More professional firms embrace employee ownership

Employee ownership is a good option for firms where employees are key to its value.

The ownership of Ayers Saint Gross has changed hands four times, all while keeping the design firm intact and in Baltimore for more than a century.

But when it came time for yet another transition, the owners looked for a less traditional way to keep the firm going without selling stock to new leaders, merging with another firm or selling to a competitor.

"It would have been easy to sell out and take our money and leave," said Jim Wheeler, a principal and president of the 150-person firm, known in Baltimore and internationally for planning and design projects at universities, museums and hospitals. "But we didn't want to lose our identity and everything we created."

A new chief financial officer had experience with employee stock ownership plans and suggested taking that route.

ESOPs, a type of employee benefit plan that was almost unheard of before the early 1970s, have become the most common form of employee ownership in the United States, covering 13.5 million workers at 7,000 companies last year, according to the National Center for Employee Ownership. They're becoming an increasingly popular option for professional firms facing an ownership change.

Companies establish an ESOP to buy out the shares of current owners, borrow money or offer a worker benefit. Typically, a company creates a trust fund and can make tax-deductible contributions of new shares or cash to buy existing shares. The trust also can borrow money to buy new or existing shares. Shares are allocated to accounts of employees. When workers leave or retire, the trust buys back shares at the current value.

A 2000 study by Rutgers University researchers found that companies with ESOPs see increases in sales, employment and sales per employee at a rate as much as 2.4 percent higher than at those without an ESOP.

"We immediately said 'This is the ticket,'" said Wheeler, who made the decision with fellow principals Adam Gross and Glenn Birx. "We could transfer 100 percent of the stock with an ESOP and become employee-owned and have a tax-efficient way to do things."

ESOPs work best for companies with strong cash flow, needed to finance the acquisition, and strong management teams to continue running the business and in cases where employees are key to the business' value, said Steven B. Greenapple, an attorney with Steiker, Greenapple and Croscut, a Philadelphia-based firm that advises firms on ESOPs, and which worked with ASG.

"Architecture and engineering firms are perfect examples. … Employees are the only asset the company has," he said.

The structure works well when owners have reached an age where they want to start transitioning out of the business, either quickly or over a period of years, Greenapple said.

And ESOPs offer strong tax benefits, he added. For instance, C corporations can elect to defer paying taxes on gains from the sale to an ESOP, and S corporations owned by an ESOP essentially operate tax-free, allowing the company to pay off debt more quickly. Also, a company's contributions to the ESOP, in the form of stock or cash, are tax-deductible, similar to retirement plan contributions.

Many more professional firms, such as architecture and engineering companies, are making the jump to ESOPs compared to a decade ago, said Michael Keeling, president of The ESOP Association, a trade group. Advisers are increasingly recommending the route for companies, he said.

"Often it's word of mouth … hearing that a company they respected did an ESOP," he said. "Architectural and professional firms … tend to be regionally based … where a business has a lot of local ties … and where the owner/founders are loyal to the area."

At EA Engineering, Science and Technology in Hunt Valley, employee ownership has helped spur growth, said Ian MacFarlane, its president and CEO.

The environmental consulting firm had been publicly held until 2001, when it went private. It adopted a partial ESOP in 2004, to buy out the 51 percent ownership shares of the founder, then last December bought out all the non-ESOP owners and became a 100 percent ESOP. The company has about 460 employees and about two dozen offices in the U.S.

"It makes it more clear that it's the employees who stand to benefit from the economic growth of the firm," MacFarlane said. "ESOP status allows us to attract and retain fantastic and excellent folks who deliver great service and who sustain our reputation with our clients, which allows us to do well in business. Doing well in business then rewards the owners of the business, who happen to be our employees."

ESOPs face some risks specifically related how they're structured, Greenapple said. ESOP transactions can overvalue the stock, which then requires an excessive amount of the company's cash flow to pay off debt.

"The way you avoid that is you get a good valuation and work with professionals who don't overvalue it," he said.

"The second risk is you don't have a management team that can take over when the founder leaves. The ESOP is a financial buyer. It doesn't run the company."

ESOPs are not a panacea for corporate woes. If a company fails, the employees stand to lose what could be an important part of their retirement savings. In a bankruptcy reorganization, for instance, shareholders, whether employees or not, have a lower priority than creditors and rarely see a payout.

That seemed to be the fate of the employee-owners of Hedwin, a Baltimore-based plastic container maker, which had operated as an ESOP since 2004. Last year, after struggling with rising costs, the recession and a major plant fire, the company filed for Chapter 11 bankruptcy protection to facilitate a sale.

The bankruptcy auction turned competitive, bidding up the price, said Alan Grochal, a Tydings & Rosenberg attorney that represented Hedwin in the bankruptcy.

Fujimori Kogyo Co., a Japanese firm that bought Hedwin at a bankruptcy auction last year, initially planned to keep operations in Baltimore but announced in December it will move operations to Delaware and close the local plant by 2017.

Though local jobs will be lost, the employee shareholders will be fully paid — an unusual outcome, Grochal said. After Hedwin's creditors were paid off and attorneys took their fees, the shareholders likely will get about $1.2 million, or $13 to $14 per share, he said.

"You don't see this normally in a case, that shareholders or employees receive this kind of payout," he said, adding that the ESOP's tax-exempt status also meant no tax bill on the gain of the sale of the assets.

Despite the benefits for many firms and growth of ESOPs among professional firms, the structure still is a fairly uncommon type of ownership transition, Keeling said. The number of ESOP firms has remained relatively flat over the past decade.

"The common thing you hear is people say 'Oh, they're complex,'" he said. "There are a lot of regulations and laws to creating an ESOP. It's a little bit of a psychological barrier."

For those that choose that option, he said, "There's just a good feeling that the group of men and women selling to an ESOP … got their money and the company's going to continue."

Ayers Saint Gross implemented its ESOP in October 2013, and last month announced that Luanne Greene, a principal and director of its campus planning studio, will take on the leadership as president in January.

"Company ownership is new to everyone," Wheeler said of the transition. "People think ownership is about privilege and getting to make decisions, but they don't think about the responsibility of providing paychecks for 150 people every two weeks."

Greene is heading an effort to create a strategic plan that will foster a culture of employee ownership. It will includes ways to parcel out more responsibility to employees with long-term leadership potential.

"It's been liberating to younger [leaders] participating in more … of the planning for what we do each year to gain long-term value. That in and of itself is a cultural shift," she said. "Now we're excited to start the next phase … how to engage all employees of the firm to make the place stronger."

lorraine.mirabella@baltsun.com

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