By Franco Silva
Often, specialty business owners want to access some of the value they’ve built in the business, while others want to near retirement and move on. Many business owners consider a third party sale to be the most important way to achieve these goals. However, there is an alternative that may be a more preferable option for unlocking the value of a specialty contractor: an Employee Stock Ownership Plan (“ESOP”).
What it is – How it works
Basically, an ESOP is a pension plan that, like a profit-sharing scheme, lets employees participate in the company’s success. More specifically, an ESOP is a trust established by a company into which the company contributes its stock — or alternatively, cash to purchase its stock. Shares are granted to Company employees over time; As employees grow with the company, they are progressively transferred to their ESOP account. (For more information on ESOPs, see this video, https://www.prairiecap.com/videos-and-podcasts/what-is-an-esop.)
Unlike a third-party sale, an ESOP enables contractors in specialty areas such as plumbing, HVAC, electrical, and fire systems to ensure their business 1) continues to operate in accordance with the values and history they have established, and 2 ) in a way that rewards the hard work and dedication of its employees – both now and in the future. Recently, Manhattan Mechanical Services transferred ownership to its employees through the implementation of an ESOP and joined other specialty companies including MJW Consolidated, H2I Group, Tri-City Electrical Contractors, Votaw Electric and Commonwealth Electric Company of the Midwest.
Below are five key reasons why an ESOP is an attractive ownership transfer strategy for specialty businesses:
1. attract and retain employees – Since the start of the COVID-19 pandemic, companies in the United States have begun recruiting and retaining employees by offering a work-from-home option. However, this is generally not an option for specialist companies as they require their staff to be on site. In response to this fact, a special report by Engineering News Record suggests that one way for construction companies to increase engagement and loyalty is to offer employees an ESOP. Also Prairie’s 2nd Annual Construction Survey, “ESOPs: Insights into 2021 and Beyond”, published January 11, 2022, (https://www.prairiecap.com/articles/prairies-2021-esop-construction-survey) found that overall, employee-owned construction companies expect that an ESOP will not only fuel the company’s continued growth in 2022, but also increase employee retention, even in a difficult job market.
2. Culture – Many specialist construction companies have employees who already understand how their day-to-day contributions can have a direct impact on the business. Offering an ESOP will often further increase employee engagement with the company and foster a culture of ownership. This, in turn, can benefit the company’s valuation and therefore the estimated value of the company’s ESOP stock. Employees who are educated on how an ESOP can increase their personal wealth are often highly engaged.
3. heritage – Owners who have worked diligently to build and grow their business often hope to preserve their legacy both in the community and in the larger construction industry, even when they eventually retire. However, if they choose to sell their business to a third party, the likelihood of that happening diminishes. Luckily, since implementing an ESOP means that the business remains in the hands of the people who helped build it, it also helps ensure that the values espoused by the original owners are perpetuated over the long term, so that the positive impact that the company had on the community will persist.
4. independence – Some believe that selling a specialist construction company to another construction company, or even to private equity, can damage the company’s reputation and reduce brand appeal. While an ESOP requires the company’s management team to consider the impact of their actions on the ESOP, the company still retains its independence as a corporation and the ESOP becomes a vehicle for the transfer of ownership to employees in a tax-advantaged manner.
5. liquidity – An ESOP can be structured to accommodate a variety of liquidity events. For example, depending on the owner’s goals and timeline, selling 100% of the company’s stock to an ESOP may not be practical or desirable. However, an ESOP may be structured to provide partial liquidity to one or more shareholders. In fact, an ESOP is an excellent option for multi-stakeholder situations where one owner is looking for liquidity while others want to remain in control. In fact, the ESOP can be set up to initially give the ESOP a minority stake in the business — thus providing some liquidity — with plans to sell the remainder of the company’s stock to the ESOP or even a strategic buyer at some point in the future. In other words, an ESOP offers owners of a special contractor many ways to transfer their shares.
In summary, ESOPs offer a variety of benefits to owners of specialty construction companies and they can be an extremely effective tool for change of ownership. It’s no surprise, then, that the National Center for Employee Ownership, a nonprofit that supports the employee ownership community, states that privately held construction companies are currently one of the top three US industries with ESOPs.
Franco Silva is a Director at Prairie Capital Advisors, Inc. He can be contacted at 312/445-9213 or email: [email protected]