The Ultimate Employee Buy-in

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So Schramski began casting about for an alternative, and in the process discovered ESOPs. After considerable research, he decided an ESOP was for him, and in 1995 he began selling the business to his employees in stages. By 1998 he had sold all his shares. In 2004 he gave up CEO duties completely.

Was it the right choice? On the one hand, Schramski paid a considerable price for his decision. As required by law, CPES's valuation for the ESOP sale was determined by an independent appraiser, who put it at $2.5 million. Schramski believes he could have sold the company to a strategic buyer for $3.5 million--though, of course, he wouldn't have received those aforementioned tax breaks, which were worth between $200,000 and $300,000.

On the other hand, his employees kept their jobs, and CPES--now known as Community Provider of Enrichment Services--has done better than ever. The company grew from $5 million in revenue in 1995 to $25 million in 2004; the payroll has swelled from 250 to 775. Families of clients, often mistrustful of for-profit companies in the field, liked the idea of employee ownership. Line employees learned to control key budget items such as vehicle expenses and maintenance costs, thereby boosting the bottom line. Managers who might have left the company, including one who got an offer doubling her salary, stayed with CPES to realize the rewards of equity. "We couldn't have grown like that without the ESOP," says Schramski. Employees help explain why. "The ESOP was really huge for me in terms of my investment in the company--my loyalty and longevity," says Cindy Gallon, an associate director at CPES. "Huge."

Legally, an esop is a tax-qualified retirement plan. It borrows money to buy the owner's shares, then allocates them to employee retirement accounts as the loan is paid off. In certain circumstances the selling shareholders can defer capital gains taxes. But these dry descriptions don't begin to do justice to the concept--and anyway, they beg the question of how on earth the U.S. government came to be offering tax breaks for selling a company to its employees.

The saga begins with an iconoclastic San Francisco lawyer named Louis Kelso, who believed fervently that capital ownership should be more widespread, and who realized even in the long-ago pre-leveraged-buyout era that would-be owners could buy a company by borrowing against its future earnings. Working on his own (and against the advice of his legal partners), Kelso in 1956 set up the first proper ESOP: Employees of a California company called Peninsula Newspapers used it to buy out a retiring owner. For years thereafter he pushed the idea hard. He wrote books and gave speeches. He set up a few more Peninsula-type plans on his own. (They came to be known as Kelso Plans, a name he disliked.) He lobbied politicians for government support to make the idea more palatable to skeptical company owners and their lawyers.

Then came the big break: In 1973 Kelso was introduced to an aide of Sen. Russell Long. Long, a Democrat and son of the fabled Louisiana populist Huey Long, was chairman of the Senate Finance Committee and one of the most powerful men in Congress. Soon Kelso and Long were having dinner together at Washington's Madison Hotel, and Long was buying what Kelso was selling--namely, that American workers should own a piece of the companies they worked for. Between 1973 and his retirement in 1987, Long and his allies sponsored legislation that created the tax preferences that ESOPs now enjoy.

Still, it took a while for ESOPs to catch on, partly because all those lawyers and financial advisers couldn't quite believe what the tax code was telling them. But today, the Kelso-Long legacy is visible for all to see: Sprinkled around the U.S. are hundreds of companies that "went ESOP" long ago, are now wholly owned by their employees, and are prospering beyond any founder's wildest dreams. This elite group includes:

Jackson's Hardware, a 65-employee store in San Rafael, Calif., that goes head-to-head with Home Depot and other big competitors yet continues to grow and thrive. With annual revenue ranging between $18 million and $20 million, it generates a ton of cash for its size--enough to pay off its ESOP loans "about 10 or 12 years ahead of where we originally planned," according to President and CEO William Loskutoff.

McKay Nursery Co., in Waterloo, Wis., which does $14 million in sales, aims for growth of about 5% a year, and has watched its stock increase in value about 8% a year for 20 years straight. Employee owners get anywhere from 10% to 50% of their base wage in cash bonuses every year in addition to their ESOP stock.

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