NCEO November 2022 Newsletter

ISSUE HIGHLIGHTS

● Find out how ESOPs and family ownership can work together on page 3.

● The NCEO’s 2022 Executive Compensation Survey results show the impacts of the labor market on ESOPs. See page 4.

● What goes into a repurchase obligation study? See page 5.

● A Wisconsin court upholds a local brewery’s sale to an ESOP. See Cases & Rulings on page 6.

● The U.S. House of Representatives passed a bill that would limit arbitration in ERISA plans. See News & Ideas on page 7.

● What typically triggers a DOL audit? This and other questions answered in the Employee Ownership Q&A on page 8.

● Why don’t politicians and pundits think employee ownership matters? See the Owners’ Page on page 9.

EMPLOYEE OWNERSHIP REPORT

“WHEN MANAGEMENT PICKS MY BRAIN”

Leadership Humility and Team Involvement as a Means for Success

By Dallan Guzinski, NCEO Director of Culture and Engagement

Of the many takeaways attendees leave NCEO meetings with, I’m always curious to know what they have learned about team dynamics and what makes some teams more successful than others. After all, at the heart of many great company cultures are the norms and values that inform the behaviors of their teams and team members, whether they serve in management roles or not.

In fact, one of my favorite moments from the NCEO’s Fall Forum in St. Louis, Missouri, was a slide that posed this question: “Please recall an experience when you felt particularly proud, energized, satisfied, and/or effective. What was happening? What made the experience memorable for you?” The presenters, Jesse Tyler of associate-owned Hypertherm and Jon Sweigart from Praxis Consulting Group, shared a series of responses. Some of the comments from employee-owners referred to a sense of agency doing what they felt needed to be done at work, a sense of pride in one’s craftsmanship, or feeling like they were truly supported at the company because they never got torn down by others.

● Teamshares converts yet another company to employee ownership. This and more in Company Highlights, page 10. Continues on page 2

One of the comments in Sweigart and Tyler’s slide deck was highlighted, large, and bold on the screen. It seemed to be the most simple yet most thoughtful and touching of them all. It read, “When management picks my brain.” Could it really be so straightforward? The unassuming act of asking for this employee-owner’s thoughts and input on a given matter made them feel proud, energized, satisfied, and effective. It seemed so easy, yet in many workplaces throughout the United States, it is a less common occurrence than it ought to be.

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The NCEO is a self-sustaining nonprofit membership organization that helps employee ownership thrive. We provide practical resources and objective, reliable information on employee stock ownership plans (ESOPs), equity compensation plans, and ownership culture.

EMPLOYEE OWNERSHIP REPORT

©2022 National Center for Employee Ownership Permission to reprint must be requested in writing.

ISSN: 0899-8833

Employee Ownership Report is published online monthly by the National Center for Employee Ownership.

For membership fees or information, contact:

National Center for Employee Ownership membership@nceo.org 510-208-1300 NCEO.org

NCEO STAFF:

Megan Bonwell

Joanne Burns

Evelyn Castro

Michelle Cronin

Grace Dawson

Timothy Garbinsky

Dallan Guzinski

Nathan Nicholson

Jaymie Oviedo

Scott Rodrick

Ramona RodriguezBrooks

Aaron Supple Charlene Thomas Ivette Torres Suzanne Vinson Nancy Wiefek

MANAGEMENT PICKS MY BRAIN”

Continued from page 1

that large in-person events would not resume until a vaccine was widely available.” The company leveraged the experience, knowledge, and input of their teams: “We would need their contribution to identify and execute new business opportunities as well as eventually support reopening.”

SENIOR

STAFF: Corey Rosen EXECUTIVE DIRECTOR: Loren Rodgers

STAFF HIGHLIGHT Dallan Guzinski

Dallan Guzinski is the director of culture and engagement at the NCEO. He was born and raised in the Bay Area and received his master’s degree in political science from Pennsylvania State University. At the NCEO, Dallan works closely with employee-owned companies to develop and administer custom employee surveys that are used to help gauge the quality of their ownership cultures and take full advantage of employee ownership. He is also a contributor to NCEO publications and webinars.

In his free time, Dallan enjoys traveling, hiking, and exploring California’s abundant natural beauty, meeting new people, and discovering both new and old music. n

Jesse and Jon used this exercise and the comments that came from it to demonstrate the importance of humble leadership and high involvement at the team level when trying to create successful continuous improvement programs. Organizational learning scholars call this “quality in conversational turn taking,” which is to say that everyone at the table has a chance to speak up. Teams with these characteristics tend to outperform teams without them, regardless of the number of high performers either has on their team. Team members not only feel more seen and heard in these workplace environments, but more, if not all, team members are given opportunities to identify potential problems and provide viable solutions to organizational challenges. Without high involvement, organizations open themselves up to more organizational errors and failures.

Scaling the Conversation

When the COVID-19 pandemic shut down the world, employee-owned Crêpes à Latte had bigger problems than finding out what a lack of conversational turn taking might look like at the organizational level. As Haydee Caldero, Crêpes à Latte’s chief operating officer, told people in St. Louis, the company, which provides catering for live events, had to find a way to survive a devastating hit to its revenue for an unknowable period. I was fortunate enough to run into her at one of the NCEO’s networking events and learn about how they dealt with these extraordinary challenges.

For Caldero, the key was how to be resilient, a process she describes as “an organization’s ability to respond and adapt quickly to disruptions or significant, unplanned changes that could threaten its operations, people, assets, brand, or reputation.”

Caldero highlighted in her presentation that even if the stay-athome order was lifted, “many states, organizations, and clients were clear

The company began seeking input immediately and implemented various cross-functional initiatives to identify solutions to problems and create new business opportunities quickly and efficiently. Surveys and small team meetings enabled groups to look for new lines of potential revenue. Crossdepartmental teams were formed to work on long-term strategic planning and short-term experiments. By summer 2020, 84% of surveyed Crêpes à Latte employee-owners said they had learned new skills through this whole process. The company ended up being able to generate revenue through an innovative Crêpes à Latte treat box that could be personalized and sent to people in remote meetings (the NCEO did that for one of ours). With in-person events resuming, Crêpes à Latte is in good position to rebound.

Getting Everyone on the Same Page

I invited Deanna Colombo, executive assistant and member of the employeeowned Butler/Till’s employee communications committee, to St. Louis to share insights on her company’s work ensuring that employee-driven teams and leadership teams are in constant alignment with and support of one another. Her summary of Butler/Till’s vision for success rings true for all the companies mentioned here: Leadership support of team-based initiatives can ensure that the efforts of both are successful, as long as communication is not a one-way street. These success stories never seem to be tales of micromanaging or one group telling another group what to do without a shared vision and buy-in from both sides. When the involvement of all players in the game results in setting short- and long-term engagement goals for committees, teams, and the organization as a whole, employeeowners and the leaders of their businesses celebrate in these successes together as a real team where no one player matters more than the whole. It is shared experiences like these from employee-owned companies that make the ESOP community one of learning and truly something special. n

Dallan Guzinski with Deanna Colombo at the NCEO Fall Forum in September.

“WHEN

ESOPs and Family Ownership

ESOPs are most often used to buy out 100% of the ownership of a closely held company. Often, ESOPs are the best choice for a family business that has passed ownership from generation to generation (for example, King Arthur Baking was family owned from the 1790s until it did an ESOP). But what if there are family members who want to stay in the business? Can ESOPs still be the right choice? A couple of stories show they can.

Like almost all family businesses, Commercial Casework in Hayward, California, had to plan for when family owners would want to sell. The company, with about 100 employees, is one of the San Francisco Bay Area’s premier casework companies. Formed in 1976 by four brothers, the company set up a pioneering open-book management system that helped it prosper. By the 1990s, Bill Palmer, the CEO and one of the brothers, started looking at ways to ensure business continuity. They could have sold to another company or maybe even a private equity firm, but Bill opted for an ESOP. Bill’s son Nick, now the CEO, says the choice “really came down to there being a lack of other viable options that he would consider. Selling the business to private equity would strip Commercial Casework of what it was known for; selling to the employees who had no cash wasn’t viable; and closing up shop didn’t sound good.” An ESOP just made sense.

The company was sold gradually to the ESOP, and now is 100% ESOPowned. Nick says that being an ESOP allows the company to keep its culture and gives all employees a true stake in the game. “Everyone wants employees to ‘think like owners,’” he says. “With an ESOP, you are an owner, no pretending needed.” Nick knows that in many family businesses, he could have become the sole owner, but he’s happy that the choice was an ESOP. The company has prospered—most employee accounts in the ESOP are well into six figures (and

often high six figures)—and Nick has shared in this prosperity.

While most ESOPs end up owning 100% of the company, many familyowned businesses keep some of the ownership in the family and some in the ESOP. That is the case for New York–based Stewart’s Shops, a chain of over 350 convenience stores with over 2,850 employee-partners. Stewart’s makes its own ice cream from its own dairies (and this ice cream has been named the best in the country by the World Dairy Expo). The Drake family, now in its third generation, owns 60% of the company, but they also found an ESOP to be the ideal way to share the rewards of growth with employee-partners and provide liquidity for family owners. The ESOP owns the other 40% of the company and has provided employees with a substantial benefit. In 2020, for instance, employee accounts grew by 20%, and employees got contributions to the plan worth 19% of pay. In fact, Stewart’s has over 100 millionaire ESOP participants. Perhaps that is part of why Stewart’s is consistently named one of the best places to work in the region.

For many companies like Stewart’s, there may be owners who are not involved in the business and would like to sell. Other family members may not have the funds or risk tolerance, and the company would have to use after-tax dollars to do a redemption. The ESOP provides a ready market funded by pretax dollars.

Limitations and Opportunities for Family Ownership

If a seller to an ESOP takes advantage of the Section 1042 tax deferral treatment on the sale to an ESOP by reinvesting in

other securities, direct family members and their spouses cannot get any of those shares allocated to them. If that is not the case, the family members can participate in the ESOP, and often will accumulate substantial ownership interests. There is a 5% “de minimis” exception, but the interaction of this rule with other rules makes it generally not very useful.

Whether the limitation applies or not, family members can get additional equity if the company grants shares directly or, more commonly, provides the individuals with synthetic equity. Synthetic equity is usually preferable in S corporations because holders of actual shares will normally want a distribution to pay their taxes. The ESOP has to get a pro rata share of these distributions, and if the trust is a substantial owner, this could be a very large amount. Synthetic equity does not raise this issue.

Family members can still benefit, however, even if they end up staying with the company and not getting ownership outside the plan. Because sellers to the ESOP can get a tax deferral, their sale proceeds are substantially higher net of taxes, so the children get more. If the family has a charitable interest and uses a charitable remainder trust to which it contributes the qualified replacement property, the corpus of the trust is higher, and the payout from the trust is higher as well. Qualified replacement property not sold or donated but held till death gets a step-up in basis, so no capital gains taxes are ever paid.

Many family businesses want to keep ownership only in the family, but an ESOP is worth considering for any family business open to the idea of creating a bigger “family” of owners. n

Many family businesses want to keep ownership only in the family, but an ESOP is worth considering for any family business open to the idea of creating a bigger “family” of owners.

Survey Results: Impacts of the Labor Market

Last month, the NCEO released its 2022 Executive Compensation report, an analysis of compensation-related survey responses from 380 privately held ESOP companies.

While the NCEO’s intention with this offering is always to provide up-todate data on current trends related to executive compensation, this year’s survey also included questions about how the labor market has impacted companies, specifically in regard to employee recruitment and retention. These questions provide insight into how the labor market has impacted base pay,

what compensation-related changes companies used in order to recruit and retain employees, and companies’ outlook on their future.

The labor market seemed to have the strongest impact on the recruitment and retention of nonmanagement employees, with 71% of respondent companies reporting difficulties attracting and retaining these employees and 79% reporting having to make compensation adjustments in response to these difficulties. Recruitment and retention difficulties for nonmanagement employees were more pronounced in the retail, manufacturing, and construction industries and were typically reported

more in larger companies. While recruitment and retention issues for management-level employees were less commonly reported, 23% of respondents still reported such difficulties with non–executive management employees and a majority reported having to implement base pay adjustments for employees at this level. Companies reported having difficulty retaining and recruiting executive-level employees at a low rate, 8%, although one-third reported increasing base pay for these employees. Figure 1 provides a complete look at how companies responded to these recruitment and retention questions as well as other questions related to the labor market. n

Executives

Executives

FIGURE 1. How has the current labor market impacted your company with respect to executives, other top management, and nonmanagement employees? (373 responses)

Executives

We increased the normal base pay adjustment for 2022

We have difficulty attracting or retaining employees at this level

For selected employees, we match competitors’ offers to avoid losing key personnel

We have added signing bonuses for new recruits at this level

Despite the labor market, we stuck to our compensation philosophy to ensure we can sustain pay levels

We have added retention bonuses for selected employees at this level to enhance retention

We increased the potential size of bonus targets for 2022

33% 8% 10% 8% 35% 8% 18% 14% 57% 23% 27% 20% 32% 13% 21% 13%

33% 8% 10% 8% 35% 8% 18% 14% 57% 23% 27% 20% 32% 13% 21% 13% 79% 71% 43% 35% 28% 20% 19% 4%

We have added equity compensation for selected employees at this level to enhance retention

Other top management Non-management employees 33%

33%

8% 10% 8%

Other top management Non-management employees 8% 10% 35% 8% 14%

Non-management employees 33% 8% 10% 8% 35% 8% 18% 14%

79% 71%

8%

23% 27% 32% 13% 13%

57% 27% 20% 32% 13% 21% 13%

20%

57% 23% 27% 32% 13% 13% 19% 4%

71% 43% 35% 28%

FIGURE 1. Based on the way the pandemic and subsequent issues (labor market, inflation, supply chain) have impacted your company, how do you feel about the sustainability of your company (i.e., ability to meet ESOP repurchase obligation and execute the strategic plan) compared to before the pandemic? (377 responses)

Much more optimistic 2%

Slightly more optimistic 26%

Slightly less optimistic 57%

Much less optimistic 15%

35%

71% 43% 28% 19% 4%

79% 71% 43% 35% 28% 20% 19% 4%

NCEO EMPLOYEE OWNERSHIP REPORT NOVEMBER 2022 / PAGE 4

The NCEO extends its thanks to those who participated in the survey and made this report possible. The full survey results are available to NCEO members at a significant discount. Click here to purchase our 2022 Executive Compensation Report.

What Goes into a Repurchase Obligation Study

This article presents key observations made in a presentation by Renee Stadtmueller of Blue Ridge Benefits and Alex Grasser of SJC Fiduciary Services at the 2022 NCEO Fall Forum.

A good repurchase obligation study is an essential component of any sustainable ESOP program. Getting reliable output depends on using appropriate input. That is only the first step, however. Each factor will impact many other factors. A rising share price, for instance, might affect diversification and turnover rates (albeit counterintuitively—rising prices will probably decrease both factors).

Employment growth rates will affect when stock is redeemed and how much each participant gets reallocated to them. A change in senior leadership might affect how your valuation firm views your stock value. While many companies do these studies in-house, it pays to at least have professional advice in setting up your analysis and periodically reviewing it. The following tables look at the key factors and the critical variables for each. n

TABLE 1. ESOP Repurchase Obligation Inputs

FACTOR KEY CONSIDERATIONS

Census data Use the most recent completed allocation data. Decide whether to wait or not if close to plan year-end.

Stock price timing Typical to use the most recent completed allocation data based on prior valuation. Should you wait or not if close to plan year-end?

Stock price value Use enterprise value as the starting point to determine growth rate assumptions. Then factor in necessary adjustments to enterprise value to determine equity value, such as one-time or special items, cash, etc.

Redemptions Are you redeeming shares, redeeming and recontributing some or all shares, or putting cash into the plan to buy back shares? If redemption and recontribution depends on how many shares are up for redemption, what is the formula for recontributing them? Will there be a loan between the company and the ESOP?

Distribution policy Do you plan to retain the current policy, or will you change it depending on results of the study or other factors?

Do you use lump-sum or installment payouts? Are they in stock or cash? What is the minimum required force-out number?

Participant number changes Will you be adding or subtracting people? How will that affect the age distribution of your workforce?

Groupings If you group participants into demographic groups (age, pay, tenure), are these groups clearly defined and stable?

Replacements When someone leaves, what does their replacement look like? Will new senior leadership have similar demographics? Will new hires have a different age/ compensation than the current group?

Separation of service Break down by expected turnover, mortality, disability, and retirement. Is this based on years of service or actuarial tables?

Diversification What do you expect? Will higher prices cause less diversification? (They often do.) Should you consider (and test) enhanced diversification options?

Other elements What are your contribution and dividend amounts? What about ESOP loan terms or releveraging? What are forfeiture and vesting expectations?

TABLE 2. Observations on Critical Factors

Separation of service Retirement is usually the most important event for separation of service in most ESOPs. These are the people with the largest account balances. Ordinary turnover has a smaller effect in most companies, but not every company.

Diversification Higher diversification pulls shares forward in the study horizon, lowers future retirement payouts, and brings other shares into the study. Long-term observed rates average between 30% and 35%.

Turnover Best practice is to use a years of service approach if age is not a factor.

Lump-sum vs. installments Affects all elements other than demographics.

For an overview of the repurchase obligation, see the NCEO’s The ESOP Repurchase Obligation Handbook .

Contributions and dividends Software programs may not differentiate, but they can have differing impacts. Contributions in excess of debt and RO needs will build cash. Watch for system-generated contributions in excess of 25% of compensation. This may warrant a re-run with dividends/distributions.

Loan servicing If prepaying loan, calculate the impact compared to not doing this.

CASES & RULINGS

HIGHLIGHTS:

● Former investors cannot challenge New Glarus sale to ESOP

● Alerus agrees to settlement in KPC case

● Aetna, CVS win case over drop in Aetna stock in 401(k) plan after merger

● Plaintiffs must arbitrate ISCO ESOP claims

● Court orders restitution to ESOP where seller acted as trustee

State court upholds sale to ESOP:

In Eichhoff et. al. v. New Glarus Brewing (WI, No. 2021CV002011 (Cir. Ct., Dane County, Oct. 6, 2022), a Wisconsin court dismissed a lawsuit against ESOP-owned New Glarus Brewing over the price three of its early investors got when they sold their stock after the ESOP was formed.

The investors claimed the valuation of their stock was fraudulently undervalued when they sold their shares in 2017. One of the investors sold directly to the ESOP, the other two to the company.

The investors claimed they should have been able to see the valuation report, but the judge ruled that the company was under no obligation to explain how it arrived at its per-share offer. In one sale, the purchase was made by the ESOP, so the price was set by the trustees. The judge said there was no recognized market for the shares and that the board has the duty and right to set the share value for any offer it makes to buy the shares outside the sale to the ESOP. Because of this, the company did not— and indeed could not—misrepresent the price because the board ultimately sets it (or, in the case of the sale to the ESOP, the ESOP trustee sets the price). The judge called the lawsuit “a simple case of greed and overreach.”

Alerus agrees to $4 million settlement in KPC case: In Gamino v. KPC Healthcare Holdings, Inc. et al., No. 5:20-V-01126-SB-SHK (C.D. Cal. Oct. 10, 2022), Alerus agreed to a $4 million settlement with KPC Healthcare in an ERISA valuation case. As we detailed in the October 2022 issue of this newsletter, litigants had already secured $5 million from other defendants in the case. Plaintiffs alleged the stock price the ESOP paid was too high because it was nine to 15 times higher than the price of company shares on the public market just two years before.

Aetna, CVS defeat claim in suit over stock price drop in 401(k) plan after merger: In Radcliffe v. Aetna, Inc., 3:20-cv-01274-VAB (D. Conn. Sep. 30, 2022), CVS and Aetna defeated a claim that the defendants acted imprudently in not disclosing information about the financial risks facing CVS that emerged after the merger. CVS acquired Aetna in 2018. Aetna employees had been able to invest in Aetna stock in their 401(k) plans. With the merger, Aetna shares became CVS shares. CVS stock fell sharply after it disclosed that its acquisition of Omnicare, a long-term health provider, required CVS to take a $2.2 billion goodwill impairment because of financial issues at Omnicare. CVS was also facing litigation (which it ultimately lost) over its prescription pricing policies with hospitals. The plaintiffs argued that information about the impairment and litigation should have been provided to them. The court ruled that the defendants were not fiduciaries, having delegated that authority to a committee that was not the subject of the litigation. More important, the court found that the defendants cannot be held responsible for the choice to move Aetna shares into CVS shares because the allegations made concerned events that only hindsight could show would affect stock price.

ISCO plaintiffs must arbitrate their claims: In Best et al v. James., No. 320-cv-299-JRW (W.D. Ky., Sept. 22, 2022) a court ruled that plaintiffs must agree to arbitrate their claims against executives of ISCO Industries concerning the buyback of company shares from the ESOP. In a prior 2019 decision, Swain v. Wilmington Trust N.A., a federal judge approved a $5 million settlement with a class of employees at ISCO Industries who alleged the ESOP had overpaid for the shares. The settlement amounted to about $12,000 per employee, minus legal fees and taxes. The ESOP paid $98 million for the shares with a note from the sellers at a 2.4% annual rate over 25 years. Post-leverage, the shares were revalued at $39 million. In settling, Wilmington denied it had done anything improper.

That turned out not to be the end of the affair. In 2017, Wilmington was replaced by an independent trustee with limited experience in trustee issues (Stephen James), because the Kirchdorfers, executives of the firm,

wanted to buy back all the shares from the ESOP and Wilmington was reluctant to approve their proposal. In 2016, the company stock value was relatively low, but by 2017, a variety of circumstances led to the promise of significant growth. Plaintiffs allege the Kirchdorfers wanted to underplay these prospects so that they could buy the shares at a lower valuation. Plaintiffs also allege they were urging employees to write brief explanations of why the ESOP was not working for them. The new trustee approved a sale price of $96 million, $2 million less than what the ESOP paid in 2012. Plaintiffs say James made little effort to question the input for the new valuation.

Defendants said that the plaintiffs were covered by an arbitration agreement between the company and its employees that included any issues arising out of ERISA. Best, one of the plaintiffs, said his agreement predated the ESOP, so it could not be covered. The other two plaintiffs’ agreements came after the ESOP. The judge ruled that Best was still covered because the agreement would by implication include future benefits. The judge also ruled arbitration was applicable because there was nothing in ERISA to prevent arbitration clauses. There have been a few similar wins for ESOP defendants in arbitration cases, but other courts have said that employees cannot waive the right to sue.

Court Orders $540,000 to be Restored to ESOP in Case Where Seller Acted as Trustee: In Walsh v. Robert N. Preston, TPP Holdings, No. 1:14-cv-04122-ELR (N.D. Ga., Sept. 20, 2022), a court ordered TPP Holdings and former owner Robert Preston to restore $540,000 to the ESOP over an alleged overvaluation of shares the plan bought in 2006 and 2008, as well as other violations. Preston acted as both the trustee and the seller in the plan. The ESOP paid $6 million in the transactions. Two years after the final transaction, the stock was worthless. The DOL alleged that the valuation was flawed and based on excessively optimistic projections. The DOL also alleged that the company failed to make required distributions to the ESOP, allocated fewer shares to the plan than required, commingled company and plan assets, and failed to make required distributions to terminated participants. n

House Passes Bill That Would Limit Arbitration in ERISA Plans

By a vote of 220–205, the House passed the Mental Health Matters Act, which, among other provisions, would bar compulsory arbitration in all ERISA plans. It would also ban forced arbitration clauses, class-action waivers, and discretionary clauses, and make representation waivers unenforceable. Participants can still agree to arbitration, but only if there was no coercion and they are informed in writing of their right to refuse without retaliation, and they also must have a 45-day waiting period to agree to arbitration. Plans would have one year to comply with the regulations. Senate prospects are uncertain.

HR Needs a Seat on the Executive Team

Our Fall Forum keynote speaker and CEO of the 100% ESOP-owned SRC Holdings, Jack Stack, is at the helm of one of the most successful and influential ESOP companies ever. Jack is also the author of the best-selling The Great Game of Business.

Jack told the audience that the biggest challenge SRC—and just about every company—is facing is getting the right people. That has always been important, of course, but never more than now. If companies really do believe it is people who drive their success and create their culture, then it should follow that the HR function needs a much more prominent role on the executive team. Jack noted that HR used to be called “industrial relations,” then became “personnel,” and later “human resources.” Now some companies are calling the job “chief people officer.” In all these iterations, however, the job has been mostly administrative, focusing largely on compliance and reporting. HR directors rarely have a role in company strategy.

That approach has to change, Stack said. This might start with a name change that reflects the enlarged role (vice president for people is one we have heard) and a seat at the executive team table. He wrote more about this in a blog. We would love to hear your ideas about how your company has made HR a key part of your strategy. Let us know by emailing Corey at crosen@nceo.org

Project Equity Founders Win Heinz Award

Hillary Abell and Alison Lingane, founders of Project Equity, have been named as one of the two winners of the Heinz Family Foundation Award. The other winner was Chrystel A. Cornelius, president and CEO of Oweesta Corporation, which works on economic development projects for Native Americans.

Project Equity was created in 2014 with a focus on promoting employee ownership in low-income communities, initially primarily through worker cooperatives, but in recent years ESOPs as well when appropriate.

What Do You Take Back from an NCEO Conference?

An NCEO conference is a better investment if you bring back ideas to anyone who might find them useful at your company. Jesse Tyler, an employee engagement and experience associate at employee-owned Hypertherm always does this, and this year he was generous enough to share what he sent back with us. Here are some facts and ideas he found worth sharing:

DATA

● ESOPs have a 6% quit rate vs. 20% for non-ESOPs.

● The average ESOP account balance $132,000, while the median retirement account balance for an employee in a private-sector company is zero (because half this workforce is in no retirement plan at all).

CULTURE TRENDS

● Teams: Dallan Guzinski of the NCEO says that “frontline, midlevel and executive leader presence and active participation all create a symbiotic loop.” Moreover, “ESOPs don’t create ownership mindset, they reward it.”

● Create a culture calendar that is easy to get to. No clutter, just culture.

● Communicate with your workforce at least three times to break through and reach different learning and communication styles. Up to seven times may be needed to convey a message. Shortcuts and acronyms may not translate well. – Butler/Till

● Send a brief Monday morning employee ownership nugget. Regular small bites can break through.

● Questions for listening sessions:

● How much do others feel like owners of the company? How much do you?

● Do we influence parts of the business? What do we want to influence?

● Why do you stay at [your company]?

CYBERSECURITY

Cybersecurity is an expanding topic at conferences. Jesse referenced some ideas from Evan Rice at Guide Star:

● Conduct monthly phishing tests: 1 fail = 20-minute required training; 2 fails = you and your manager both must pass the training;

3 fails = PSIP (personal security improvement plan);

4 fails: meet with CEO to discuss the fails (no one has gotten to this, yet).

● Post Days Since Last Cyber Incident with all traditional safety signs and metrics.

● Share metrics of attacks and saves: Celebrate the wins, did you know we fended off X attacks?

FINANCIAL LITERACY

Financial literacy and improvement accounts: Train all employees on financial basics to understand how the company works, that your good fortune you are used to here is not a given. Train groups of up to 25 in two-hour sessions. Interactive, gamify.

● Start with personal finances, link to work finances. Topics include balance sheets, cash flow, cost of sales, admin expenses, how we use cash position to make money. The two biggest surprises: timing of dollars spent vs. dollars received and of top six costs for the company, four are related to people.

● $100 improvement accounts for all nonmanagerial employees: What improves work? Food and clothing excluded. Can be combined with others for larger spends. Examples: 3-D printers, hand tools, antifatigue mats. Put the money into their hands to spend like owners to improve their work experience and efficiency.

● Put a value on our safety investment. Help our associates understand how much we spend on PPE, ergonomics, etc. n

EMPLOYEE OWNERSHIP Q&A

Does our board have a fiduciary duty to focus only on shareholder value?

In most states, a board’s primary duty is to protect the interests of shareholders and the company, a kind of “dual primacy.” Stock price, especially over the short term, is not the only consideration. Boards can argue, for instance, that social goals, long-term investment strategies, or pro-employee policies are an essential part of business success. Second, some states explicitly allow boards to consider other issues and some allow companies to be organized as B corporations, which have a specific requirement to consider issues that are for the public benefit, a broadly defined term.

On the other hand, ERISA says that ESOP fiduciaries are supposed to focus on the long-term value of plan assets. An argument could be made that that should be measured by share price, but boards have a lot of latitude in how they determine the best way to get there.

In short, the best advice is for boards to focus on decisions that help create a company that is economically successful and sustainable over the long term.

Can an earnout be part of a sale to an ESOP?

There is no specific restriction on using an earnout as part of an ESOP purchase, but trustees are generally not comfortable with the idea. It is difficult to value an earnout, so the prudent thing to do is to discount it substantially. If there is a concern that the company might not perform as well as expected (in which case an earnout can provide some protection), it may be better to have a clawback provision in the sale terms. If the reason for the earnout is that the seller wants more of a potential upside, warrants are a better approach.

When we set up our ESOP, we did not know that the internal loan could be longer than the external loan. Now we realize that we are going to allocate all the shares over a short period of time. What can we do? Can we extend the internal loan?

You are not alone in this. A lot of ESOP companies were never told that this is something they can do or why they should do it. Extending the internal loan is possible, but because this means participants are giving up a benefit they would have otherwise had, the trustee will only agree to this if participants get something in return. It can be hard to identify an acceptable benefit they can get within the plan. One option would be to commit to an additional cash contribution; another might be a floor price for some number of years. The best option, however, is to refinance part or even all of the loan. The company would borrow money to buy out some portion of the plan’s holdings, then reallocate those shares as the new loan is paid. Employees now get some diversification in return for their shares. This approach requires that you have the cash, of course, and it will require analysis by the trustee as to its fairness.

How is net unrealized appreciation computed with respect to ESOP shares?

In Rev. Rul. 2003-27, the IRS ruled that an ESOP is required to adjust its basis in S corporation stock for the ESOP just as it would for any other shareholder. So in a lump-sum distribution of ESOP shares to a participant, the basis would be adjusted to reflect distributions made to the plan, meaning employees would have a higher basis in their stock than would otherwise be the case. This basis is taxed as ordinary income. Companies could distribute cash to the participant to reflect this basis adjustment, leaving the remaining value subject to net unrealized appreciation treatment (meaning it could be taxed as capital gains). In practice, this will rarely matter, as very few participants will retain stock in the company in any event, and the sale will make them subject to ordinary income treatment.

What typically triggers a DOL audit?

The Department of Labor looks for several key issues. Audits may be part of ongoing random audit programs, computer-generated identification of a

potential problem, private lawsuits, or a complaint by a participant. The DOL will focus on fiduciary duty, prohibited transactions, and conflicts of interest.

The audit will ask for standard plan information and investigators will interview the fiduciaries. They may ask for corporate information such as the board of directors meeting minutes, articles of incorporation, and the financial statements. Some key areas that come up are:

● Inadequate ESOP fidelity bonding.

● Proper disclosures to participants.

● Who makes decisions for the ESOP and are there conflicts of interest that could lead to problems?

● Conditions of the ESOP loan in the event of default.

● Improper collateralization of the ESOP loan.

● Proper release of shares, contributions, allocations, vesting, and distribution.

● Math errors.

● Improper ESOP refinancing (refinancing that benefits the company or other parties more than the ESOP).

● Valuation. No issue is more critical than an improper valuation—or an improper procedure to vet the valuation.

● Accuracy of financial projections and/ or overreliance by the appraisal firm on excessively optimistic projections.

● Excess payments to officers and/or non-ESOP owners.

● Failure to honor the put option.

We have a 6% owner and a 94% ESOP. Can we force the 6% owner to sell?

This is a state corporate law issue. Generally, you cannot force an owner to sell unless you have some by-law stipulation on that or there is a buy-sell agreement. But you may be able to make it unattractive for them to hold on to shares by not making a distribution so that they can pay taxes. You can also offer to buy back their shares at the company level for a premium. That works under ERISA provided the premium is not deemed excessive (and thus a waste of corporate assets) by the trustee. n

Why Don’t Politicians and Pundits Think Employee Ownership Matters?

By Corey Rosen, NCEO Founder

Employee ownership works for companies, communities, and employees. And there is a lot more broad-based employee ownership than most people realize. There are about 6,500 ESOPs in the United States with about 14 million participants, and another 11 million or so employees in companies that give everyone some form of equity and/or give them significant discounts on shares they purchase.

Data on all these plans show that employees are paid better, are laid off much less, and accumulate much more wealth than they would if they worked for a non–employee ownership company. Companies do better as well, growing faster in sales and employment and retaining their workers at higher rates.

At a time when trust in the economy is fading, where half the population cannot put its hands on $1,000 in an emergency and half the private sector workforce has no retirement plan assets, and where just about every employer is saying that attracting and retaining employees is their primary or one of their most important challenges, you would think that an idea that addresses all these problems and has essentially no political opposition would be getting a lot of attention from political leaders and pundits. But when is the last time you heard a candidate for office talk about employee ownership, or saw a talking head on a news channel mention it? Working as much on this issue as we do, we have come across some true champions— Representative Dean Phillips (D-MN), for instance, has become a valuable champion, and Senator Bernie Sanders (I-VT) has been a longtime leader. Both are leading legislative efforts that could bear fruit this year or next. There are a few others, from both parties, who also consider the idea essential.

But these people are exceptions. Employee ownership never comes up in a presidential race and almost never in any other election.

John Case and I wrote our new book, Ownership: Reinventing Companies, Capitalism, and Who Owns What to argue that employee ownership needs to be a priority, not just an idea that gets lots of pats on the head but does not make it on almost anyone’s list of top 10 ways to fix the economy. It is a tough sell.

So what’s going on here? I have a number of theories:

It Is Not Controversial Enough

It always seemed to me that the fact that the right and the left, that Democrats and Republicans and everyone in between liked employee ownership was a strength. The concept’s very popularity should make it a no-brainer for any politician to campaign on and an interesting idea for pundits to discuss. About two years ago, I was disabused of that notion. I had an interesting call with someone who wrote a good op-ed on employee ownership (it would not be appropriate to say who). I talked with him about this very issue. He had been part of the 2016 Clinton campaign team. Employee ownership was explicitly advocated in a long policy paper developed for the campaign by the Center for American Progress, a progressive think tank.

That policy paper strongly endorsed employee ownership and profit sharing and had a number of ideas to promote these practices. But Hillary Clinton never once said “employee ownership” out on the campaign trail. “Why not?”

I asked. “Because,” he said, “it is not controversial enough. You can’t campaign on an idea your opponent likes too.”

Plan Rules Are Complex

Imagine you are writing a 650-word column or giving a campaign speech and you want to talk about employee ownership. Most people will understand

that term to mean worker cooperatives or employees buying stock. Some will think of stock options in tech firms. But you want to talk mostly about ESOPs and a little about broad-based grants of various kinds of equity. It is hard to briefly describe how these work in a way that allows people to see why they are so effective. You could mention tax benefits, but then will people think, Is this just a tax dodge? You could say employees get the shares free, but then it seems there has to be a catch. Sure, you could explain all the nuances—but by then you would have lost people. There are ways to communicate the value of ESOPs succinctly, but they are not obvious to someone not well schooled in these ideas. By contrast, if you say, “Cut taxes and regulations” or, “Tax the super-rich and use the money for climate change and schools,” you don’t need to say a lot more.

What Needs to Be

Done to Move the Idea Forward Does Not Involve Major Changes

Say you are out on your stump speech or writing the column you hope will get a lot of eyeballs and you say something like, “The best things we can do to create more employee ownership programs are to provide funding for outreach and education and to include ESOPs and worker cooperatives in federal and state loan support programs. None of this will cost much money.” One the one hand, that sounds terrific, but on the other it hardly makes you sound like a big-picture thinker who has game-changing ideas.

These barriers are tough to overcome. The good news, though, is that the changes can happen even if employee ownership is not seen as a big part of the economic reform agenda. Legislation at the state and federal level is in process that could get us a long way toward where we want to be. With enough advocates in the community making their voices heard, these changes can happen. n

● Teamshares has closed another deal, making the employees of Old Town Market in Double Oak, Texas, the new owners of the company. Old Town Market is a butcher shop that has been in the Knowles family since 1977, and this deal allows selling owners Shawn and Sharon to retire knowing that their employees will be justly rewarded. In a statement on Facebook, the Knowles said, “Passing the business onto our employees is our way of honoring their hard work and preserving the company’s legacy for generations to come… While we are retiring, we’re doing so with the confidence of knowing Old Town’s legacy is in the best possible hands: Our employees.” As with their previous deals, a member of the Teamshares team, Lucinda Ochwat, will work with the selling owners to learn more about the business for taking over the next phase of the company. The terms of the deal were not disclosed. Teamshares has now acquired more than 50 businesses in less than two years. Most are in the 20–50 employee range. Teamshares uses equity investment money to buy the companies and shares 10% of the equity up for sale with employees. The company uses future profits to buy back shares from Teamshares. The shares are then retired, so the percentage of total stock owned by employees increases. The goal is for the employees of each company to end up with 80% of the company. Funds used for these purchases are not tax-deductible, as they would be in an ESOP.

● Idaho’s Iliad Media Group is now employee-owned by an ESOP. This will put the company’s 46 employees, who work at the company’s various radio brands and stations in Boise and Twin Falls, in the driver’s seat of the company’s legacy. This is in stark contrast to the area’s other local radio stations, none of which are locally owned. CEO Darrell Calton commented on the reasoning behind the 26-year-old company’s move to employee ownership, saying, “One of the biggest concerns that the ownership and I had about the company was not the year-to-year successes, but the decade-todecade success… Many independent business owners struggle with what to do about the march of time regarding estate and business planning. We are so fortunate to have an owner that wants to recognize the efforts of our longterm employees and wants to put the future of the business in our hands. This ESOP business transition tool is precisely what we all needed.”

● Integrity Tree Services, a vegetation management company located in Grandville, Michigan, is now 100% ESOP-owned. The 24-year-old company completed the sale in August 2022, making its more than 200 employees the beneficial owners, while also hoping to write a “new chapter of employee retention” in the process. A statement from CEO Phil Sims elaborated on the company’s hopes for the ESOP and its impact on workers’ jobs, saying, “We are excited about this change because it encourages our team members to take ownership of the company’s culture and success… Every decision they make will affect the profitability of the company and can increase their stock value. We will also be able to deliver an even higher quality of work to our clients across the nation.”

● Another Michigan company, Twisthink LLC, is also becoming ESOP-owned. The digital consulting company, which is currently based in Holland but will relocate to Grand Rapids early next year, saw employee ownership as the only compelling option for the company, with chief technology officer Kurt Dykema saying that the “ESOP was the clear choice for this team,” and that both the team and the company’s clients are highly enthusiastic about their new employee ownership. Financial director Steve Honderd said that, in addition to giving an ownership stake to employees, the move to an ESOP also “makes us a tax-efficient company, enabling us to reinvest back into our people and the growth of our business.” n

NCEO BOOKSHELF

For a complete listing of books and other materials on employee ownership and ownership culture, visit us at NCEO.org.

Understanding ESOPs

A general introduction to ESOPs, how they are established and used, and what the rules are. Visit here for excerpts or to order. (166 pp.) $25 for members, in print or PDF

Leveraged ESOPs and Employee Buyouts, 7th ed.

A practical, straightforward guide to ESOPs for business owners, executives, advisors, and lenders, with an emphasis on financing. Visit here for excerpts or to order. (129 pp.) $25 for members, in print or PDF

Selling to an ESOP, 11th ed.

A guide for those evaluating a sale to an ESOP, from feasibility to the taxdeferred Section 1042 rollover; also compares ESOPs to other exit strategies. Visit here for details or to order. (137 pp.) $25 for members, in print or PDF

S Corporation ESOPs, 4th ed.

Covers legal issues, state-by-state tax treatment, valuation, complying with Section 409(p) anti-abuse rules, administration, incentive plans, and creating an ownership culture and a sustainable ESOP. Visit here for details or to order. (195 pp.) $25 for members, in print or PDF