When people learn that Harris & Associates transitioned to a 100% employee stock ownership plan (ESOP), they typically ask me the same questions:
- Why did you do it?
- Did you lose control of your company?
- What does your staff get out of it?
I wanted to answer these burning questions here because they speak to the interesting crossroads faced by today’s architectural, engineering and construction industry. In one direction, firms seek options for transitioning their financial ownership; in another, a new generation of workers wants conditions offering a greater sense of connection and motivation. Some firms find that a 100% ESOP structure solves both issues by turning employees into owners.
I’m going to describe my experiences with Harris’ ESOP transition—starting with some changes I never saw coming.
A New Culture of Engagement
With my background in finance and dual role as Harris President and Chief Financial Officer, I first saw ESOP as purely a financial transaction and benefit retirement plan for employees.
I did not anticipate the profound cultural impact the plan would have on the firm. Harris moved from having a select group of shareholders to complete employee ownership. This was our first step in creating our "One Harris" vision for the company: everyone works together across markets, practices, departments and geographies, regardless of titles.
We all work toward common goals with a stake in the outcome. We are equally engaged and motivated for Harris to succeed, which leads to each of us performing better. The efficiencies we gained from moving to a collaborative structure, as well as the stronger bonds that employee-owners have with one another, have paid the firm back in ways I couldn’t have predicted.
Impact on the Next Generations
An ESOP can be a powerful employee benefit and recruiting tool. It functions as a retirement plan, with a staffer’s shares vesting over time. Typically, the longer you stay in the ESOP, the more potential you have for accruing more shares through advancement, additional shared to company releases to the ESOP trust and through redistribution of shares from owners who leave the company.
The best part of this deal: Employees benefit without subtracting from their paychecks (unlike a 401K). They enter the plan after a period of employment, receive shares which vest over time, and as the value of the company increases (through market forces, improved company performance and other factors), the value of their shares generally increases.
I asked Harris employee-owner Ashley Houk to share her thoughts on the ESOP:
Benefits of Engaging a 100% ESOP Firm
Clients also notice the ESOP difference. They feel more comfortable contracting with companies that have secured a stable financial future by successfully implementing an ownership transition plan. And 100% ESOP S-Corporations often have the cash to invest in future innovations, process improvements and staff development due to their tax efficiencies.
Desperately Seeking Transition Solutions
Earlier, I mentioned our industry’s crossroads. Many firms, due to the recession and other market forces, have top-heavy leadership structures and limited options when it comes to transitioning ownership to the next generation of leaders.
Harris was in this position when I joined in August 2011. It had a minority ESOP of 47% with the rest of the shares held by individual shareholders. When I looked at the pending retirement of many shareholders, financial obligations to former shareholders, current income levels and share value, I realized we would have serious issues transitioning ownership and maintaining financial viability.
I started doing more ESOP research, attended ESOP association conferences and soon discovered why many companies converted to 100% ESOP S-Corporation structures: By converting, a company pays significantly less in federal and state taxes.
This was the solution I was searching for. Harris could save money by paying the lower tax rates and apply the savings to paying out former shareholders and retiring ones.
So I had a plan, but would it work?
Making the Case
Truthfully, many leaders are reluctant to convert to 100% ESOP because they see it as giving up control of the company. ESOPs are often generalized solely as a way for owners to cash out quickly. ESOPs do provide a partial exit strategy—but without losing control of the business. And as I stressed earlier, they become so much more than financial transactions!
In 2012, my CEO and I engaged the entire firm in a discussion about the choices we had in front of us in an open and honest way. Even though it took many conversions and many months, everyone decided what was in the firm’s collective best interest. The result: all 37 Harris shareholders chose to sell their shares, which enabled Harris to file for S-Corporation status.
One of the most powerful lessons I learned during this process was the need to communicate, especially by varying our approaches. We hosted webinars and several in-person meetings (small groups, large groups and one-on-one) with shareholders.
In August 2012 we completed the transaction using a loan to pay our shareholders partially with cash and partially on a note (so that we’d continue to pay them over time). The money we save by paying lower taxes gives us the cash flow to pay off our debt without affecting our ability to invest in our company.
Success vs. Failure
The ESOP not only helped us successfully transfer ownership of Harris, ensuring our future and stability. It also allows us to pay our bank debt and notes and meet our repurchase obligations every year. We have an acceptable debt ratio of less than 2:1 almost four years after the transaction.
Where companies often fail is spending the savings from the tax breaks on bonuses or large repayments to shareholders or employees. They neglect their cash flow and aren’t able to meet their repurchase obligations.
Control and Trustee Oversight
To the question of control, I can assure you we did not lose control of the firm.
We engaged a directed external trustee who represents the ESOP Trust. The trustee has the fiduciary responsibility to make sure the ESOP Trust works to the benefit of all participants (Harris’ current and some former employees). The Trustee is an objective and informed individual we keep informed about our performance, long-term goals and company dealings—he understands who we are and what we are trying to accomplish.
My advice to skittish leaders: As long as your overall goal is to benefit the company, you will have no issues with your ESOP trustee, who merely works to ensure all actions intend to benefit the ESOP. If you have a leadership or ownership transition issue, you should give serious consideration to an ESOP.
That said, an ESOP is not a magical solution for every firm. Consult appropriate advisors, tax consultants and bankers to make sure all parties understand ESOP conversions and how ESOP companies function.
What are your experiences with ESOP companies? Please share them in the comments below. Do you have more questions around ESOPs? Fire away—as you can tell, I love to talk about them.