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How 'Rewarding Rollups' Can Help Owners and Employees

Try this succession planning method to better position your employees to build wealth.

By Inc.Arabia Staff
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BY BILL FOTSCH, FOUNDER, ECONOMIC ENGAGEMENT

In my 30 years as a business coach for hundreds of companies, I learned plenty about the challenges of starting and scaling a business. I learned just as much about leaving a business behind. It's an education that became personal when I began to invest in companies, including those owned by coaching clients.

Over a decade ago, I became a stakeholder in the West Coast remodeling company One Week Bath. Business has been good, and our employees are engaged. But my co-owner, Matt Plaskoff, and I have run into a problem. As we're both in our 60s, succession planning is on the horizon. An ESOP would seem like the natural next step -- we already see our employees as trusted partners. But the expense of an ESOP makes the idea unattractive.

Selling the company to a private equity firm is even less attractive. Why forfeit a life's work to a stranger, bypassing the employees who've helped build the company's value?

Many of the business owners I've coached have confronted the same succession plan jam. This was true at Anthony Wilder Design/Build, a company I began working with in 2006. (Together, we'd weathered the 2008 financial crisis, amazingly with no layoffs; MSNBC featured the award-winning company on Your Business.) Adams + Beasley Associates, another company that's particularly committed to their employees, harbored similar reservations about ESOPs and private equity acquisitions alike.

PE companies excel at financial engineering. They buy small companies in the same industry for relatively little and combine them, selling the rollup for a much higher value and extracting wealth for themselves. It may be legal, but it advances the plague of inequality and doesn't often make life better for employees, customers, or even owners.

Twenty years ago, I helped one client develop a customized employee equity program. It was ESOP-like but low cost -- no big tax advantage but plenty of flexibility. The owner recently called to tell me they were acquired by a PE firm. He walked away with millions, and thanks to the simple equity program, so did his employees.

"Bill, it's pretty simple," he told me. "We buy companies at 3-4 times their earnings and roll them up into a company worth 8-10 times earnings, just because of the larger size. It's hard not to make money."  

I got off the call, thinking: Why don't company owners just do this themselves?

If several businesses came together to create their own rollup, the cost of the ESOP per company would plummet. Individual companies could continue to operate autonomously. Meanwhile, the ESOP turns the employees into owners, who could directly improve the value of their stock by sharing and implementing best practices within the rollup. If the companies applied a management approach like Economic Engagement, which is shown to double profit growth, even better. Whichever way you look at it, the "Rewarding Rollup" retains and enhances value for the owners and employees rather than for an outside entity.

Let's compare the approaches:

 

PE acquisition

1-company ESOP

10-company ESOP

Profit from sale

3-4 times earnings

3-4 times earnings

6-8 times earnings

Cost of ESOP

None

$150k-250k (1st year)

$30k-50k (Annually)

$25k-40k/company (1st Year)

$6k-8k/company (Annually)

Cash received

At time of sale

At time of sale (bank financing); or over time (seller financing)

At time of sale (bank financing); or over time (seller financing)

Tax benefits

None

For owners and employees

For owners and employees

Employee benefits

None

Employee ownership

Employee ownership and job security

Overall outcome

Owner cashes out; PE builds wealth

Owner cashes out; employees gain ownership

Owner cashes out at a higher valuation; employees gain ownership of a stronger company that shares best practices

Arguably, company owners could beat private equity at their own game. Encouragingly, plenty of others seem to agree:

  • Gil Hantzsch, CEO of MSA and a former client, has put the concept into action. He's been in an ESOP firm for 30 years that has made multiple acquisitions, with similar results to a true rollup.
  • Dan Cunningham, fifth-generation owner of a Cincinnati area manufacturing firm, has found synergy and added value using various types of strategic partnerships with other organizations. 
  • Shannon O'Neil, one of our Economic Engagement coaches, is working with members of the National Landscaping Association on next steps to a rollup in their industry.
  • Kevin Long, renowned ESOP attorney and president of Employee Benefits Law Group based in California, is providing expertise and guiding us to optimal use of a rollup via ESOP. (Check out our podcast episode on ESOPs.) 

One former client had a reservation. "What about the inevitable downturn?" he asked. A PE company might not care about laying off employees, but he did. He thought this kind of rollup would magnify the problem.

It brought to mind another former client, Southwest Airlines, who shares the employee partnership approach. Through decades of downturns, they avoided layoffs. Their secret was to save cash for a rainy day. When the financial crisis came, they expanded to other markets, buying at lower costs due to the downturn. This expansion created plenty of work for employees, improving job security and ultimately boosting profits and the value of SWA's stock. Rewarding Rollups stands to benefit from the same strategy: acquiring companies during a downturn and using employees to improve them, avoiding layoffs, and accelerating the value of each participating company.

Don Taylor, president of Welty Construction and a former client, liked the idea a lot -- so much that he said, "Bill, I think you should keep this quiet. What if somebody steals your idea?"

I told Don, "I hope people do."

If my sole motivation was making money, I'd be tempted to keep this to myself. But this could improve business results for thousands of companies around the world, all while improving the lives of the employees and owners who drive those results. In time, it could mitigate wealth inequality. It could better serve customers, as employees begin to act like owners. It could make for better business, contributing to society instead of just extracting wealth. It could make the world a better place. It could be -- and should be -- accessible to everyone. 

My life's work has been coaching hundreds of companies in partnering with their employees. Rewarding Rollups helps company owners make something meaningful of their life's work. It's time we invest back into the people who create that value: the employees and the stakeholders.

Big gains are won by working together, and in this case, we're learning by doing. The number of Rewarding Rollups partners is growing rapidly, with activities already in the logistics, specialty manufacturing, and urgent care industries. I can't help but think of Margaret Mead's words: "Never doubt that a small group of thoughtful, committed, citizens can change the world. Indeed, it is the only thing that ever has." If you share our interest, we want to hear from you.

Photo Credit: Getty Images.

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