must be a strategic imperative
If not, sustainability is a matter of luck rather than
design / purpose
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3. Repurchase obligation is to great
The problem is not repurchase obligation per se, but
repurchase obligation in excess of normal benefits levels
Valuation issue: current valuation standards for ESOPs
incompatible with “ESOP in perpetuity”
Current standard: willing buyer/willing seller from IRS Revenue
Ruling 59-60
• Written in 1959, before ERISA law of 1974
This standard does not consider repurchase obligation in excess of
normal benefits levels as a claim against cash for valuation
purposes
Management issue: may mean a fluctuating share price
Communication, communication, communication
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4a. No consensus definition of
shareholder value
Different views / lack of definitional alignment of
shareholder value among the following:
Trustee(s) of the ESOP Trust
Non-trust shareholders
Board of Directors of the company
• Maybe influenced by state of incorporation
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Senior leadership
Middle/front line management
Non management employees
ESOP committee
Employees not in trust (seasonal, part time, foreign)
Terminated employees
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4b. No consensus definition of
shareholder value
What is shareholder value in an ESOP company?
Proposition 1: Shareholder value in an employee owned
(ESOP) company is solely share price, and all the
organization’s energy should be directed towards maximizing
the share price.
Proposition 2: Shareholder value in an employee owned
(ESOP) company is something other than solely share price,
and all the organization’s energy should be directed towards
maximizing that value proposition.
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4c. No consensus definition of
shareholder value
Proposition 1
Standard “wall street” definition
Shareholder value = share price
Proposition 2
Terms shareholder value and share price are not identical –
must be careful when using these terms
Each ESOP must spend time defining what is its shareholder
value proposition
• Must be buy in from the different stakeholders
• Must be buy in from the Board of Directors
Each ESOP must communicate its definition of shareholder
value to the employees
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4d. No consensus definition of
shareholder value
The employment dividend
Those cultural norms, work place rules, benefits,
etc. that your company implements only because it
is an ESOP. (Some examples.)
The employment dividend generally
depresses the current share price
But may support longevity of the company, and a
create a higher share price in the long run
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4e. No consensus definition of
shareholder value
Is proposition 2. legal?
Does it conform to the fiduciary duties of the
Trustee(s)?
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5a. Succession discontinuity
3 levels
Board of Directors
Senior Leadership
Employee selection / turnover
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5b. Succession discontinuity
Board of Directors
Challenge: implementing “best practice” of outside dominated
Board while getting real Board buy-in to the ESOP ownership form
(refer to the “Shareholder Value” discussion)
Selection
• Define what your company wants
– Number of insiders versus outsiders
– Specific technical or industry knowledge
– Is ESOP knowledge a pre-requisite?
– How to filter for “ESOP-aligned values”?
Recruitment
• How to find: not a large pool of ESOP-ready directors
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5c. Succession discontinuity
Senior leadership
Generally, many private company ESOPs are started by an
owner/CEO who believes in employee ownership, or who
does an ESOP to keep the company independent and comes
to believe in ESOPs more broadly through that experience.
In most cases, the owner has a ready successor in either a
family member or a long term, trusted and proven employee,
who is the designated successor CEO.
The problem generally comes with the third CEO.
or develop.)
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(Recruit
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5d. Succession discontinuity
Senior leadership continued
Recruiting from outside—some problems
• Limited pool of talent to become a senior leader/manager
(CEO, CFO, etc.)
• Limited pool of philosophically oriented leaders outside of other
ESOP companies
– In addition, most senior managers at ESOP companies like
their company and are reluctant to move
• S Corps have almost no ability to give a recruited senior leader
capital gains treated gain sharing, i.e., 15% tax rate
– Rangel bill: Paragraph 3701
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5e. Succession discontinuity
Senior leadership continued
Developing next generation of senior leadership from within
• In a bigger ESOP company, this should be a central focus of
the BoD and current senior leadership
• Issue: ESOP company maybe too small to have successors on
staff
– Now what?
Are the required leadership competencies in a sustainable
ESOP different from other capital / cultural structures?
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5f. Succession discontinuity
Employee selection
New employees
• Selection / recruitment criteria consistent with ESOP in
perpetuity
Current employees
• Retention criteria consistent with ESOP in perpetuity
– Why should the company retain philosophical cynics
or those that do not believe in shared equity?
• Training, development, & career advancement: build &
reinforce needed ownership behaviors & competencies
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6a. Business is not run like an ESOP
Is a mixed capital structure sustainable?
ESOP and public company
• Which definition of shareholder value prevails
ESOP and private company
• Minority ESOP
• Majority ESOP
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6b. Business is not run like an ESOP
Lack of conviction that ESOP should be sustainable (some examples)
A financial ESOP where sustainability of the ESOP is unimportant; looking for the next
exit strategy
Or, there is no perceived value in shared equity / ownership; selling shareholder
continues to run the business as before the ESOP transaction
Or, a union buyout where the union does not want ownership, just want to own it long
enough to turn it around and sell, and then go back to being employees
Failure of conviction that ESOP should be sustainable
Senior leadership and/or the BoD losses its belief in ESOPs
•
•
•
•
•
Business model is failing
Repurchase obligation overwhelming
Definition of shareholder value defaults to share price
Successor leadership has no empathy with ESOPs
ESOP model is overwhelmed with cynics
Failure to appropriately manage the inherent conflicts of interest
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7. Plan design time bombs go off
The bank run waiting to happen
Plan design assumes a constantly increasing
share price
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8a. Offer that is “too good to ignore”
Evaluating the offer:
Share price is merely the beginning
The add backs
• The employment dividend
• The S Corp tax shield
• The repurchase obligation in excess of normal benefits
levels
• The potential salary/wage premium
– Above market salary / wage structure
– Disintermediation
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8b. Offer that is “to good to pass ignore”
Do I have to sell?
Board of Directors – state law for BoD members
Trustees
• DOL statement of 1989
What can we do to slow down the need to sell
process
Adopting a “not for sale unless” statement
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Back to the beginning:
Are ESOPs sustainable?
Yes, subject to…
Not entirely clear as to all the pieces but includes
Unshakable belief in employee ownership through ESOPs
Sustainability of the ESOP as a strategic imperative
Proper governance (balancing inherent conflicts of interest)
Appropriate level of repurchase obligation (and a plan to fund
it)
ESOP philosophy is passed from generation to generation
The ability to say no to the offer that appears “too good”
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Emerging Trend:
What if ERISA Isn’t Enough?
ESOP Trustee’s duty is to protect participants
retirement interests, i.e. long-term share
value
What if that is not your sole objective?
Approaches
Board policy re independence
B-Corporation status
Coop models
Other models
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Questions
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ESOP Governance
Shareholders
ESOP
Fiduciary
Committee
Individual
Owners
ESOP Trustees
select
are
represented
by
ESOP
Participants
elect
Board of Directors
appoint and oversee
CEO / President
hire and oversee
Leadership Team
when meet
eligibility
requirements
hire and oversee
ESOP
Communications
Committee:
Promote
Ownership
Employees
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Contact Information
Alex Moss
Praxis Consulting Group, Inc.
215.753.0304
[email protected]
Judy Kornfeld
ESOP Economics, Inc.
215.606.3591
[email protected]
Peter Paquette
Tarndale, LLC
603.643.8460
[email protected]
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