Sustaining Employee-Owned Firms Over the Long-Term
description
Transcript of Sustaining Employee-Owned Firms Over the Long-Term
Vermont Employee Ownership Center2012 ConferenceBurlington, VermontJune 8, 2012
Alex Moss | Praxis Consulting GroupJudy Kornfeld | ESOP EconomicsPeter Paquette | Tarndale
Sustaining Employee-Owned Firms Over the Long-Term
2 VEOC Conference | ESOP Sustainability
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
June 8, 2012
3 VEOC Conference | ESOP Sustainability
Employee Ownership Sustainability
Being employee owned (through an ESOP, coop, or other form)
in perpetuity.
June 8, 2012
4 VEOC Conference | ESOP Sustainability
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
June 8, 2012
5 VEOC Conference | ESOP Sustainability
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
June 8, 2012
6 VEOC Conference | ESOP Sustainability
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
June 8, 2012
7 VEOC Conference | ESOP Sustainability
Reason for Terminating ESOP (source: NCEO)% 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% 9
Other 5.3% 22
Data: ESOP Formation & Termination
June 8, 2012
8 VEOC Conference | ESOP Sustainability
More Often Than Not…
Business *failure* is not our challenge The market is pretty good at handling this (!)
How will we handle business *success*?
June 8, 2012
9 VEOC Conference | ESOP Sustainability
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 value-
added in your firm until Congress changes its mind
June 8, 2012
10 VEOC Conference | ESOP Sustainability
Should Your CompanyRemain 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
June 8, 2012
11 VEOC Conference | ESOP Sustainability
Two Inter-Dependent Discussions
Can we manage the *ESOP*, as a benefit and ownership plan, sustainably?
Can we manage the *company* sustainably?
June 8, 2012
12 VEOC Conference | ESOP Sustainability
Judy Kornfeld
June 8, 2012
13 VEOC Conference | ESOP Sustainability
Peter Paquette
June 8, 2012
14 VEOC Conference | ESOP Sustainability
Challenges to ESOP Sustainability
1. Hostile legislative / regulatory environment2. Business model fails3. Repurchase obligation is too great4. No consensus view of shareholder value5. Succession discontinuity6. Business is not run like an ESOP7. Plan design time bombs go off8. Purchase offer is “too good to ignore”
June 8, 2012
15 VEOC Conference | ESOP Sustainability
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
June 8, 2012
16 VEOC Conference | ESOP Sustainability
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
June 8, 2012
17 VEOC Conference | ESOP Sustainability
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
June 8, 2012
18 VEOC Conference | ESOP Sustainability
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
June 8, 2012
19 VEOC Conference | ESOP Sustainability
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 Senior leadership Middle/front line management Non management employees ESOP committee Employees not in trust (seasonal, part time, foreign) Terminated employees
June 8, 2012
20 VEOC Conference | ESOP Sustainability
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.
June 8, 2012
21 VEOC Conference | ESOP Sustainability
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
June 8, 2012
22 VEOC Conference | ESOP Sustainability
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
June 8, 2012
23 VEOC Conference | ESOP Sustainability
4e. No consensus definition of shareholder value
Is proposition 2. legal?
Does it conform to the fiduciary duties of the Trustee(s)?
June 8, 2012
24 VEOC Conference | ESOP Sustainability
5a. Succession discontinuity
3 levels Board of Directors Senior Leadership Employee selection / turnover
June 8, 2012
25 VEOC Conference | ESOP Sustainability
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
June 8, 2012
26 VEOC Conference | ESOP Sustainability
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. (Recruit or develop.)
June 8, 2012
27 VEOC Conference | ESOP Sustainability
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
June 8, 2012
28 VEOC Conference | ESOP Sustainability
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?
June 8, 2012
29 VEOC Conference | ESOP Sustainability
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
June 8, 2012
30 VEOC Conference | ESOP Sustainability
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
June 8, 2012
31 VEOC Conference | ESOP Sustainability
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
June 8, 2012
32 VEOC Conference | ESOP Sustainability
7. Plan design time bombs go off
The bank run waiting to happen
Plan design assumes a constantly increasing share price
June 8, 2012
33 VEOC Conference | ESOP Sustainability
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
June 8, 2012
34 VEOC Conference | ESOP Sustainability
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
June 8, 2012
35 VEOC Conference | ESOP Sustainability
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”
June 8, 2012
36 VEOC Conference | ESOP Sustainability
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
June 8, 2012
37 VEOC Conference | ESOP Sustainability
Questions
June 8, 2012
38
Individual Owners
ESOP Governance
ESOP Trustees
select
Leadership Team
Board of Directors
appoint and oversee
elect
hire and oversee
Shareholders
Employees
CEO / President
hire and oversee
June 8, 2012
ESOPCommunications
Committee:Promote
Ownership
VEOC Conference | ESOP Sustainability
ESOPParticipants
when meeteligibility
requirements
arerepresented
by
ESOPFiduciary
Committee
39 VEOC Conference | ESOP Sustainability
Contact Information
Alex MossPraxis Consulting Group, [email protected]
Judy KornfeldESOP Economics, [email protected]
Peter PaquetteTarndale, [email protected]
June 8, 2012