On August 26, 2014, Mary Jacobs writes in Forbes:
The rise of private equity as a corporate ownership format has over the last 40 years or so roughly paralleled that of employee ownership, two very separate approaches to business and, in the minds of most people, approaches that are mutually exclusive.
In oversimplified sound bites, private equity often represents big money and the primacy of capital; employee ownership is caricatured as the triumph of the working class via Employee Stock Ownership Plans, or ESOPs. Put in such dramatic terms, outright war seems the next logical step, right?
But guess what: some of the smartest people in private equity are now partnering with ESOPs to buy companies. ESOPs are being formed to buy companies already owned by private equity funds. And private equity funds are buying companies already owned by ESOPs. And everyone seems to be getting along just fine.
It turns out that private equity and employee ownership have a lot in common, and going forward that may matter more than what separates them. A wonderful case study resides in Woburn, Mass.: Atlantic Plywood, a $120 million-a-year supplier of high-quality wood products, hardware and other components to the custom furniture and interiors industry along the East Coast.
Founded in 1974 by two entrepreneurs. Profitably sold to private equity buyers in 1999. Profitably sold once again to its employees in 2008. And since the ESOP, Atlantic Plywood has rapidly paid down debt taken on to finance the buyout and now its strong profits are building up in employee accounts: shares valued at 25 cents each in 2008 are now appraised at $9.95.
A worker making $35,000 a year at Atlantic Plywood can expect to see his or her ESOP account grow by $7,700 this year. And the CEO since the initial 1999 sale, Paul Vella, credits the former private equity owners with helping instill the financial and operating discipline at Atlantic Plywood that is now providing employees with a shot at a comfortable retirement.
Ira Starr, one of the managing directors of the private equity fund, Long Point Capital, remains on the Atlantic Plywood board of directors, and he is an unabashed ESOP enthusiast. The tax benefits and potential productivity gains from an ESOP, Starr tells me, “are exceptionally compelling.” Employee ownership has become a standard consideration when Long Point is buying or selling a company.
As it should with all middle market M&A, in my opinion.
I don’t want to overstate the interplay between the private equity and ESOP communities. People who embrace them both – Paul Vella, Ira Starr, myself – remain in the distinct minority. But word is getting around. And with private equity funds holding some 7,500 portfolio companies – too many to take public, too many to simply re-leverage to another private equity fund – ESOPs will become a growing factor in enabling funds to exit these investments. And a big wave of employee ownership, it’s safe to say, would demonstrate in the best way possible how we might begin solving this country’s retirement savings crisis.
Paul Vella, now 62, joined Atlantic Plywood in 1981 and moved up to run operations and sales by 1993. When its original founders decided to sell, Vella was the obvious choice to become CEO. “I was excited,” he recalls. “Like anybody, you always want to be in charge.”
The new owners from Long Point had lots of big company experience, and rather than find them intrusive, Vella soaked up their advice. “From that point on, we were a much better-run company,” he says. Financial and budgeting discipline was a particular strength of the Long Point people. Vella and his management team learned to operate with a significant amount of debt, and that would help Atlantic Plywood through downturns that followed its 1999 and 2008 buyouts.
When Long Point decided to sell in 2007, Vella says, the offers that came in weren’t great. Long Point had previously sold a company to an ESOP and Ira Starr asked Vella to look into employee ownership. Once Vella came to understand the tax benefits and potential operating advantages, he was sold. A bank experienced in ESOP lending was enagaged. And Long Point took back some paper (later paid off) to get the deal done.
Vella has a handful of key metrics that help him manage. Inventory needs to turn about 6.5 times a year. Sales people need to get the right price, rather than giving up too much, 70% of the time or more. Deliveries need to be on time and goods undamaged, a service imperative that differentiates Atlantic Plywood from mere price cutters. Atlantic Plywood has moved its product mix into higher margin goods, reducing reliance on plywood and other “panels” to 60% of revenue from 72% in 2001.
Managing through the 2001 downturn soon after the private equity buyout gave Vella and his team confidence. So, when the economy likewise tanked almost immediately after the 2008 sale of the company to the ESOP, he didn’t cut sales staff and didn’t cut inventory. “My sales went down 18%. My competition’s sales dropped 40%. We took market share.”
Adds Greg Pray, a vice president at Columbia Forest Products, one of Atlantic Plywood’s biggest suppliers: “They didn’t bury their heads in the sand. Atlantic went out to sell into new channels.”
Atlantic employs about 190 and has nine distribution facilities in the Northeast. Andrea Hallett, 32, is an outside sale rep and has worked at Atlantic Plywood since college. She works with about 200 customers in central Connecticut. “Once we became an ESOP, it definitely changed the morale of the company,” she says. “We’re working toward a common goal.” The amount of damaged good shipped to customers – always an unpleasant surprise, and one requiring extra shipping to fix the problem – is way down. Teamwork between sales and the warehouses is up.
The Employee Stock Ownership Plan (ESOP) was originally conceived and designed by Louis O, Kelso. Kelso was a political economist in the classical tradition of Smith, Marx and Keynes. He was also a corporate and financial lawyer, author, lecturer and merchant banker who is chiefly remembered today as the inventor and pioneer of the Employee Stock Ownership Plan (ESOP), the prototype of the leveraged buyout invented to enable working people without savings to buy stock in their employer company and pay for it out of its future dividend yield. See http://cesj.org/?s=ESOP.
Louis Kelso was my business partner in Agenda 2000 Inc. in the late 1960s and 1970s. Agenda 2000 was an advocacy firm developing financial mechanisms designed to empower ALL citizens to become owners of wealth-creating-income producing capital assets. The ESOP is just one of several financial mechanism designed.
Currently, the Center for Economic and Social Justice (www.cesj.org) is the advocacy group for these approaches to solving wealth inequality and poverty.
There are now over 11,000 profitable ESOP companies, of which 1,500 of those companies are worker majority owned, with workers paying for their stock shares out of future corporate profits, not by reducing their take-home labor worker incomes.
ESOPs work as designed and optimized when the workers receive the full property rights as owners, including full voting rights, not simply treated as beneficial owners with power concentrated at the top of the company, without any accountability or transparency. Unfortunately, some ESOPs have been structured so that the rights, powers, and benefits of ownership remain concentrated in a small non-accountable elite controlling corporate and financial governance. When the employees are owners, dependent on their income from the company’s bottom line rather than through ordinary labor wages and benefits, the workers’ economic interests are more invested to see that their company succeeds. In this way, each person in the company is empowered as a labor worker and as a capital worker (owner) and inspired to work together as a team to make better operational decisions to serve and maximize value to their customers.
Under our current financial system, the security (collateral) necessary to secure an ESOP loan must come from the company, and therein the current owners are providing the security to broaden employee capital ownership with the benefit that expanded capital ownership drives expanded consumer power to purchase products and services.
Under this scenario the company owners are “insuring” the risk without a benefit, which can be recompensated by paying the employees less labor wages, reduced pension benefits, and receiving government tax forgiveness benefits, which are written into the Internal Revenue Code.
With the ESOP, employees can acquire capital ownership with the earnings of capital. ESOPs have thus far only provided part of the solution, and the stock acquisition is limited to the employer company.
Robert Ashford, Professor of Law at the Syracuse University College of Law (New York) and a former lawyer in Kelso’s San Francisco law firm, specializes in the teaching of binary economics. He has expanded the ESOP trust into what he terms the “Super ESOP,” which includes multiple company diversification facilitated with private capital credit insurance or a government reinsurance agency (ala the Federal Housing Administration concept). Under Ashford’s plan, the promissory note can be offset to the government’s central Federal Reserve Bank in return for the cash equivalent of the amount of the loan, less an administrative fee. The only cost to the direct lending bank in making a loan to the corporation would be the administrative fee, or about 2 percent of the loan’s principal and then another 2 percent for capital credit insurance, with an additional quarter of a percent paid to the Federal Reserve Bank to monetize the loan and give the lender the same cash as it would have had if it had actually loaned money to the corporation. The lender’s cash loaned to the ESOP trust is replenished with the Federal Reserve Bank cash. When the company pays the ESOP trust enough money to enable the trust to repay the lender, the lender has to retrieve the note and pay back the Federal Reserve Bank. Thus, the loan cost would be essentially not more than 5 percent to allow ownership broadening financial capital to be invested in ownership broadening ESOP trusts to create new capitalists. Thus, national capital credit insurance replaces the requirement for the current corporate owners to pledge security.
ESOPs and other Kelsonian plans avoid the gambling trade and Wall Street firms that play with your money. The ESOP circumvents that. According to Kelso: “In a single transaction, you finance tools for the employer and ownership for the employees. The pre-tax yield of corporate assets of prosperous companies varies from 25 to 60 percent. The yield on secondhand securities is around five or six percent. Sure, with capital gains, you can get a little more, but don’t forget, that’s a zero-sum game; for every gainer, there’s a loser. Wall Street doesn’t fly any airplanes or raise any corn or do anything else in the way of producing products and services. It just plays games with your dough. And when you take it out in pensions, you’re going to get less than the company put in for you. You have to; that’s the dynamics of it.”
Other Kelsonian innovations include the Consumer Stock Ownership Plan (CSOP) and the General Stock Ownership Plan (GTOP), a plan designed to build capital ownership into politically designated classes of consumers within the jurisdiction of the authorizing government––state, local or federal. The ESOP, CSOP and GSOP are credit mechanisms that give corporate employees and others (non-corporate employees) access to stock ownership in future capital formation growth.
