In 1983, Mary Kilgore took a job as an accounting clerk at Mid South Building Supply, a $10 million siding, window, and cabinetry business in Springfield, Va. Two years later, company founder Norman Rales started looking for a way to retire. The problem: Rales' children had no interest in taking over the business and potential buyers were few and far between.
That's when the company's management began pitching a new benefit to employees, something called an Employee Stock Ownership Plan or ESOP. They said they wanted to sell the company to the employees, and promised workers that if they stuck with Mid South long enough, they would have a sizable nest egg for their own golden years.
“They would get us together and tell us what a great thing the ESOP was,” Kilgore recalls. “Honestly, we all thought it was bull.”
In fact, during the first seven years of the ESOP, the company had to work extra hard to pay back money it borrowed to finance the plan. “During those first seven years, we didn't own anything but debt, so I was very skeptical,” Kilgore says.
Today, at age 50, with more than $400,000 of company stock in her retirement account, Kilgore's tune has changed dramatically. Though Norman Rales retired in 1985, Mid South is still going strong as a 100% employee-owned business with $100 million in revenues. It's not unusual for frontline employees like Kilgore, now a purchasing agent, to have several hundred thousand dollars worth of stock. “It really has been amazing,” she says.
Small-Company Solution Once considered exotic, ESOPs are popular among small companies today. In 1974, there were 200 ESOP companies in the U.S. Today there are almost 11,000. Most have fewer than 250 employees, according to the ESOP Association, an industry trade group in Washington, D.C.
That growth among small companies has come for good reason. Not only have ESOPs — born out of legislation in the 1970s —paid off big for employee-owners like Kilgore, but studies have shown that ESOPs result in increased sales, and that ESOP companies are more likely to stay in business. Perhaps more importantly for the home improvement industry, though, ESOPs can provide an effective exit strategy for founders and owners who don't have children interested in keeping a business going or viable suitors to buy them out.
“At any given time there are probably just five or 10 players in the country interested in acquiring another home improvement or design/build company,” says D.S. Berenson, a partner at law firm Johanson Berenson, in McLean, Va., which specializes in home improvement ESOPs. “You usually don't have a lot of options to sell.”
Then there's the fact that many founders would prefer anything to selling their company to the competitor who's been trying to put them out of business for years. “Selling to a competitor really rubs a lot of people the wrong way,” says J. Michael Keeling, president of the ESOP Association. “Liquidating a company is even less desirable. But with an ESOP, you can get financing to cash out your chips, while putting your employees in an ownership position.”
Another advantage? Done the right way, an ESOP can provide a giant tax break for you and your company.
The ability to exit gracefully, save big on taxes, and reward loyal employees are all reasons to consider an ESOP. Having an enduring legacy and giving your life's work a good chance to live on — and provide jobs after you're gone — are a few more. But things can go wrong if the ESOP is poorly planned. The key to success, experts say, is making sure you understand the process, educate your employees, and groom your company's future leaders before you go.