Jim Redpath and Sarah Gengenbach are two of about 80 employee-owners of HLB Tautges Redpath, a 40-year-old, 115-employee White Bear Lake accounting firm that has long consulted with it clients about employee stock ownership plans (ESOPs) and succession planning.
The firm was converted to an ESOP a decade ago, as a means to ensure a fair value for people leaving the company and an ownership future for younger employees.
QWhy did your firm become an ESOP?
JRThe main reason was succession planning. We had a bunch of young partners. We [older partners] were all going to retire at about the same time. A few players in industry were rolling up [acquiring] firms, but that didn't feel right to us, to sell to a bigger company.
Whenever we look at succession, we want to know how we can keep this [business] around for our clients and our employees. I was sitting in Vegas at a conference with a potential buyer ... and I told my partner, I felt like I was in a meeting with a bunch of accountants ... boring. No fun. I said, "Why don't we do this to ourselves?"
QYou consult in this area and you lobbied 15 years ago successfully for a federal law change that would allow so-called S-corporations -- small businesses owned by individuals -- to convert to ESOPs, correct?
JRThe legislation was signed by President Clinton in 1998. We had a client who was an S-corp who believed in employee ownership. It was working and I thought, "This is better. You don't have to worry about buying out partners and our employees could benefit." Once you're here a year, you participate. Nobody buys in. You are allocated shares. The longer you are here the more you share. When you retire ... you get paid out the full amount of your stock. Some plans do it over five years. Several employees have retired or moved on and got paid out in cash since we started.
QThere are pitfalls, right? In other words, whether the partners self-finance the sale of the company over time to the ESOP, or whether you finance it through a lender, you want to be a growing business that's generating sufficient cash to pay down the debt with room to spare.
JRThe better we do, the better your retirement plan. This firm has grown every year through and after the recession. Top and bottom lines. The ESOP is part of it, I believe. We have employees who have a stake in the outcome.
The plan buys the stock from existing shareholders with profits. As the company grew, the value of the stock and shareholder value grows.
Let's say the exiting shareholders bought for $1 million. Then, we make $1,000,000 so we're worth $100,000 more. Our value goes up to $1.1 million and our debt goes down. We did ours through seller financing. In the accounting world, not many banks will lend you money to do this.
QSarah, you are president of the Upper Midwest ESOP trade group. What are the trends for ESOPs?
SGThere about 10,000 ESOPs nationally, representing about 10 million people. Almost 99 percent of ESOPs are privately held companies. The number of new ESOPs has not been growing in recent years [including the recession] but there are more ESOPs becoming majority owned ... through S-corps.
Q So an ESOP may be best for a successful company that wants to retain key people who might otherwise split after a sale?
SG An ESOP doesn't work for a company that's not growing and doesn't generate profit or cash. So, if the business isn't worth what the owner thinks, why sell [to another company]? It comes down to the business owner. And what the owner wants for the employees.
QWhat drives the decision to form an ESOP versus an owner simply selling?
SG The other options will be private equity or a strategic buyer [such as a competitor or other business] or a family member. An ESOP gives you one more potential buyer for the business. This can be a good option. It gives you some control that the firm won't be [gutted] or moved to another state.
You also need to look at the ESOP on an annual basis. ESOPs take care of ownership succession, but not management [succession]. You always need strong management and making sure management is committed and understands the ESOP. It doesn't work in a failing business.
Neal St. Anthony • 612-673-7144