ESOPS Give Employees and Exiting Owners
‘Skin in the Game’
As the third generation that had operated Williams Company, which turns 100 in 2020, third-cousins Bruce and Alan Williams were looking ahead at how they’d retire. Their children didn’t want to take it over, and there wasn’t a buyer lined up. They found a solution in an employee stock ownership program, or ESOP.
Starting an ESOP 12 years ago allowed them to transition the Orlando construction company when they retired in 2016 into what it is today: 100% employee owned. Like a 401K, an ESOP is a retirement plan, but it is very different in the benefits it offers for the owners who are exiting, the employees who are staying, the company itself and even the community. A 401K invests in a diversified portfolio of stocks, while an ESOP invests solely in the company.
“The biggest factor for Williams Company to become an ESOP was to continue the legacy of excellent service to our valued clients by retaining and incentivizing the existing employees of the company,” said Bob Lipscomb, the company’s CEO and chair of its ESOP communications committee. “Everyone wanted the big orange ‘W’ to continue on. As Bruce and Alan transitioned into retirement, the existing leadership team that had been in place for over 15 years all remained and became the driving force in the company’s growth.”
An ESOP program allocates shares of stock to employees every year, allowing them to build up a nest egg they can cash in after retirement. Unlike a 401K program, which involves employee contributions that are sometimes matched by the company, a typical ESOP operates solely with contributions by the company.
The most important advantage of an ESOP that is 100% employee owned is that it pays no federal taxes on profits. The government defers the taxes, applying them to disbursements when individuals retire or leave the company. This deferral allows for revenue to go back into the business to continue building the company’s value. It also provides the company with more resources to pay off the selling shareholders, sometimes at a faster rate, and to buy out departing participants.
The program at Williams Company has been well-received, Lipscomb said. Today the company has 126 employee owners and five who have retired.
“Every single employee became an owner, and the stock that all employees receive each year costs them nothing,” he said. “Looking ahead, for the people who remain with the company for a long time, they will become very wealthy because of their ESOP stock as they prepare for their retirement.”
A Good Fit
Will Stewart has worked with family-owned businesses like Williams Company for about 15 years. As a partner with PCE Investment Bankers in Winter Park and head of its ESOP practice, he begins by providing answers for people who want to know more about whether an ESOP would be a good fit for their company.
Explaining the structure is not a 10-minute conversation. Sometimes it takes months. ESOPs are governed by the rules of the Employee Retirement Income Security Act of 1974, or ERISA, which protects individuals. An ESOP is more formal than a traditional buyout by management of a company, and the tax benefits often make it worth the extra effort.
“If businesses are considering ESOPs, there is a fair amount of homework that goes into these,” Stewart said. “We spend a lot of time with companies before we even get engaged to make sure an ESOP is what they want to do. An ESOP can be confusing. It’s kind of an intersection of tax law and Department of Labor retirement benefits. So be prepared. Business owners want to spend some time on the front end. And once they decide to move forward, they need to be committed to the process because it does take some time to put these transactions together.”
Stewart said PCE got into this line of work because it saw a need for ESOPs with the midsize companies it serves. A former bank lender, he has served in leadership roles in organizations that support people in the ESOP world, including The ESOP Association, where he serves on the finance committee, and the National Center of Employee Ownership. He is a big fan of ESOPs — for the right companies.
“One of my favorite aspects is the ability for business owners to realize some of their investment and stay involved with the business they’ve built over their career,” Stewart said. “I’ve been involved in the ESOP’s whole life cycle. I’ve helped a number of ESOPs be created, which is our primary role, and I’ve also helped a couple of ESOPs sell. Seeing that investment realized on the part of employees is quite rewarding.”
When it’s time to put together the formal paperwork for an ESOP, companies like PCE often will partner with a law firm. Jay Van Heyde, an attorney and shareholder with Dean Mead law firm in Orlando, has been working with ESOPs since 1989 after starting out at the firm as a tax lawyer. In the past 20 years, ESOP work has become about two-thirds of his practice.
ESOPs work best for certain types of companies, he said. They’re complicated to set up legally and financially, so they work best for companies with a minimum value of $2 million to $4 million and 20 or more employees.
“One thing I’ve noticed through the years is that the type of people who want to get involved with an ESOP view their company in a little different way,” Van Heyde said. “They don’t just view it as something that’s worth dollars and cents. They don’t view it as, ‘I don’t care what happens. I just want to get the most money out of it for my retirement.’ … They feel a close bond with their employees, and they want to see themselves do well and they want to see their employees do well down the road by the company flourishing after they’ve been bought out.
“They tend to view their company as a child, and they don’t want to see their legacy taken apart by some unrelated, out-of-town buyer who is just looking at this as a financial thing and might completely destroy the culture and the image of the company. They view it as, ‘This is my baby and I want that baby intact when I’m gone.’ Those are my observations after many years of doing this.”
The founders often will stay around for a phase-out period while the next crop of leadership learns all the details about how to take the business into the next era, Van Heyde said. “ESOP companies don’t run themselves. You still have to have in place, or the plan to put in place, that next wave of management. The companies that have gone 10, 20, 30 years after the founders are gone are those that have done a good job, typically internally, of developing that next person who will run the ship.”
Sharing the Wealth
One of the most successful examples of an employee ESOP program is Publix Super Markets. “They have countless numbers of stories of truck drivers and deli counter workers who retire with hundreds of thousands of dollars in their ESOP accounts, and that’s money they would never have been able to save otherwise,” Stewart said. “They were one of the early adopters of ESOPs after ESOP legislation was adopted in 1974.”
In fact, the whole ESOP idea was an early adopter of the emerging “sharing economy,” Stewart said. “The concept of sharing ownership has become more mainstream. ESOPs do it in a more formal way than stock options and other aspects you see in a start-up environment, but they’ve been around for nearly 50 years. So I think they have been providing these benefits that we’ll see become more prevalent for a long, long time. I expect them to continue to become more popular as people start to become more educated and understand them better.”
For Williams Company, keeping the ESOP program robust means making sure employees are aware it is working for them behind the scenes. A committee of 15 employees organizes educational sessions, celebrations, charity events and fun activities. Their work keeps employees engaged — which is good for the company’s bottom line.
“I can attest that everyone feels the need to perform at a high level because they are an owner,” Lipscomb said. “Knowing that each and every person’s role has to do with the wellbeing and profitability of the company drives our people to deliver a very high level of service to our clients and also watch our overhead costs. About 90% of our work is repeat business, so our clients have come to recognize our employee owners as high performers. Human nature would tell you that if you have skin in the game, you are going to pay closer attention to the details of your job.”