Home Finance For Owners Looking to Sell, an Option That Keeps Their Company Intact

For Owners Looking to Sell, an Option That Keeps Their Company Intact

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In early 2000, Michael and Lynn Terry started a business selling horse trailers that were lighter than their competitors’ and customized to each client’s needs. Nearly two decades later, their company, Cimarron Trailers, with tens of millions of dollars in sales, employed over 130 people in Chickasha, Okla., and their trailers were sold at 30 dealerships across the country.

And they wanted to retire.

But as the couple, who met in high school, contemplated a sale, they faced a conundrum: They had offers from dealers and competitors to buy their business; they also had an offer from a private equity firm for a price so high they were shocked. But none of those offers guaranteed that Cimarron would continue as a business with its 130 employees working in its community.

“We thought, this has got to go on,” Mrs. Terry said. “We’re one of the bigger employers here in Chickasha.”

So the Terrys went with a less lucrative option a couple of years ago — selling their company to their employees. But it ensured that their company would stay in Chickasha and their employees would continue to have jobs. It also allowed them to be paid for the company they created and retire in their community.

“Was it easy? No,” Mrs. Terry said. “But it was the best for the future of Cimarron going forward.”

Employee-owned companies are still a small segment of the U.S. corporate landscape. The number has stayed at about 6,500 for the past decade, said James J. Bonham, president and chief executive of the ESOP Association, the trade group for employee-owned businesses. But he said there were now some 10.5 million employees who own stakes in the companies they work for, through employee stock ownership programs, or ESOPs, as they’re known.

For families who own businesses and are wondering about their next step, selling to employees is an opportunity that analysts say owners should consider. It keeps the company intact, it has tax benefits for the company and the owners, and it allows the owners to sell without worrying that the business might be gutted and sold off in parts.

Yet it does have downsides. It’s a complicated structure, which comes under the regulatory scrutiny of the Labor Department, since employee ownership stakes are held in their retirement plan until they leave the company.

“It’s a complicated transaction,” said Jere Doyle, family wealth strategist and senior vice president at Bank of New York Mellon, the wealth management firm. “If you talk to 100 people, you might get eight or 10 who go through the transaction.”

But he said it’s a structure, given its tax benefits, that could increase in popularity if federal tax rates begin to rise. “ESOPs may become more popular next year if the Democrats hit the trifecta and raise the capital gain rates to 39 percent,” Mr. Doyle said.

When a family sells a company to a competitor or an investment fund, they run the risk that the identity of their company will die with the sale. It may become a division of someone else’s company or worse, it may be combined with something else and sold off, never to exist again.

An ESOP allows the company to continue in its own right, guided by the employees who are the new owners. “If I sold my company to my competitors, do you think Ray Baker’s name would ever be said again?” said Ken Baker, the chief executive of New Age Industries, the flexible tubing company his father, Ray, started in 1960 and his brother operated until he took it over. “We have a bust of my father in the lobby. His legacy and my brother’s legacy continue on.”

The Terrys initially thought their daughter and son-in-law might take over the business, but when that did not happen, they thought about how some of their key employees, like Ben Janssen, the current president, could continue to run it.

In their case, Cimarron was bought by another ESOP, called Folience, which made the transaction quicker.

“There was a template in place,” Mr. Terry said. “Folience gets together once a month to talk about their failures and successes. We didn’t have that.”

For the employees, owning the company gives them a boost to their retirement income, as long as the company continues to grow. With an ESOP structure, the money that goes into it is tax-free, increasing the amount put away for the employee-owners.

John Stover, 71, who retired from New Age after 35 years as the director of sales, said he saved twice as much for his retirement in the 15 years New Age was an ESOP than he did in his previous 20 years at the company plus five years at another company. But he said he was skeptical at first.

“We didn’t understand its potential,” Mr. Stover said. “We said let’s give it a chance. And the ESOP did what it’s supposed to do — create an atmosphere where you’re not just a worker anymore, you’re a part-owner of the company, and it would behoove you to work harder.”

During the pandemic, employee-owned companies performed better in retaining jobs for workers than nonemployee-owned companies, according to research conducted by Rutgers University’s School of Management and Labor Relations and the Employee Ownership Foundation. They also maintained salaries and wages at a higher rate.

Money from the sale goes to the person who started the business. But the advantages come in many forms, including deferred taxes on the money put into an ESOP and the timing of the payout. Mr. Doyle said more sophisticated structures allowed sellers to roll over some or all of the sale proceeds into securities, known as qualified replacement property. If the seller doesn’t need the money, any capital gains in those securities will be erased at death and heirs will inherit the portfolio free of capital gains or income tax.

Mr. Baker sold New Age Industries to employees over time. When he sold his first 30 percent stake to the ESOP in 2006, the shares were valued at $45. By the time he sold the fourth and final tranche — 51 percent in 2019 — the shares were worth $649.

“We’re 100 percent tax-free now, both federal and state,” Mr. Baker said. “That translates to a lot of dollars for a company our size. We saved $14 million this year.”

He said the company used the extra money to hire employees, buy equipment and continue to grow.

There are negatives to this ownership structure.

For one, the seller is not going to get the highest price when the employees buy the company. Nor will those employees see the company’s value skyrocket the way it could if a competitor bought it.

“We pay fair market value,” said Daniel Goldstein, the chief executive of Folience, the ESOP that holds Cimarron Trailers as well as an ambulance manufacturer and a newspaper publisher, both in Iowa. “ESOPs are prohibited from paying a premium.”

That lower value ensures that employees are not overpaying for what will be the bulk of their retirement savings. It can also mean that these companies will later become ripe targets for the private equity funds that their founders avoided the first time around.

“There’s also a lot of public information available so private equity companies can come in with an offer that’s X times higher than last year’s value,” Mr. Bonham said. “They know the valuation on the Department of Labor’s Form 5500 is very conservative.”

That federal regulation is the rub. Because the assets held by the ESOPs are retirement funds like any 401(k), the Labor Department has oversight. The companies need to bring in outside auditors annually so the employees know the values of their shares.

To sell again, though, the employees need to agree to the sale. Mr. Bonham pointed to New Belgium Brewery, the maker of Fat Tire beer, which became an ESOP in 2000 but was bought by a private equity firm at the end of last year.

“The employees all made a terrific amount of money and still have their jobs,” he said. “If you don’t work at an ESOP and your company is sold, you get nothing.”

Not all families are comfortable with this prospect. Mr. Baker said he has put provisions in the ESOP agreement requiring a supermajority of employees to agree for the company to be sold.

“I’ve put fences and walls around the company,” he said. “I want the company to be around for 100 years and be employee-owned.”

The Terrys say they are glad they took that road.

“I had a sense of pride about Cimarron,” Mrs. Terry said. “I stay close to several of the employees. I’m so proud of them for taking it and running it.”

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