Five Lessons Any Board Can Learn from ESOPs

When Leland Snow, founder of Air Tractor, was ready to sell his business in 2008, he sold it to an employee stock ownership plan (ESOP) to ensure the long-term success of the company. Bob Moore, founder of Bob’s Red Mill, decided to opt against selling to a large corporation and instead created an ESOP that would benefit his hard-working employees.

Perhaps you’ve heard of Publix Supermarkets? It employs more than 230,000 people and operates 1,295 stores, and is consistently ranked the best supermarket for customer service and among Fortune’s 100 Best Companies to Work For. It also happens to be owned by an ESOP. “For Air Tractor customers around the world, the ESOP helps promote continuity of the company’s mission, of product quality and a reliable, committed aviation partner that they can count on far into the future,” according to Air Tractor’s website. In a more general way, this seems to ring true for many ESOP companies.

ESOPs may not be right for every business, but they offer reminders of governance and corporate culture best practices that all private company boards can benefit from. Especially if a private company is considering an ESOP, there are some important considerations for ensuring business success.

1. Have an exit strategy. As a private company, particularly if led by a founder-owner, it is imperative that the board and leadership team discuss what will happen to the company, if and when the owner decides they want to sell. Selling to a private equity firm is certainly an option, as is going public through a de-SPAC (special purpose acquisition company) transaction, initial public offering, or direct listing.

But successful ESOP companies show that with careful planning, the right team of executives and advisors, and consideration for stakeholders, selling to an ESOP can be a great exit strategy. That’s not to mention the tax advantages of standing up an ESOP.

Under the wrong circumstances, however, ESOPs can trend in the opposite direction. “A lot of people think [ESOPs are] the solution to every problem. They can be a phenomenal tool in the right circumstances,” said Tom Bakewell, a consultant to boards and executives, author, and experienced director. “But they come with a lot of complexity, a lot of sophistication, and a lot of risk.” Whichever path a private company chooses, an exit decision should be well thought-out and prepared for years in advance.

2. Know your succession plan. While selling the company to another business or a private equity firm entails executive succession planning, the other company or private equity firm is there to make those decisions. When it comes to exiting via an ESOP, companies should know who their next leader is in advance; the decision falls to the board, exiting owner, or other remaining executives.

“An issue with an ESOP is that if the owner does retire and moves away from the company, you don’t have the knowledge base and the expertise that that owner has had,” said Jack Pfeffer, a director at Air Tractor, Cactus Feeders, and Liberty Military Housing. “It’s very important once an ESOP transaction decision is made that you have thought through the management going forward and how the company is going to be governed.”

While perhaps it may not be a surprise, private companies should all be reminded of the importance of advanced succession planning.

3. Communicate, communicate, communicate. When an ESOP is set up, most employees have no idea what that means. “It doesn’t mean that the employees are making all of the decisions of the company. It’s important in an ESOP culture to go into it so the employees understand that governance, senior management, the president, the officers of the company, and the board of directors have a role, just like the owner did,” Pfeffer said. “I always say when you have a new ESOP, it takes three years to really start getting the employees engaged. How do you communicate the good of the new ESOP to the employees and how they will benefit from it?”

At non-ESOP companies, too, transparency and communication with employees and other stakeholders is key, especially in this environment of employee mobility. To attract and retain talent, boards should encourage management to communicate to employees the importance of their roles, the work that they do, and what the company offers in return.

“The best way management could keep all this forefront of employees’ minds is by communicating with employees on a regular basis. We do a monthly call with all employees here. We talk about operating results, how we did as a company, and they can see how we’re performing,” said Ellis Moseley, senior vice president and chief financial officer at Hisco and a director of Air Tractor.

He recommends that ESOP companies form a communications committee, which is usually management-appointed, to talk to employees about the benefits of the ESOP to keep the ESOP fresh in employees’ minds. Non-ESOP company boards should consider if a management-level communications committee might improve transparency and culture at their own organizations.

4. Support employees and give them a voice. At ESOPs, as at all companies, it’s important that corporate culture is nurtured and allows employees to feel that they are all working together toward a common goal.

“With an ESOP, everybody’s in it. It’s not a top-heavy plan; the top managers don’t get all the benefits,” Moseley reiterated. “In Washington, they talk about wealth equality, and I’ve always wondered, ‘Why don’t they talk about ESOPs?’ Because this is truly a great way for all the participants to benefit.”

“If you see there’s a problem in your department, if you see there’s waste going on, if you have an idea of how to improve… don’t be quiet, you’re an owner,” Kerry Withrow of Business Exit Planning Advisors at RBC said. “Let people know how we can improve because the more profit we make the better this company does, the better you do now. Once educated and people understand that, it changes the culture of the company.”

According to the National Center for Employee Ownership, in 2019 ESOP companies saw an average quit rate of 9 percent compared to the national average of 31 percent; that same year, ESOP companies also had a 5 percent average involuntary separation rate, compared to a 14 percent national average. This is according to the organization’s ESOP Topics Survey of 160 ESOP companies, the results of which were released in July 2020.

5. The basics matter. Creating an ESOP “can accelerate the good, but it can also accentuate the bad,” Bakewell said. ESOPs, while in many cases a motivator to workers, can in other cases lead to complacency. Great culture won’t come only naturally; at any company, the tools put in place as employee benefits, such as an ESOP, should not be an excuse to neglect more active efforts to engage employees.

“In terms of offering employees an opportunity to have a genuine ownership stake and to grow that and to make wealth through that, that’s certainly going to have a positive impact on culture,” Bakewell noted. “The flip side is it’s a tool, and if the tool is not properly used, or if the market doesn’t cooperate… it can present challenges. The fundamental issue becomes how the tool is used and is it in the proper circumstances?”

Boards should not fall prey to thinking any one tool can “save” their businesses or keep them afloat. Company success is always dependent on industry changes and the macro environment. Shoring up governance and leadership practices, elevating board engagement, and bringing on independent directors before making any business-altering decisions should be the priority. Having good governance practices in place long before an exit strategy is considered means that those practices can help your company determine whether an ESOP, for example, is the right tool in the first place. Then, companies will be better able to seize the opportunity for great culture that these decisions present.