In today’s WSJ there was an article titled “Amid Crackdown, Some Firms Rethink ESOP Sales Practices” which relates to owners rethinking how to sell to employee-stock-ownership-plans (ESOP) following a crackdown by the Labor Department. It seems to me we are missing a piece of important information in the ESOP relationship that allows the new owners to make an informed decision.
The Basics: When a founder or majority shareholder wants to liquidate their closely controlled shares to their employees, one option is an ESOP. In this scenario, a trust is created that will hold the company shares. The value of these shares is determined by an outside appraiser. The purchase of these shares may be funded by the employees’ retirement savings account. In my view, the premise of this structure is that the employee is not capable of making an informed decision. A trustee is hired (often an outsider and, with the recent crackdown, a likely choice to protect the business owner) to protect the workers’ interests and a third party valuation firm is hired to determine a value. It seems to me that if employees have a working knowledge of the organization that includes the institutional knowledge and business savvy, they are qualified to make their own decisions. If they don’t, are they really qualified to be an owner?
What If: I would submit that an employee team that has the information necessary to make an informed decision regarding the purchase of their company results in a better outcome for both the current owner and the future owners. An ownership group that is informed will be equipped to capitalize on the historical successes and lead the firm well into the future. This means today’s owners need to invest time and resources in the future owners by passing on the institutional knowledge and business savvy to the next generation of leaders. By institutionalizing this knowledge and getting it out of the leader or founder’s head, it will make the company more valuable not only in the owner’s eyes but in those around them.
The WSJ suggests that the Labor Department has observed that the value of a firm may be set to meet some predetermined expectation on the part of existing owners. This could be viewed as a one-sided negotiation that a willing participant would never accept when buying a car or home. Why should we consider it when buying a business?
The ESOP is to be used as a financial and legal tool to facilitate the completion of a business relationship between competent, knowledgeable parties. It should not be used as a tool to manipulate terms and conditions based on a lack of knowledge or transparency. As business leaders it is our duty to pay it forward by developing a team of leaders and owners that have a sustainable financial foundation to lead the company into the future. It should not be our priority to squeeze every cent out of the transaction by taking advantage of our position.