Anatomy of an ESOP
Delcie Bean recalls that he was advised — by more than one individual and on more than one occasion — that it might not be wise to initiate an employee stock ownership plan (ESOP) while the company was still very much in a strong growth mode. But he decided this self-described gamble was certainly worth taking — and for many reasons.
Delcie Bean likened an employee stock ownership plan, or ESOP, as one is commonly called, to an onion.
By that, he obviously meant that it has many layers of intrigue and complexity, as he found out while researching, planning, and eventually executing one for the company, Paragus Strategic IT, that he founded 17 years ago, when he was just 16.
“My initial understanding of an ESOP amounted to this 30,000-foot view,” he explained. “Over the past 2 ½ years, we kept peeling back the layers. I’ve learned more about this over the past few years than I could ever have imagined.”
Despite all these layers, Bean, as he explained why and how he went down this path, said there are two basic truths that he started with and that were still there when he peeled away all those layers: That this is, at least in his mind, the proper and fair course to take, and it is also (and this is in nearly everyone’s mind) a gamble.
“There’s a big part of me that believes that it’s the right thing to do — the fair and equitable thing to do,” he explained. “It’s not like I work that much harder than anyone else here, and there are people here who I’m sure work much harder than I do some days.
“To me, I always just felt uncomfortable with the fact that this young company was growing so fast and amassing a decent evaluation,” he went on, “but, for the most part, that was predominantly just to benefit me; I didn’t really like that.”
As for that second basic truth, Bean said he’s gambling that if he fast-forwards 10 years … 60% of the valuation of the business (as an employee-owned company) will be roughly the same or more as 100% of the valuation if he had remained the sole share holder in the venture.
“And I’ll never really know the answer to that, because we won’t be able to see both, obviously,” he told BusinessWest. “But it is something I really believe is possible. However, it takes a lot more than just forming an ESOP — there’s a lot of cultivation, education, and motivation needed. But if we get it right, then I think we can leverage the ESOP to grow the company, not only faster, but better, making it healthier, more stable, and more resilient than it could have been had I owned it and just had a bunch of employees.”
Referencing this ‘gamble’ part of the equation, Bean noted that he was actually advised — very early and quite often — against taking this step now, when the company is still very much in a growth mode, as opposed to full maturity or something approaching it, when ESOPs are a far more attractive option.
“They told me I might be leaving a lot of money on the table,” he said, adding that he didn’t want to wait 10 years or even 10 more months, because he thinks this gamble is well worth taking, and one he believes other business owners should take as well.
Why? Primarily because giving employees an ownership stake in the company can — that’s the operative word here — bring advantages ranging from greater ability to recruit and retain talented workers, to improved morale, to an even sharper focus on growth and strategies to enable a company to function more effectively and more profitably.
And as one small, yet hopefully effective example, Bean pointed to … the company’s postage machine, or, to be more, precise, to the fact it’s been retired in favor of simply placing stamps on envelopes (no one has to lick them anymore).
“One of the employees pointed out that the cost of our postage machine we were renting, for the amount of postage we were using, just didn’t make sense,” he explained. “We thought ‘we’re a business, we’re supposed to have a postage machine; no one puts stamps on envelopes anymore.’ But she ran the math and figured out it would save us $1,800 a year to just pay for stamps and put them on, even with the labor added in.”
But overall, ESOPs are undertaken for more far-reaching, and more long-term, strategic thinking and implementation, he went on, noting that with ownership of the company comes what amounts to a greater stake in its success.
For this issue and its focus on business management, BusinessWest uses the Paragus ESOP as a window into this complex and often misunderstood business tool, and also at what Bean believes it will mean for his already-highly-visible company.
To help explain just how onion-like and complicated an ESOP is, Bean said the plan to initiate one was actually announced to staff at a company retreat nearly three years ago, and he had undertaken preliminary research and calculations long before that.
Then, as now, the company was defined by strong growth (roughly 24% per year has been the average), as well as physical expansion — the company is already starting to feel snug in new quarters opened in Hadley just two years ago — a constantly growing staff, and the mounting challenge of finding and keeping talented help in that climate.
In all ways, the arrow was pointing decidedly up.
And this is not the time, as noted earlier, when business consultants advise ownership to go the ESOP route.
But Bean, who has generated headlines in recent years for all kinds of reasons — from almost-permanent residence on Inc. magazine’s fastest-growing companies list, to BusinessWest’s Top Entrepreneur award for 2014, to the opening of new businesses and a unique training facility to prepare people for careers in IT — decided it was time to generate one of a different kind.
And, again, he said there were many motivations, and primarily a desire to share the wealth — in part because it should be shared, in his thinking, but also because doing so would benefit the company.
Seeking to feel more comfortable with the manner in which the pie would be divided, Bean started doing some research.
It involved books, articles, case studies, and some recent examples, locally and nationally. As noted with the onion reference, he learned that ESOPs are quite involved and require planning, execution, and a large team to handle both.
As part of the exercise, Bean became closely acquainted with the ESOP undertaken by a Springfield, Ill.-based company that remanufactures and resells engines. That case was considerably different — the venture had been bought, the buyer announced its intention to sell it or shut it down, and the employees, fearing the loss of their jobs, secured the capital to buy it — but the machinations were similar enough to make it a learning experience.
There were others, including the ones at Harpoon Brewery and Chibone Yogurt, Bean went on, adding that his research revealed that in most cases, ESOPs are initiated by companies looking to raise capital for equipment purchases and other reasons, or by owners looking for an effective exit strategy.
“As Baby Boomers look to retire, if they don’t have a succession plan already created they may use ESOPs to help them with that challenge,” he said, adding that given current demographic trends and the lack of succession plans at companies large and small, it’s likely that there will be an uptick in ESOPs in the years to come.
Despite his aggressive research, though, Bean found it very difficult to find an ESOP quite like the one he was planning, for all those reasons stated earlier.
“I’m not looking to go anywhere,” he said, adding that this was a point he had to drive home to his employees over the course of the nearly three years it took to bring the plan to fruition. “Rather, it’s a commitment that I’m all in.”
And as he explained ‘all in,’ Bean offered some specifics as to how this ESOP works, and, more importantly, how he expects the company to leverage it in the years and decades to come.
He started by saying that unlike those cases where an ESOP is an exit strategy, no funding was raised by employees and no cash changed hands. In essence, 40% of Paragus (roughly $1.4 million) was gifted to the 40 or so employees in the form of a trust that is wholly owned by the employees of the company. And this share of the company becomes a type of retirement plan, or another retirement plan as the case may be (there’s a 401(k) program already in place).
“Once a year, employees will get a statement showing how many shares they have in their account, and what the valuation (of the company) is, and therefore what those shares are worth and what their account is worth,” he explained, adding that the ESOP becomes a perc — in his mind, a very attractive one.
We need to help the employees understand, from the context of their job, the things they can do to have an impact that matters and that can change the bottom line. We have an obligation to simplify the business down so that every position has a metric that they can understand, that is tracked, is clear, and that ties into our profitability, so they know what they can do.”
Indeed, the company has a 10-year goal for growth and valuation ($40 million to be specific), and if it is hit, he projects that the average ESOP account, governed by ERISSA, will be worth “in the low six figures.”
As for leveraging the ESOP, which closed June 8, Bean said the company had already generated a culture of ownership — reinforced with rewards — throughout its ranks, but the ESOP will hopefully take it to a higher level.
“In order for this gamble to work, there is an obligation on the part of the employee, but there’s also an obligation on us,” he explained, meaning company leadership. “We need to provide education, training, and motivation.
“We need to help the employees understand, from the context of their job, the things they can do to have an impact that matters and that can change the bottom line,” he went on. “We have an obligation to simplify the business down so that every position has a metric that they can understand, that is tracked, is clear, and that ties into our profitability, so they know what they can do.”
Elaborating, he said that each position has such a metric, and, therefore, steps, or operating strategies, that can improve profitability. Examples include everything from purchasing policies, to the level of customer service provided by service techs, to that postage machine.
At present, the company is looking at every position from the vantage point of creating a metric and providing employees with the tools, and motivation, to know where and how to work harder and better.
“If they don’t know where to invest the effort, then even if they want to, they won’t do it,” he explained, adding that one key through all of us is to take steps that improve profitability while not negatively impacting quality of service.
The Bottom Line
When asked if and how the company would begin to know if this gamble was paying off, Bean said a look at the numbers about 16 months from now would provide some clues.
“We’ve been averaging about 24% growth over the past seven years; if we can increase that number, I think we can be fairly confident that it’s because of the ESOP as the biggest factor,” he explained. “We’ll know at the end of 2017, when we’ve had a full year with this; we’ll see if we beat that 24% number.”
But the company is looking well beyond the end of next year, he added quickly, noting that the key isn’t achieving more-profound growth, it’s sustaining it.
“It’s not about a short-term bump, it’s about a long-term sustainable approach,” he said in conclusion, adding that he firmly believes an ESOP can help attain all that, and that’s why he took this gamble.
George O’Brien can be reached at email@example.com