Just over 10 years ago, John Wright decided to sell the family business to its employees.
Wright Tree Service was founded in 1933 by John Wright's father. After staying in the family for nearly 70 years, the younger Wright decided it was time for a transition plan. In 2002, he sold 100% of the company to employees through an Employee Stock Ownership Plan (ESOP).
Wright wanted employees "to become a financial participant in the success of Wright Tree Service and to help grow our company both in profitability and in efficiency of operations and customer service."
From all accounts, it appears that Wright's vision came true. Since that time, the tree service has doubled its workforce throughout the nation. Based in West Des Moines, Iowa, the company now has expanded its service area to cover 26 states.
CFO Terry McGonegle says it is obvious employees take great pride in the company.
"Employee decisions consistently reflect awareness of their ownership and stake in the success of the company," said McGonegle. "This has helped to promote a very positive organizational culture for our company, one that we believe is unique to an employee-owned company."
There are approximately 10,000 ESOPs in the United States covering 10.3 million employees, accounting for about 10% of the private sector workforce.1 Even though the plans are found in all industries and all sizes of companies, there is a general lack of knowledge about them. Understanding how an ESOP benefits the company, the employees and the selling owner can help you evaluate if the plan may be right for your company.
An employee stock ownership plan is a qualified defined contribution retirement plan that is invested primarily in the common stock of the sponsoring company. It is unique among retirement plans in that it can borrow money. This allows the ESOP to be a flexible succession strategy for a business owner who, as in the case of John Wright, is looking to sell all or part of their business.
ESOPs mean something different to each of the key stakeholders. Company executives see ESOPs as tools that help align employee goals with company goals and improve organizational performance and as a differentiator in recruiting, retaining, and rewarding employees. To employees, ESOPs are a benefit that helps them prepare for retirement. For the selling owner(s), the ESOP is a tax-advantaged way to transition ownership of their business and diversify their retirement assets.
Benefits to the Company
Not all that long ago employee benefits were commonly referred to as fringe benefits, implying that they were marginal or secondary to salary. Given the cost and the importance that employee benefit plans play in attracting, retaining, and rewarding employees, fringe seems hardly appropriate anymore.
Executives view their employee benefit programs as part of their human resource and business strategies. The design of the programs can assist the company with achieving business objectives. For example, wellness programs have been shown to reduce not only health care expenditures but also absenteeism and the incidence of disabilities.
ESOPs have been shown to improve organizational performance. The Employee Ownership Foundation's 21st Annual Economic Survey of ESOP Companies highlighted the following:
• 93.3% of survey respondents reported that creating employee ownership through an ESOP was a good business decision that benefited the company.
• 76% of respondents indicated the ESOP positively affected the overall productivity of the employees.
• Both profitability and revenue were up from previous years — 70.5% of respondents reported profitability increased and 76.2% of respondents noted revenue increased.
• 80% of respondents stated the company's stock value increased as determined by outside independent valuations.2
Why do ESOP companies report better performance? The ESOP creates aligned incentives. Through the ESOP, employees earn ownership interests in the company.
Increased organizational performance typically leads to a higher share price and therefore a higher balance in employee ESOP accounts. Simply put, when the company does better so do the employees. The ESOP provides a return on their sweat equity. That generally leads to highly motivated employees. It's not uncommon to see employee owners engage in the following activities:
• Turning off the lights when leaving the room
• Brainstorming on ways to reduce waste and rework
• Cross selling or up selling to customers
• Excellent customer service
Benefits to the Employees
Employees understand the ESOP is a benefit that helps them accumulate retirement savings. This is extremely important given only about a third of employees (37 percent) believe that they will be financially prepared for a comfortable retirement.3
Optimism prevails among employees with ESOPs because the plans can have a significant impact on overall retirement savings. According to Corey Rosen, the cofounder and senior staff member of the National Center for Employee Ownership, ESOP balances were three to five times higher on average than 401(k) plan balances.
But the benefits from an ESOP are more than just financial. Employee stock ownership plans are a form of shared capitalism in the United States. A recent study found that shared capitalism:4
• Improves the well-being of workers.
• Has greater participation in decision making.
• Creates higher pay, benefits and wealth.
• Leads to greater job security and satisfaction.
• Increases trust in the firm and management.
ESOPs also tend to perform better during times of economic downturn and so lead to greater job security. The 2010 General Social Survey found that working adults that worked for companies with ESOPs were one-third to one-fourth as likely to report having been laid off in the prior year as compared to those without an ESOP.5
Benefit to the Selling Owner(s)
ESOPs typically buy their shares from one or more shareholders that are looking to sell as part of an investment diversification or succession strategy. Using an ESOP has several distinct advantages for the selling owner(s). An ESOP:
• Creates a buyer where one may not readily exist.
• Can be a minority owner.
• Can pay up to fair market value for the stock.
• Allows the selling owner to determine how much and when to sell.
• Potentially allows the selling owner to defer or eliminate capital gains tax.
An ESOP offers a great deal of flexibility to the selling owner. An ESOP can be a very effective technique in an owner's succession plan. Whether they want to sell all of the company at once or through multiple transactions, the ESOP allows them to control the timing and extent of exit.
The ESOP can also be used by a business owner who wants to create a liquidity event so that they can diversify their investment portfolio. Many business owners have the majority of their wealth tied up in their business. Selling a portion of the company to the ESOP can generate the cash needed to allow for diversification.
Employee Stock Ownership Plans benefit the company, the employees, and the selling owners. An ESOP can be a great strategy for a company looking to enhance organizational performance, help employees prepare for retirement, and allow a business owner to meet succession or diversification goals.
The experience of Wright Tree Service is not unique. Employee Stock Ownership Plans have helped thousands of companies propel their business strategy forward.
1. A Statistical Profile of Employee Ownership, The National Center for Employee Ownership, February 2012.
2. The Employee Ownership Foundation's 21st Annual Economic Performance Survey of ESOP Companies, The ESOP Association, September 6, 2012.
3. The Pincipal Financial Well Being Index SM, The Principal Financial Group, 1st Quarter 2013.
4. Blasi, Dr. Joseph R., and Dr. Douglas L. Kruse. Shared Capitalism at Work: Employee Ownership, Profit and Gain Sharing, and Broad-Based Stock Options (National Bureau of Economic Research Conference Report). Chicago: The University of Chicago Press, May 2011.
5. 2010 General Socal Survey, National Opinion Research Center 2010.