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.
Stone Construction Equipment, a $55 million company that has watched competitors move production operations offshore, but itself runs a profitable, growing manufacturing operation out of a sprawling factory in Honeoye, N.Y. Stone's 240 employee-owners can deliver a customized, built-to-order piece of equipment in a few days or less--a level of performance unmatched in the industry.
Having just co-authored a book about such companies, I can testify: These three aren't unique. What unites them and the many others in this high-performing club is that their leaders take the ESOP seriously, spend enormous amounts of time reinforcing the idea of employee ownership, and go to great lengths to encourage employee involvement and innovation. As at CPES, employees return the favor. A Stone team came up with the idea of mounting the tires on cement mixers after the mixers were painted rather than before, shaving six minutes off an extremely tight production schedule. A McKay hourly worker figured out how to reduce the labor required for drainage trenches, saving the company $10,000 a year. "Some of the ideas that get suggested are just phenomenal," says McKay chief financial officer Tim Jonas.
But make no mistake: It can be a long, hard slog from the moment of creation to that kind of business nirvana. Employee ownership is still a weird notion to most Americans. Sell the company to an outsider, sell it to management, pass it along to your kids--in all those situations, everybody knows who's in charge and what's supposed to happen. But selling to the employees? Will the inmates be running the asylum?
The legalities are clear and reassuring to nervous managers. The business runs as usual, with the CEO and the board in charge. The ESOP shares' votes are in the hands of a trustee, who is appointed by the board, just like the CEO. What's not so clear are people's expectations, fed as they always are by hope and fear. Managers who hear that the ESOP is part of an exit strategy may wonder what opportunities will be open to them when the owner departs--not to mention wondering when the hell that is going to be. Employees who are suddenly told they are owners may believe they're now entitled to run things.
One key to success is educating employees about what it means to be an owner. Yes, you will benefit in a major way if the company makes money and grows; here's how. No, you don't get to tell your boss what to do, and no, you aren't automatically entitled to know what she makes.
A second key: making sure that the CEO or his successor is up to the peculiar challenges of running an ESOP. Some ESOPs fail, if that's the right word, not because an ESOP company is any more likely to go belly-up than its non-ESOP counterparts. They fail because a selling owner can't let go, or because new managers don't draw enough benefit from employee ownership by pursuing a participatory management style. In both cases, employees decide that nothing has really changed, so they might as well go back to doing things the old way.
