ESOPs: Key to Keeping Jobs in New York City?

Add New York City to the list of places that believe ESOPs can be an invaluable tool for keeping businesses running—and employees employed. (A previous blog post focused on efforts to tap ESOPs to keep businesses running in North Carolina.)

A report from the office of Letitia James, the Public Advocate for the City of New York, estimates that—every year—the city loses 114 businesses that each have sales of more than $1 million.

The reason those businesses close: The owner retires.

The annual cost to the local community: 2,220 lost jobs.

James knows now what the ESOP community has known for some time—that ESOPs can offer retiring business owners a great potential buyer for their mature companies.

And ESOP Association President J. Michael Keeling—who attended a panel discussion on ESOPs immediately following the press conference on James’ report—ensured everyone in attendance knew about the latest research that shows ESOPs outperform conventionally-owned companies at retaining jobs.

Benefits such as these must not have been lost on James, who wants to push for expanded efforts to establish ESOPs in the Big Apple. Her report states: “New York City should encourage business owners nearing retirement to consider transitioning to employee ownership.”

James is encouraging the city to provide education and support for business owners who are considering retirement. She wants the New York City Small Business Services to create a Succession Planning Unit that will reach out to businesses whose owners are nearing retirement age, and educate them about succession planning and services.

She further suggests that this unit perform basic feasibility analyses that would help businesses identify their best succession options—including employee ownership.

While being aware of ESOPs is a key first step, James also understands that creating an ESOP can take work—and money. So she wants the City to help business owners find funding to launch an ESOP.

The report states: “The city should also create a program that would provide financing for business owners that wish to transition to employee ownership. As more Baby Boomers reach retirement-age, these transitions will become an even more important job retention strategy.”

To help manage the costs associated with becoming employee owned, James wants one of two things to happen: New York State to renew funding for its Employee Ownership Assistance loan program, or the New York City Economic Development Corporation to create a program that would provide financing for companies that transition to employee ownership.

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Letitia James, NYC Public Advocate

ESOPs: The Answer for Retaining Jobs?

The state of North Carolina could be facing massive job losses in the near future. And encouraging retiring business owners to sell to an ESOP—rather than closing up shop—might be an especially effective way to stop that potential job hemorrhage, according to a new report from the North Carolina Justice Center, an anti-poverty group.

According to the report (Down Home Capital: How Converting Businesses into Employee-Owned Enterprises Can Save Jobs and Empower Communities), the potential for business-closure job loss is particularly dire in North Carolina, and the possible benefits of encouraging ESOPs may be especially well suited to that state.

But the coming storm of retiring business owners—referred to by some as the Silver Tsunami—is something all states will face. So, encouraging the transition to ESOPs might help other states retain more jobs as well.

Job Losses Caused By Business Closures

Since 2000, 2.2 million jobs in North Carolina were lost due to business closures. In any given year, more than 25 percent of job losses occur because businesses decide to close their doors.

These types of job losses “have seriously hampered North Carolina’s economic recovery,” the Justice Center report states. Since 2010, the number of jobs lost in the state due to business closures is larger than the net job gains made in the state during the same period. Conditions in the state are ripe for those losses to continue.

“A huge share of the jobs lost to business closure happen in relatively mature enterprises. North Carolina is particularly reliant on older businesses,” the report found, noting that the percentage of the state’s businesses that are 15 years or older is twice the national average.

These mature, viable companies are a tremendous source of value—and jobs—to the communities in which they are located. And if these businesses close, it can be a tremendous hardship—especially for communities that are economically challenged, or have few available employment options to replace the shuttered companies.

The Perfect, Rural Storm

Patrick McHugh, the author of the study, says many of the states’ most economically challenged areas sit right in the cross hairs of this coming trend.

Many of these areas are rural, have a high density of individuals approaching retirement age, and are particularly dependent on mature companies as sources of employment.

And because these regions are less populated and less affluent, they may struggle to provide an adequate pool of local buyers for retiring business owners. And local buyers—including employees—are key to boosting the financial health of these areas, the report finds.

Buyers from outside the local area are more far likely to move the business—even to reap only modest, short term gains—the report states. By contrast: “When firms are locally owned, the profits are more likely to be spent or reinvested locally, keeping that capital flowing and creating opportunities within a community.”

The report states that: “All other things being equal, communities with more local business ownership tend to achieve faster economic growth than areas where comparatively few of the firms are locally owned.”

Some of the regions poised to suffer most from the coming Silver Tsunami also are ones that have been economically depressed for multiple generations, says McHugh.

Better Than No Option

Some argue that owners who sell to an ESOP may be leaving money on the table. But in some of the less affluent regions of North Carolina, ESOPs can provide an opportunity to find a buyer where few, or even none, might otherwise exist.

What’s more, a business sold to the current employees will have an easier time transitioning than one sold to an outsider, who must take the time to understand the customer base, employees, suppliers, and more, McHugh says.

Perhaps most importantly, programs that help keep existing jobs—rather than investing valuable resources in luring outside businesses to create new ones—are inherently more efficient. “It is often more cost-effective to save what already exists than to bring in something new,” the report states.

The report found that North Carolina’s traditional job creation efforts are far more costly than comparable efforts of the Ohio Employee Ownership Center. The result, the report states: “Compared to the traditional economic development incentive programs, expanding employee ownership is an incredible bargain.”

A Penny Saved

The report makes note of the potential benefit to sellers of using the 1042 rollover, which allows owners of C Corporations who sell stock to an ESOP to defer capital gains from the sale, in certain conditions.

The 1042 rollover became a source of controversy last fall, when the Joint Committee on Taxation determined that applying it to S Corporations would cost the United States treasury more than $7 billion in lost revenue over a 10-year span.

Does the potential for ESOPs to cost-effectively save jobs in places where they are needed most—like the areas in North Carolina identified by the report—provide an argument for expanding the 1042 roll over? For the moment, McHugh steers clear of conversations about tax deductions. He is more interested today in programs that might help business owners pay the cost of initial inquiries that help them see if an ESOP is right for them.

But, he adds, if a tax incentive were the reason that business owners were prompted to sell to an ESOP—and retain to jobs in areas where they are needed most—that would be a positive outcome he would welcome.

A Recipe for Political Agreement

Today, there are plenty of issues that divide the United States, and few that can serve to unite those same states.

The ESOP model of employee ownership is one of those rare issues that frequently provides common ground for potential adversaries. And it has done so for decades.

A key reason for this mutual agreement is that research shows ESOPs benefit employees and businesses alike. So, unlike measures that promote one at the expense of the other, ESOPs draw support from business and employee advocates; from groups with conservative and liberal ideologies—and everything in between.

As our nation grows more polarized, and as its citizens and representatives grow farther apart, ESOPs increasingly are drawing together groups that traditionally would be at odds.

 

Chamber and CAP

The U.S. Chamber of Commerce—which traditionally holds a conservative view on public policy—recently endorsed ESOPs as one option its members can use to “offer quality retirement benefits to their workers.”

The Center for American Progress—which holds a more liberal view—began endorsing ESOPs in the past two years as a means of addressing growing wealth inequality. In one report, the organization states:

“Employee ownership can be a powerful tool to ensure that workers at all levels are able to share in the gains of a company’s collective performance. Research shows that employee ownership typically provides a host of benefits—not just for workers but also for businesses and investors. If these programs were to grow throughout the economy, they could promote broad-based wealth creation, thereby fostering sustainable economic growth and reducing inequality.”

As a result, the Chamber and CAP offer remarkably similar calls to action:

Encourage ESOPs—promote the benefits of ESOPs and protect them from frivolous litigation and excessive regulation.” –U.S. Chamber of Commerce

“Increase tax incentives for the formation of employee stock-ownership plans, or ESOPs.” –Center for American Progress

 

Congressional Commonalities

The long-running bipartisan support for ESOPs was evident most recently in two identical pro-ESOP bills introduced in the last Congress.

In the House, HR 2096 was sponsored by 59 Republicans and 36 Democrats. In the Senate, S 1212 was sponsored by 17 Republicans, 15 Democrats, and 2 Independents.

Democrats and Republicans alike on both tax committees—the Ways and Means in the House, and the Finance Committee in the Senate—supported the bill.

Moderates also endorse ESOPs. The Third Way, a self-professed centrist organization, recently published a paper endorsing ESOPs. The paper also pointed out that ESOPs enjoy broad support from all sides.

The paper cites the Republican Party platform, which states:

“We therefore endorse employee stock ownership plans that enable workers to become capitalists, expand the realm of private property, and energize the free enterprise economy.”

The paper also notes that the Democratic Party platform endorsed profit sharing plans, and that Secretary Hillary Clinton “expressed strong support for the idea of employee stock ownership as another example of profit sharing.”

 

Rare Agreement

One of the two independents who sponsored S 1212 was Senator Bernie Sanders, an ardent supporter of average pay workers and a legislator known for his liberal public policy agenda.

Senator Sanders and President Ronald Reagan—who espoused conservative ideals—would have been hard pressed to find issues on which they agreed. But both agreed on the value of ESOPs.

Ronald Reagan was the staunchest presidential supporter of ESOPs our county has seen, helping to draw attention to ESOPs and spur legislation that promoted and protected them. And Senator Sanders began his bid for the White House by once again voicing his support for ESOPs, including sponsoring S 1212.

 

Moving Forward

The ESOP model of employee ownership possesses a rare power to unite us. And that power is needed today.

Perhaps instead of focusing so much energy on issues where our nation—and our members of Congress—are destined to disagree, resulting in rancorous debates, we should start by spending a little time focusing on areas where we agree. ESOPs offer a perfect opportunity to build agreement.

The Ownership Infection

What if the spirit of employee ownership was like a virus, something that could be caught and transmitted to the next person you talk to?

What if it already is?

Amy Kirby is an employee owner at DCS Corporation. Last year she wrote an impressive letter nominating one of the people on her staff, Karla Langhus, to be The ESOP Association’s Employee Owner of the Year. Langhus, the chair of the DCS ESOP Communications Committee, won the award.

Ask Langhus about the remarkable list of accomplishments detailed in Kirby’s letter, and she credits Kirby for supporting her work as committee chair. “If it weren’t for her, it would never have gotten done,” says Langhus.

Langus also points out how well she and Kirby work together in their daily roles. Kirby, says Langhus, often acts like a partner, someone with whom she can bounce around ideas and work with to solve problems.

Langhus’ accomplishments clearly are the result of energy and hard work. Why does she put so much into the job of helping co-workers understand the ESOP? What does she get out of it?

“I get to do what I want to do,” says Langhus.

Taking ownership is important to Langhus. And she recognizes that it is important to others as well, so she makes sure committee members have autonomy and can make the projects they tackle their own. “I leave it to each committee member to figure out what will work best in their area,” she says.

Committee member Alan Johnson agrees.

“We come to her with ideas and she says, “Yes, that sounds good,’ and gives us feedback. And then we run with it.” Says Johnson: “We do feel like we are responsible for making an impact.”

Like a virus, ownership seems to have been passed from one person to another. Each one ends up with the space to claim ownership of his or her own efforts.

The results are more than just a good feeling. They are a focus on the long term benefit of the employee owners and the company.

Johnson says that while some investors in public companies may care only about the short term—and might be willing to tolerate cutting staff or shuttering branches to achieve that goal—he feels ESOP companies are more focused on the long term and are more loyal to their employees. In turn, that helps him focus long term.

“Having the long term in mind means you can plant these little seeds. And if you stay with the company you can see those seeds grow and grow,” says Johnson. “You actually are empowered to make a difference, and you can see that difference unfold.”

He adds: “I know the reward for helping out the company as a whole is eventually going to come back to me.”

Clearly, Johnson has the employee ownership spirit bug—one he caught from Langhus and Kirby.

Newsflash: Employee Owned Firms Are Good for Employees

While ESOPs can provide softer benefits to employee owners—such as greater involvement in decision making—at their core, they are a means for putting money into employees’ pockets. Typically, that money is intended for use in retirement. But ESOPs also tend to provide financial benefits that employee owners may realize much sooner.

For example, an ESOP requires no out-of-pocket contribution by employees—so they still have the same funds available to invest elsewhere, such as a 401(k). And many ESOPs provide that option: The 2015 ESOP Survey of members of The ESOP Association found that 93.6 percent of respondents offer a 401(k) in addition to their ESOP.

In general, research has found, ESOPs are more likely to provide two retirement benefits than most firms are to provide only one.

And it doesn’t stop there: The ESOP Survey found that 2.6 percent of respondents also offer employees a defined benefit pension. That means employee owners in these companies get two retirement plans, and neither plan requires them to invest a single dime from their own pockets.

Some critics assume that all this generosity must come at a price—namely that companies pay for their ESOPs by cutting back in other areas. But that doesn’t match up with the research. In a brief slated for publication in the November IZA World of Labor, Rutgers Professor Douglas Kruse writes that in almost all studies “employee ownership tends to come on top of market levels of pay.”

He adds that in comparisons of conventional and employee-owned firms, “employee owners in general reported higher levels of annual earnings, and were more likely to say they are ‘paid what they deserve’ and that their fringe benefits are good.”

Perhaps most importantly, employees at ESOP companies are less likely to be laid off. And that is true whether the economy is in recession or going great guns.

So employee owners at ESOP companies get a great retirement benefit that costs them nothing, often still have access to other retirement options such as pensions and 401(k)s, typically earn salaries at or above market level, and are more likely to keep their great pay and benefits because they are more likely to stay employed.

This last point is the most important, because the best pay and benefits in the world won’t amount to much if you can’t keep your job.

ESOPs Excel at Making AND Sharing the Wealth

Employee ownership is a fantastic concept, one that immediately brings to mind thoughts of equity, fairness, and sharing the wealth with those who have helped create it. But that concept sometimes gets a sideways glance from pragmatic business executives who know that sharing the wealth isn’t possible unless there is wealth to be shared.

Put another way, you won’t have much to share if you are broke.

Those executives can rest assured: ESOPs are generally very good at making money—and often are even better at it than conventionally-owned companies.

But talk is cheap, so let’s look at some facts:

Sales per employee at ESOP firms are 8.8 percent higher, on average, than at non-ESOP businesses. For the group studied, ESOP companies averaged $44,500 more in sales per employees. This means a 200-person ESOP firm would generate an additional $9 million in sales, compared to a traditional business.

Companies that were 100 percent ESOP-owned, and those with higher ESOP account balances, performed above the average.

(Source: 2008 study by Brent Kramer, a doctoral candidate at the City University of New York. Kramer is now a lecturer and holds his Ph.D. in economics. The study was funded by the Employee Ownership Foundation and included 328 firms that are at least 50 percent ESOP owned, and over 2,000 matching non-ESOP firms.)

On average, companies perform 4 percent better after adopting an ESOP, or compared to non-ESOP companies. (Source: Effects of ESOP Adoption and Employee Ownership, page 11, Steven F. Freeman, University of Pennsylvania.)

ESOPs appear to increase sales, and sales per employee by about 2.4 percent over what would have been anticipated, absent an ESOP. (Source: A study comparing 1,100 ESOP companies to 1,100 comparable non-ESOP companies for more than a decade. The study was conducted by Professors Joseph Blasi and Douglas Kruse of the School of Management and Labor Relations at Rutgers University, and was funded in part by the Employee Ownership Foundation.)

So the record is clear: ESOPs are not only good at sharing the wealth, they are also very good at creating it.

Nearly 10,000 Years of ESOPs

About 40 years ago, a smattering of critics said ESOPs were nothing more than a way for wealthy owners to cash out of their businesses. The typical ESOP, these critics said, wouldn’t last more than a few years. After that, it would be sold to the highest bidder.

Those critics were right about one thing—ESOPs are a great way for owners to cash out of a business. But the critics misunderstood a vital factor that motivates owners to sell to employees, instead of someone else.

It is longevity.

When you start or own a business, you invest a great deal of yourself into it. You bear a responsibility to your customers, and to the people you employ. And the way you meet that responsibility reflects who you are as a person; it reflects your values and ideals.

If you value what you have built, you want to see it live on. And you want the people who helped build it to shepherd it into the future, and to be rewarded for doing so.

In short, you want your company to carry on.

If your business is solely a way to make the greatest amount of money possible, why go to the trouble of setting up an ESOP—which might sell to the highest bidder a few years later? Why not cut out the middle man and sell to the highest bidder today?

For proof that ESOPs are an enduring form of ownership, just look at the list of Silver ESOPs—companies that have maintained an ESOP for at least 25 years. The ESOP Association has been honoring members that reach this milestone since 2008. In that time, 386 member companies have achieved Silver ESOP status.

Take those 386 companies and multiply them by the 25 years they’ve each had an ESOP, and you come up with 9,650 years of ESOP management.

Any many of those firms are still going strong—which probably makes their founders and former owners very happy indeed.

(Additional materials: a video about this year’s Silver ESOP companies and the press release announcing this year’s winners.)

The 2016 Silver ESOP Award companies are:

American Systems Corporation, Chantilly, VA

Black, Gould & Associates, Inc., Phoenix, AZ

BRPH Companies, Melbourne, FL

Bryant Air Conditioning & Heating, Lincoln, NE

Cannon Cochran Management Services, Inc., Danville, IL

CTL Engineering, Inc., Columbus, OH

EBO Group, Inc., Sharon Center, OH

Edmund A. Allen Lumber Company, Momence, IL

First State Bancorp, Inc., Caruthersville, MO

Goettle Construction, Cincinnati, OH

Granco Clark, Inc., Belding, MI

Great Lakes Orthodontics Ltd., Tonawanda, NY

Jackson’s Hardware, Inc., San Rafael, CA

KCI Technologies, Inc., Sparks Glencoe, MD

Kemner-Iott Group Agency, Adrian, MI

Kendall Electric, Inc., Portage, MI

Messer Construction Co., Cincinnati, OH

Morton Buildings, Inc., Morton, IL

New England Controls, Mansfield, MA

Pavement Recycling Systems, Inc., Mira Loma, CA

Prime-Line Products Company, Redlands, CA

Rable Machine, Mansfield, OH

Slakey Brothers, Sacramento, CA

Telephone Electronics Corporation, Jackson, MS

Trans-Overseas Corp, Romulus, MI

Veterinary Service, Inc., Modesto, CA