ESOPs: Keeping rubber company legacies alive

The dollar is the driving force in any merger or acquisition, and company purchases by other entities have been numerous in the rubber processing industry to begin the year.

As it should be—the bottom line in business is to make money, and a company is worth whatever someone is willing to pay for it.

But an option that often goes unconsidered is employee ownership, which can be accomplished in a number of ways and under various structures. Employees can buy stock directly, be issued stock as a bonus or offered stock options, obtain stock through a profit-sharing plan or even enter worker cooperatives.

But far and away the most common method is the Employee Stock Ownership Program, of which there are more than 6,400 in the country today, according to Ken Baker, CEO of Southampton, Pa.-based NewAge Industries Inc.

The rubber and plastics hose and fittings manufacturer has 280 employees and is 100-percent ESOP-owned.

"Mergers and acquisitions are fine," Baker said. "But a better way to do it is through an ESOP. It broadens the view as a systemic counterpart to mergers and acquisitions.

"Selling the company to an ESOP trust—and employees then have a piece of that trust—the mindset changes and employees feel like they are part of something bigger than themselves."

NewAge established its ESOP in January 2006 when Baker sold 30 percent of the company into an ESOP trust—which does not pay corporate income taxes—as a way to ensure the company legacy and give employees a lucrative retirement plan.

In time, the company became 49-percent ESOP and 51-percent Baker.

And in 2019, NewAge became 100-percent employee-owned. "The ESOP added a new facet to our company's culture—a complete commitment from everybody to the success of the organization," Baker said.

According to Loren Rodgers, executive director of the Oakland, Calif.-based National Center for Employee Ownership, ESOPs give employees true ownership, where their decisions and hard work can bring real, tactile financial success to their colleagues and co-owners.

"A good analogy is that you are out to lunch and you smell the buffet—this gives employees a sense of ownership," Rodgers said. "ESOPs answer the question of 'why' an employee should invest or remain at a company.

"I don't want to downplay the dollars (available from mergers and acquisitions) ... but ESOPs add wealth to those who would otherwise not have it," Rodgers said. "With an ESOP, employees can be confident that they will have jobs and a say in their future—when a private equity or holding firm takes over, employees can never be sure."

Stockwell Elastomerics Inc., based in Philadelphia, is a company of about 100 employees that is 45-percent ESOP-owned. The other 55 percent is owned by William Stockwell, former president and now chief technical officer of the silicone gaskets, seals and cushioning pad company.

Much like Baker's staggered approach, Stockwell sold an initial 30-percent share into an ESOP in 2017 to establish the trust. He added another 15 percent in September 2021 as the company enters its fifth year of partial-ESOP ownership.

"The company made the move to ensure that we were true to our mission for the long run," Stockwell Elastomerics President Tom Rimel told Rubber News. "Stockwell has developed a benefit mission statement that outlines who we are, what we do and what we stand for. Sometimes after an acquisition, by any party, characteristics that have defined the business run the risk of changing."

Rimel is confident in the ownership strategy moving forward.

"We believe in our place in the Philadelphia community, our obligation to the employees who have built the business, and our support and service to our technology sector customers that mean so much to Stockwell.

"The decision was made ... as the best chance to continue our future in alignment with these characteristics of this business for the next 100 years and beyond."

At their core, ESOPs are retirement plans, essentially placing deferred corporate income tax money into a trust for the benefit of employees.

Contrary to popular belief, according to the NCEO, ESOPs rarely are used to save troubled companies—at most, a handful of such plans are set up each year.

Instead, ESOPs can provide a market for the shares of departing owners of successful, closely-held companies; motivate and reward employees; and take advantage of incentives to borrow money for acquiring new assets in pre-tax dollars.

In almost every case, ESOPs are a contribution to the employee, not an employee purchase. "One of my key reasons for establishing the ESOP was building on our legacy and maintaining the business model that made us successful," William Stockwell said. "Now it is up to the new management team and employee owners to carry this forward."

According to Baker, the 100-percent ESOP NewAge would have paid about $60 million in corporate income tax last year, but the entirety of the money was deferred to the ESOP (which does not pay such taxes).

"If you sell a portion or all of the company shares to an ESOP trust, that portion pays no federal or state (corporate) tax," Baker said. "That's huge."

To wit, a company—ESOPs in the rubber industry tend to be sub-chapter S corporations—does pay other taxes, Rodgers explained, including payroll, property and other taxes. "But ESOPs do tend to increase employment," he said. "When an ESOP company grows, it tends to grow faster ... and when the company shrinks, it tends to shrink more slowly."

Come tax time, for example, a 30-percent ESOP company that owed the IRS $1 million in corporate income tax would write a check for $700,000 to the shareholder(s), who then would write the check to the IRS for the same amount.

That same company then would write another check for $300,000 that would be funneled directly into the ESOP trust (which, again, does not pay taxes).

Valuation firms determine the percentage of taxes paid between shareholders and the ESOP trust for partial ESOPs.

According to Rodgers, Uncle Sam gets his when an employee retires and draws the money (based on the shares they have) from the trust.

"And the increase in payroll taxes more than makes up for the deferred money," Rodgers said. "So Uncle Sam still stays well-ahead."

So what does a company do with the money it saves in deferred corporate income tax?

"You can use it for extra equipment or an extra plant. ... We have one planned for Europe," Baker said.

Or an astute business might spend more in worker compensation, allowing the ESOP structure to help mitigate a loose labor market that has seen difficulty in hiring and retention. "You can pay people a little more, maybe hand out more in bonuses," Baker said. "Employees have to pay for this benefit when they retire ... but the harder they work, the more money they will make as part of an ESOP account."

Rimel said Stockwell Elastomerics has always "invested aggressively back into the business."

"That investment continues today," Rimel said. "Just in the last two years, we have purchased six major new pieces of equipment, improved several areas in the facilities and updated our ERP system for the future of the business."

Beginning an ESOP takes one initial stockholder who does not value every last dollar that can be gleaned in an acquisition, not always an easy step for a shareholder to take, Baker said.

"It's for a company that has a selling shareholder who cares about employees, cares about the legacy of the company after he or she leaves and cares about the community where the company is located," Baker said. "When companies get sold, they (often) move. It's probably (going to take) a selling shareholder who is not trying to wring the last dollar out of a deal."

Every employee in an ESOP has a cash account and share account.

As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting. Employees must be 100-percent vested within three to six years, depending on whether vesting is all at once (cliff vesting) or gradual.

When the employee retires, the company buys the shares back from them at fair market value.

"It sounds predictable, but I know it to be true," Rimel said. "Realizing the benefits of an ESOP is a journey—not a destination. The ownership culture will continue to develop over time just like businesses evolve over time."

Of Stockwell's 100 employees, about 25 have joined the silicone processor since the ESOP was introduced, Rimel said.

"As new associates join the company, we must continue to share information about the ESOP, the company and our culture," he said. "If we do this well, we will continue to be true to our customers as well as our mission."

Of the 6,400 or so U.S. ESOP companies that are either partially or fully owned, only about 20 are rubber companies, according to a list provided by the NCEO.

Of those rubber companies, at least eight are 100-percent ESOP (one other is minority ESOP-owned; others are "not noted").

Rodgers said the number of employees in ESOPs are increasing as companies grow and hire, but the number of overall ESOPs has remained stagnant for the last several years.

NewAge had 70 employees in 2006 when Baker introduced the ESOP with his initial sale of 30 percent of the company to the trust, and the company has grown to 280 employees since that time.

"But ESOPs are stagnant in developing. ... Many just don't know that this option is available," Baker said. "They think they have to sell to someone, maybe to that private equity firm that keeps bugging the crap out of them.

"Awareness is important. There's more to selling a company than getting a bunch of money. It is about legacy and what you leave behind."

To promote such a program requires constant education, Rodgers said, teaching employees the nuances of stock and cash accounts.

"Companies need to make it a point to talk about how they make their money," Rodgers said. "It requires teaching employees how to be business owners.

"To an employee, this can feel foreign, as they are used to an 'us and them' kind of culture. It can be counter-cultural to be an employee-owner."

Baker agreed, noting that some employees "just won't get it." Clearly others at NewAge have gotten the message.

"We have 32 millionaires working here right now," he said. "This is where you have to train and talk about what the program means to everyone. You have to have a loan (between a bank and the company to establish the trust), and you have to pay back that loan.

"To do that, you need to be a profitable organization. But with education, ESOPs can happen. I can tell you that ideas and free-thinking (of how to improve the organization) have increased dramatically with 100-percent employee ownership."

Stockwell's Rimel said employees there seem to recognize the long-term benefits to such a program. The company continues to reinforce concepts that promote ownership.

"Last year, we combined some education events so that employees could be more informed shareholders, by doing some fun games and events that were very positive for morale," Rimel said. "We believe that the ownership culture will continue to develop over time. Stockwell enjoyed about 100 years as a family business and the best of that culture has aligned well with the culture of our ESOP.

"The ownership family has been expanded."

Other hurdles in the transition to an ESOP can be initial cost, as the low end to get such a program established is about $40,000, according to the NCEO.

As attractive as the tax benefits of an ESOP are, the law does not allow ESOPs to be used in partnerships and most professional corporations.

Private companies must repurchase shares from departing employees, and this can become a major expense, according to the NCEO. Any time new shares are issued, the stock of existing owners is diluted.

That dilution must be weighed against the tax and motivation benefits an ESOP can provide. In addition, companies "need to have some mass to them," Baker said, of perhaps "at least 25 employees."

Florida-based grocery store chain Publix is the largest ESOP in the country with about 150,000 employees.

"Although not a primary factor in the decision (to establish an ESOP), it can level the playing field when total benefits are taken into account," he said. "Many smaller businesses have a high percentage of long-tenured workers, and this longer term appeals to this group.

"But all companies are looking for tools to retain talent for the long term, and the ESOP aids us from this perspective."

And as mentioned, ESOPs can improve corporate performance only if combined with opportunities for employees to participate in decisions affecting their work, the NCEO said.

Retirements have started under the 45-percent ESOP at Stockwell Elastomerics, and that means disbursements from the trust have begun.

As many companies are facing labor shortages and absenteeism, retirements are likely to continue.

"We are a new ESOP and value builds over time," Rimel said. "Our expectation is that as we take care of our business, that value created will be conveyed to the shareholders."