Is This the Succession Plan For You?
Introduction:
This week, Jay Goltz and special guests Peter Koehler and Jimmy Kalb discuss the hottest new thing in succession planning. You may recall that earlier this year Peter was a guest on an episode in which he explained how he helped Laura Anderson sell her seafood restaurant to what’s known as an employee ownership trust or a perpetual purpose trust. Both Jay and Jimmy listened to that episode and were intrigued. Both had questions for Peter. So we recorded a conversation in which we discuss what makes a business a good candidate for trust ownership. The issues we address include: Is this only for businesses that have a save-the-world type of purpose? How much does it cost to create an ownership trust? Can owners sell to a trust and still run the business as they wish? And perhaps the biggest question of all: What can go wrong?
— Loren Feldman
Guests:
Jimmy Kalb is CEO of Triad Components Group.
Peter Koehler is founder of Lumo Group.
Jay Goltz is CEO of The Goltz Group.
Producer:
Jess Thoubboron is founder of Blank Word.
Full Episode Transcript:
Loren Feldman:
Welcome Jay, Jimmy, and Peter. It’s great to have you here. As all of you know, the past few years, we’ve been exploring the options that owners have to transition both the ownership and the leadership of their businesses. Much of this exploration has tracked Jay’s attempts to figure out what he’s going to do with his business. In fact, I think this may have all started with a conversation in which Jimmy helped introduce Jay to the basic contours of an employee stock ownership plan. So I’d like to start: Peter, could you just imagine that Jay has knocked on your door to ask about employee ownership trusts? How would you begin the process of determining whether he and his business are good candidates for an EOT?
Peter Koehler:
Sure, absolutely. People do knock on my proverbial door a couple times a week these days. And so these are conversations I’m used to having, I love having. So thank you, Loren, for inviting me on to have this live. Jay, I’ll ask you some questions. I know that there may be limits to what you’re comfortable sharing.
Loren Feldman:
But Peter, don’t hesitate to ask anything you want to ask. If Jay doesn’t want to answer, he doesn’t have to.
Jay Goltz:
I have the right to remain silent. Everything I say can and will—yeah, I’m used to that drill. [Laughter]
Peter Koehler:
Great, excellent. So just high-level, Jay, tell me about your business: what it does, what its purpose for existing is.
Jay Goltz:
Okay, I started in picture framing. It evolved into also a furniture store, a wholesale molding business where I sell to other frame shops, and an art business. I’ve got 130 employees and own all the real estate. Based in Chicago. And the reason I’m talking to you today is because I’m 68. I plan on working. I have no interest in retiring. But there is a reality. There will come a day where I’m not going to be able to work. You know, that’s just the way it is. And my kids are not really interested in taking it over.
Peter Koehler:
So, okay, 130 employees. You’re 68 years old. You’re working. What’s your role? Are you the CEO? Or do you have another role?
Jay Goltz:
I’m the CEO, but I made someone the president of the framing company and the wholesale business. So I am not doing day-to-day stuff. I’m not dealing with customers. I’m not dealing with vendors. So I am very much hands-off, but I still come in every day so I can talk to Loren and stuff and Jimmy.
Peter Koehler:
Okay, so, sorry, to be clear, I think maybe I was confused. All of these are separate businesses, or they’re all under the same—
Jay Goltz:
They’re all under the same legal umbrella, but they’re very much separate businesses.
Peter Koehler:
Mhmm, and so when you’re thinking about a transition plan, you’re thinking about it for all of these businesses?
Jay Goltz:
Yeah.
Peter Koehler:
Okay, got it.
Jay Goltz:
And I might add, I’m the biggest in the country. It’s not like there’s some strategic buyer out there that’s waiting to buy me. I wouldn’t do it anyway, because I have no interest in retiring. But it’s not like I’m in the kind of industry that there’s roll-ups going on everywhere, and somebody’s gonna give me a big check for the business.
Peter Koehler:
Right. Okay, that’s helpful. So what’s the current ownership structure? Are you the sole owner? Do you have any other shareholders?
Jay Goltz:
Sole owner.
Peter Koehler:
And what’s the corporate structure of these entities?
Jay Goltz:
Subchapter S.
Peter Koehler:
For all of them?
Jay Goltz:
I only have one corporation that the others fall underneath. I obviously could change that. And the buildings are all owned outside of the business, so they’re not part of the business.
Peter Koehler:
Okay, interesting. And what about other key leaders of the company? You mentioned the president. What about others? Where are they at in their career arc?
Jay Goltz:
That’s a good question. They’ve been with me for 20-30 years. And the key people, I would say, one’s 60, one’s 49, one’s 48, one’s 52. So I certainly want to keep it going, at the very least, until they retire. And I would like to believe I’ll be alive and coming to work every day in 15 years. I won’t be 103. I’d be 83. But as you know, who knows?
Peter Koehler:
Yep, who knows? That’s true for anyone of any age. How’s the business doing financially?
Jay Goltz:
Um, okay. You know, high interest rates have slowed the furniture business down dramatically. The entire industry’s off, but it should be fine as soon as things get more normal. And the framing industry has gotten mature. The big growth days of framing are probably behind us, but that’s fine. It’s stable, and the wholesale business is growing. So it’s a mixed bag.
I can certainly tell you this: I’m done entrepreneuring. I’m done opening businesses. I’m not pushing like I used to. I just am perfectly happy to have a very moderate growth rate. I have absolutely no desire or ambition to get back to the growing 10-or-15-percent-a-year thing.
Peter Koehler:
Yeah, so moderate growth rate. Is the company currently profitable? Cash flow positive?
Jay Goltz:
Um, probably. It’s a tricky business. Until I take inventory at the end of the year, I’m never sure exactly how much I made. But yeah, I would say it’s profitable. It’s certainly in a down—the furniture business is a substantial part of the business, and the entire industry is off 20-25 percent. Because when people don’t move, they don’t buy furniture, generally.
Peter Koehler:
That’s an interesting point. I had to put that puzzle piece together—why high interest rates would affect furniture like that. And then what does the balance sheet look like? Do you have any debt on the balance sheet?
Jay Goltz:
Sure. I’m carrying a ton of inventory. I mean, the reality is—which is what took me a while to figure out—if I went to just do a conventional sale for, I don’t know, three times EBITDA, three and a half times EBITDA, I use so much inventory. I now understand that people make as much money having a going-out-of-business sale as they do selling the business. I’ve got a lot of inventory. If I had no inventory, that would be another story,
Peter Koehler:
And so, when you think about an exit plan for yourself—to the extent you’re willing to share—what are your personal financial goals for such an exit?
Jay Goltz:
I own all the real estate, so I’m in good shape. So, the issue is, I have no interest in retiring, but I do need an emergency plan, in case something happens.
Peter Koehler:
So just to be clear, when you think about a sale of the company, are you trying to achieve a fair market value, like selling it to a trust, let’s say, for a fair market value? Or that’s less important to you because you’re comfortable and you own the real estate?
Jay Goltz:
I would say that’s less important. I just don’t need the cash out, at this point. I don’t want to just squander it all, but getting the highest value of it is not number one. Number one is: I want to make sure that I can keep my employees gainfully employed and get into retirement if—and this is the big word—if I can do that. Because I don’t believe there are any guarantees to any of this, that I could come up with a plan.
And so I just want to give it my best shot, to do the best I can with making sure that when I’m out of the picture, my employees still have jobs and can continue on. If there was someone in private equity out there who wanted it, the chances of them messing it up are extremely high, as far as I can see. Because I know the way it operates, and I want no part of that.
Peter Koehler:
Okay, so this was super helpful. And on its face, kind of after this short round of questions, you seem like you check a lot of the boxes that we’re looking for when we’re thinking about whether someone might be a fit for a purpose trust or an employee benefit trust or an employee ownership trust. So, some of those boxes: You, as an owner, are the sole owner. So having one decision maker, one owner to work with, is a lot easier than having 10 or 20 or 30 people—
Jay Goltz:
Or two.
Peter Koehler:
Or two, totally. If it’s two, it’s often a couple, which makes it a little easier, but not always. And so then it sounds like you’re flexible, both on the amount and timing of a prospective payout for the equity you own in the business.
Jay Goltz:
Absolutely. Yeah.
Peter Koehler:
That’s important. It sounds like you are very purpose-driven in your commitment to maintaining a great workplace for employees, a good place to work where their jobs are secure, where they’re happy to come to work every day. And having that “why” and that purpose orientation is also a criteria box we look for.
Jay Goltz:
Yes.
Peter Koehler:
And then it sounds like, in terms of the business performance, maybe a little rocky since interest rates went up, but generally positive. Slow to moderate growth, but that’s okay in your industry at this point. And maybe profitable, maybe sometimes closer to break even, but you’re not hemorrhaging cash or anything.
Jay Goltz:
I’ve been through six recessions since September 11, whatever. I mean, so this is a normal cycle. Yes, no big deal.
Peter Koehler:
So, I think what you’re looking for—and tell me what I’m missing, or if I’m right or wrong—really at the crux of it is kind an ownership, governance, leadership solution, less so than like a financial solution for yourself. You want the company to exist, ongoing, if you get hit by that bus tomorrow or in 10 years. And you want employees and the folks who work in the company to kind of have that security and the knowledge and the knowhow of perpetuating that company on their own after Jay moves on. Is that right?
Jay Goltz:
Yes, but you’re leaving out one big word, which is another reason why the ESOP thing does not sit well with me: flexibility. I need flexibility, because I don’t know what’s coming. I mean, people laugh when I say this. I’ve got a 12-year-old grandson. In 20 years, I’ll hopefully be around. I’ll be 88. Maybe my 32-year-old grandson or maybe my 27-year-old granddaughter wants to take it over. Like, I don’t know. There’s that. Maybe someone comes along and says, “Oh, this really fits. We want to give you eight zillion dollars.” And I think, “Oh, with eight zillion dollars, I could give all my employees a really big bonus, and that’s okay.” I don’t want to do anything that I’m going to wake up one day and go, “What the hell did I get myself into?”
So I need to stay flexible. Because the upsides of doing this are not big enough to cover the downsides. Because one of the options is to do nothing, which is an option, and that’s a better option than doing something that’s going to tie my hands one day and have me say, “Oh my God, what did I do to myself here?” Because I’ve managed to avoid all of that for all these years. I don’t have a partner. I don’t have landlords. I’ve managed to get myself in a place where I have control over things as much as you can.
Peter Koehler:
So quickly, just summarize for me what you see as the downside of doing nothing. Like, why not just do nothing?
Jay Goltz:
Okay, that’s an excellent question. The downside of doing nothing is something happens to me, and all of a sudden, my wife’s left with this business. I’ve got three kids. None of my kids have the interest to go jump in and take this thing over. So the reason I’d like to do this you already brought up. It’s putting an infrastructure in place that will at least give a good shot to having the business continue on without me here.
And without that in place, I’m going to have a lot of crying and screaming and, “What are we going to do?” And, “No, you should do this.” And I don’t want to leave—it’s an insurance policy. I want to leave some structure in place, as best as I can, that at least it’s already in place. Everything clicks in, and it continues on. And doing nothing, that’s not going to be the case.
Peter Koehler:
Yeah, that makes a lot of sense. A purpose trust or an employee ownership trust, it makes it possible for business owners like you, Jay, to sell or transition the ownership of the company in a way that kind of maintains the company’s existing setup. It maintains the purpose and values. It perpetuates its independence. People always ask, “What’s different under a trust?” And the answer is a bit anticlimactic. It’s like, “Well, actually, not that much.” But that’s the point, because the counterfactual never came to pass: the sale to private equity or the owner passing away and the business getting shut down before its time.
And so what you’re doing is protecting against that counterfactual, which is not as good as just continuing as is, which is for a good business like yours, that’s a great thing—to be able to continue as is. And so what trust ownership does is, it solves this problem: How can you sell your business without, quote-unquote, selling out? And the flexibility you talk about is another key hallmark of the trust structure versus other alternatives.
However, it’s not completely flexible. And so, one thing to be aware of, for example—and I just want to get your quick reaction to this—a purpose trust is not an eligible shareholder in an S corp. So one thing you have to do is transition to that C corp structure. And for most clients we work with, that’s not a problem. We figure it out. We work through it. But for others, there’s a lot of hesitation around that, and I’m just curious to get your quick take on that.
Jay Goltz:
To go to a C corp? Though I have an accounting degree, I’ve never practiced. I presume that causes some tax issues, doesn’t it?
Peter Koehler:
It introduces that kind of quote-unquote double taxation, that additional layer of taxation, where you have corporate taxes, and then you’re still on the hook for your personal taxes. One difference is whatever your personal tax rate is—let’s say it’s in the 30s. Currently the C corp corporate tax rate at the federal level is 21 percent. And then one difference is that a distribution to you from an S Corp is going to be taxed at your ordinary income rate, whereas a dividend from a C corp is going to be taxed at that long-term capital gains rate.
One consideration that we always work through with clients is: What does it mean to transition to a C Corp, both for the business, but also for the owners, in terms of their bottom line? There are, of course, benefits to a C Corp that may or may not be relevant to your business. But, for example, you can more easily issue multiple classes of stock, if you ever wanted to raise any non-voting preferred stock, let’s say, from investors or customers. And that may not be relevant to you.
Jay Goltz:
No, I put that in the category of: blah, blah, blah, blah, blah. Yeah, not happening. Not relevant to me whatsoever.
Peter Koehler:
To summarize my take: You check a lot of the boxes. There are some boxes I have question marks on. And if I were to work with you—and when I work with clients like you—we typically would have to do a little bit more of an in depth look at what we call visioning and viability. So if we were to do this, what would the vision be? What would that governance look like? What would the trust purpose be? What would the objectives of the trust be? How would we solve for things like leadership, succession? What would be the cultural impacts?
And then we look at the viability, like financially, what would it mean for the business? What would it look like for you? How would that C Corp transition affect us? And those are some of the questions we would investigate more fully. And then at that point, typically, we’d say, “Okay, now we know what it would look like from a vision standpoint. We understand the viability from a financial and legal standpoint. Do we want to implement this?” And then, owners would typically say yes or no. But we don’t even start the visioning and viability phase until we understand that a client kind of checks enough of those boxes, which based off this short conversation so far, I think you do. But I’ll open the floor up to you now, Jay, or anyone here. What questions do you have?
Loren Feldman:
Before Jay starts, can I just clarify one thing? Peter, you said you’d want to talk about what the purpose would be. We did talk about that a little bit. Jay stated that his purpose is maintaining the business as a place where his employees could continue to work. If that’s the purpose, is that enough? Or do you need more of a save-the-world type of purpose to work?
Peter Koehler:
No, I mean, that’s the beautiful thing about these purpose trusts, or these employee ownership trusts. They’re extremely wide open and flexible in how broad or narrow you want them to be. And you can make the purpose very simple and down to earth, or you can make it lofty and Patagonia-esque, but just saying, “We want the purpose of the trust to be to continue this company so that employees have a secure place to work,” that’s totally enough. And then you can have sub-objectives that you outline, if you feel that would be beneficial.
Loren Feldman:
Jay, have you got questions?
Jay Goltz:
Yeah, I do not believe that every business owner owes it to their employees to make sure this business goes on for their benefit. I fully believe everyone needs to do what’s right for them. And if you can—I most certainly want to do that in my situation. But if I needed that money to retire, that might be another story. So I’m not on some advocacy thing here of: Everybody should hand their business over to their employees. Not at all.
On the same token, it would be a shame to have my business crumble simply because I didn’t do everything I could to try to make it viable when I’m not here. That’s why I throw in the word: All I can do is try to make this work. And Peter, to your point: There’s no guarantee with all this stuff. All somebody can do is do it and hopefully it works out right. But there’s way too many variables to think that there is some 100-percent cure to this problem. And, “Oh, if you do this, you’re good to go.” That is hardly the case.
So I want to give it my best shot. So it seems like this solves my one problem of my wife says to me, “What happens if something happens to you?” My father-in-law died at 67, pretty suddenly. What happens? I don’t have an answer: “Yeah, you’re kind of screwed.” At the moment, I don’t have anything in place. So I don’t see any problems so far with this.
Loren Feldman:
Do you have any questions?
Jay Goltz:
I don’t know. It took me a while to figure out why the ESOP didn’t work for me. I’m not sure I understand enough about this, as to what could go wrong with this if. Here’s a simple question. I’m under the impression this is completely flexible. I can do whatever I want. I can give X percent to whomever I want. How many years, totally my game plan, versus that’s absolutely not the case with an ESOP. They’re heavily regulated. So I’m under the impression that I can write my own plan with this, and it’s all, quote-unquote, legal. Are there some restrictions that I don’t know about, that if I went to sit down, you’d say, “Oh, no, Jay, you can’t do that”? What can’t I do with this?
Peter Koehler:
You can’t continue as an S corp if you want a purpose trust.
Jay Goltz:
Okay, got it. Correct me if I’m wrong: Difficult to borrow from the bank if you do this?
Peter Koehler:
That depends. It depends on your existing balance sheet. A bank’s going to look at it like any other company. And if it’s an underwritable loan based on the strength of your balance sheet and your cash flow and your projections, then they’ll underwrite it. For them, the owner doesn’t matter if it’s Jay or a trust.
Jay Goltz:
Well, I just have to correct you on that. Just in my situation, I personally guarantee everything. And while a lawyer [goes], “Oh, you should stop doing that.” Well, great, but I can’t. I mean, my balance sheet obviously isn’t strong enough to be able to go ahead. Like I said, most of the equity is in the real estate, which is not in the business. So they’re still asking for my personal guarantee. So I’m of the belief that this would be difficult to go out to my same bank and get the same credit line I have now if I wasn’t signing for it. So I would only do this with the knowledge: Don’t count on getting money from the bank.
Peter Koehler:
So yeah, that was my next point, which you’re totally right on. If you’re currently personally guaranteeing these loans, and kind of that’s a requirement for the bank, then you or someone else will have to continue to personally guarantee those loans. I mean, I’ve seen a couple exceptions in my time where the banks have accepted a guarantee from the trust. And of course, the only asset that trust holds is the stock of the company, and so they’re pledging that stock as collateral, but most banks aren’t interested.
Jay Goltz:
Right. Okay, so if I did this, this isn’t today. I plan this out, and by the time I do it, I’d make sure I’m totally out of debt. I can get past the C corp thing. No problem. I can get past the bank thing. No problem. One of the goals of this would be—not only to put an infrastructure in place to try to keep the company going—but I certainly would like to put an infrastructure in place that I can start to bonus people out and have a structure for transitioning. And, like I say, flexibility.
The problem is, you know how life is. I know 82-year-olds who are playing tennis every day and act like they’re 40, and they’re perfectly fine. And I know some 82-year-olds who don’t know what their name is. So who knows what the next 10-15 years are going to bring. And that’s a difficult thing to try to plan around.
Loren Feldman:
There are a couple of other questions that are worth getting into, but I want to bring Jimmy into this conversation. Jimmy, correct me if I’m wrong: I believe you are well on the way to selling your business to an ESOP. I think you’re at 30 percent. Is that right?
Jimmy Kalb:
We’re currently at 12 percent. We bought out a minor shareholder with the understanding that the next liquidity event will happen in 2026.
Loren Feldman:
So having made that decision several years ago, what do you think listening to this conversation? What reaction are you having to it?
Jimmy Kalb:
Well, it was interesting. I listened to the podcast a couple weeks ago, and I was really intrigued. And then Peter and I exchanged a lot of different emails, Slack—
Loren Feldman:
On the 21 Hats Sounding Board I believe you had that conversation, Jimmy.
Jimmy Kalb:
That is indeed true. And so, after going back and forth on that, I was very intrigued. And I thought, “Well, this could have been a significant opportunity for me as an owner to use this as a tool to exit the company. And subsequently, since I’ve been listening to him here talking to Jay, he’s completely talked me out of that idea, for a lot of different reasons.
Loren Feldman:
Why is that?
Jimmy Kalb:
First of all, we already are a C corporation. It’s not a big deal. We pay the corporate taxes and California taxes, so that’s not a big deal. But one of the things that has stopped me from doing this is that subsequent sale. So one of the things about being an ESOP is there’s a trustee who represents the employees, and so the employees and/or the trustee can turn around and sell the company anytime they want for a great windfall for the employees, once they have that amount of business, that amount of shares of stock.
So for instance, if I sold the company for $10 million, and someone were to, I don’t know, three or four years from now, get a couple nice, big contracts in the door, and the company’s now worth $100 million, the employees can then choose to sell their $10 million company for $100 million and retire extremely wealthy, whether or not they continue on with the business. So they get that windfall at the end. That’s impossible to do with an EOT, as far as I can see, because that whole idea is perpetual trust. So it can never be sold subsequently to anybody else.
Loren Feldman:
Let me stop you there, Jimmy. That’s really interesting. I know a number of ESOP owners who describe the situation you just described as kind of their biggest nightmare. They don’t like the idea that they would sell the business to the employees, and then the employees would turn around and sell it for lots more. That wasn’t the reason they created the ESOP. You’re saying, it sounds like, that wouldn’t bother you. Is that right?
Jimmy Kalb:
That would not bother me in the least. I’m doing it to protect my employees. In fact, it would benefit me, because I’m going to end up taking back a significant amount of paper to finance this ESOP buyout, and by them reselling the company, it takes me off the hook. I get all my money, straight up. I no longer have to finance it, because that’s part of the money that they would have to put in the deal is to buy my note out.
Loren Feldman:
But your business goes away. It’s operated by private equity or somebody else, and you’re okay with that?
Jimmy Kalb:
I’m totally okay with that, because the employees at that point would be killing their own jobs, not me.
Jay Goltz:
Which just shows you that there’s no right or wrong to this. What he said makes perfect sense for you. I totally understand where you’re coming from. In my case, I don’t think that there is someone who is going to come along and give a zillion dollars to the company. So it’s not even an issue for me.
But would it bother me? Like Loren just said, yeah. I suppressed the value of the business so I can keep it in business for the employees, and they turn around and sell it? I can see where a lot of business owners would say, “Wait a second. I did this to be nice to my employees, and now I gave away from my family or charities I would have given to or to key employees I would have given it to. All of a sudden, I just gave away this big asset, and then they decided what to do with it.”
Jimmy Kalb:
No, no, Jay. I didn’t give it away. I sold it.
Jay Goltz:
I know, but you could have sold it at a suppressed value versus what if, in fact, they could turn around and sell it for 10 times more in a few years. I’m just saying.
Jimmy Kalb:
In a few years. But I would have to keep it, and I would have to continue running it, and I would have that risk going forward. So the point is, I’ll give myself a safe shameless plug here, but my company has just celebrated its 10th consecutive year on the Inc. 5000 Fastest Growing Companies in America. So we are growing at an average of 23-percent a year for the last 13 or 12 years. So if we continue that trend, we are going to continue to grow—potentially grow—and it will be worth a lot more to somebody else in the future, but I’m okay with that. I’m walking away.
Jay Goltz:
I totally, I understand. I’m not in that situation at all. I’m not even close. So I say, for you, it sounds like you absolutely did do the right thing, and it makes sense. It depends on lots of factors. There’s the business situation, your personal situation. There’s just a lot of pieces to this that—
Loren Feldman:
Well, Jay, I want to follow up on one of those factors that you mentioned. Peter, when Jay was talking about it, he was referring to an ESOP that he was kind of assuming he might have to sell at a suppressed value. If he did it as an employee ownership trust, would he similarly have to take less than he might otherwise, if he sold to someone else on the open market?
Peter Koehler:
So, it’s totally company by company. I would say, most clients that we work with, they sell at a quote-unquote fair-market value. And that fair market value is probably not the highest value. It’s not like what that perfect strategic acquirer would come in and say, “We really want this puzzle piece. We’re willing to pay a premium for it.” But it’s what you would get if you were to go get a third-party, fair-market valuation, a third-party appraisal. Most clients sell their company to the trust in that range of what fair-market would be.
Sometimes they take a bit of a discount. Sometimes they gift part of their company to the trust to make it more affordable for the company to buy them out, and also because they don’t need the money. And sometimes we have gone a little more in the premium range, where the owners have said, “You know, we got this offer from private equity. We essentially want to match that when we’re doing this trust transaction.”
So it really varies. But again, it goes back to the financial liability of the company, their cash flows, what they can afford over what time period, and what the owners are willing to accept. So that becomes a spreadsheet problem.
Jay Goltz:
It does appear that, if money is your number one thing, I’m not sure any of these things, it seems to me—if getting the most amount for your business is your number one priority, then my guess is you’d be best off putting it up for sale. And then, to your point, some company, the strategic buyer who’s already in that business, can strip out a bunch of overhead. It would be way worth more to them than it would be to somebody else. If that’s your number one goal, you probably should just go sell your company to the highest bidder.
Peter Koehler:
Well, if you can. Some companies might not be able to.
Jay Goltz:
No, no, for sure. I’m saying, if you can.
Jimmy Kalb:
So what I have, the way I structured it, Jay, since I’m doing the financing, I also get warrants to participate in that future sale down the road. So I am going to get that higher valuation somewhere down the road, if indeed the employees were to sell it to an outside entity. So I’m basically giving myself a second bite of that apple as if they were to sell it down the road somewhere.
And the reason why I’m going to do that is because I’m taking the risk of the paper and holding the paper, and they’re going to pay me a slightly less interest rate as they would from a bank. And by doing so, then I have some risk and some give back to the company. So their trade-off is they’re going to give me back warrants to get that second bite of the apple if they were to sell it to a strategic buyer down the road. So I’m going to get both sides of this.
Loren Feldman:
So Peter, Jimmy explained why he is happy that he chose an ESOP instead of an EOT. Does that reasoning make sense to you?
Peter Koehler:
Yeah, I want to talk about a few things Jimmy said. So, first of all, I agree with Jay. There are many ways to slice the apple. Different structures work better for different folks. I think ESOPs are great. I don’t want to be the anti-ESOP guy. I’m not the anti-ESOP guy. I think they’re great for certain companies, for certain owners. They’re not for everybody. But just to address a few things, because I want to make sure we’re all clear: Can a trust-owned company be sold? That was one thing that Jimmy brought up.
And the answer is: Yes, it can be sold. Because, again, the trust agreement, which governs the trust—the trust is a stand-in for the owner—kind of outlines how the trust is going to treat its assets, and the asset being the business in this case. So most times, the founders, the owners, they don’t want the company to be sold in the future. Jimmy’s correct about that. They’re interested in perpetual independence, because they think that maintaining their independence is a critical piece of being able to achieve their purpose and their mission in the world. And they’re worried that if a third-party owner came in, that whatever it is that they’re working on—whether that’s employee-wealth building, or a sustainable supply chain, or saving the world; in Patagonia’s case, saving the environment—then that third-party owner might not be beneficial towards those goals.
But that said, typically, of course, we don’t want to close the door. So, typically, there’s language such as: If a sale of the company would be in the best interest of furthering the purpose, then the trust stewardship committee may vote to sell the company under such circumstances. And maybe you require a supermajority vote, in that case. But you could say whatever you want. You could say in an employee ownership trust: If selling the company would be to the benefit of the employees at the company, in terms of maximizing their wealth, or however you wanted to say it, then the trust may decide to sell the company, if such an offer were to come along.
So that is possible, although I would say that most times in the trust agreement, the owners we work with make it kind of hard to do. And they also put in a poison pill, so to speak, where no one is incentivized to try to sell the company. Like, no one would personally get rich from selling the company. So sometimes you see these poison pills that say: After paying our debts and obligations, etc., any remaining proceeds from such a sale will go to mission-aligned charities.
Jay Goltz:
Okay, so far, so good then. I think, again, that was more flexibility. Great. So tell me, what could be something that I would wake up and go, “Oh, wait a second. I didn’t know that. I’m sorry I did this”? Because so far you haven’t said anything that I think, “Oh, that’s bothersome.” So far, so good. Am I missing anything?
Peter Koehler:
I was just at a conference in D.C. a couple months ago where there was a gathering of practitioners and lawyers and company owners in the EOT/PPT space. And there’s this debate happening of: Should we kind of fight at the legislative level or advocate at the legislative level for similar tax benefits to an ESOP to incentivize the creation of these employee ownership trusts and these purpose trusts?
And there’s a large contingent, I would say, maybe a majority of the people in that room, at least, who said, “No, we should not do that.” Because if you get those tax benefits, with that will come the regulation and the oversight that ESOPs have, that’s the trade off. That’s why the government says, “You want these tax benefits? Great, we’re going to regulate you in a certain way.” And so, because we know that flexibility is paramount for a lot of the companies that are interested in this structure, wishing for the tax benefits might actually not be what they want when they think about it.
Jay Goltz:
That makes perfect sense to me. I was holding my breath waiting to hear what the majority was thinking. I was thinking, “Are they crazy?” But no, that makes perfect sense. That’s exactly why the Employee Ownership Trust—for people like me—it’s different. To go ahead and get the regulatory thing, well, now you’re back to like, Baby ESOP. What’s the difference?
Loren Feldman:
Peter, one thing we haven’t discussed is, if Jay sells the business to an employee ownership trust, where does the money to pay Jay come from? What are you imagining would happen?
Peter Koehler:
Well, so the most flexible and simple structure is to do a seller note where the business pays Jay out over time from company cash flow. The other kind of common structure we see is what Laura did on that previous podcast [episode]. Laura from Local Oceans, where she did 50 percent from a bank loan, so she got some initial liquidity, and then the other 50 percent she held as a note to get paid out over the subsequent 10 years. So usually, either just a seller note or a combination of seller note and external debt is what we see. We have also done deals with external equity, but those are much less common.
Jay Goltz:
So let me tell you what the key to that is: In my particular case—but not just me; there’s lots of people in this situation—I don’t plan on retiring, so let’s just assume that I’m perfectly healthy until the day I drop dead. Okay, now the issue then is: What happens the day I drop dead?
Well, if this wasn’t in place, my wife and kids would have the incentive to wash their hands of this and say, “Just sell the business or have a going-out-of business sale. I don’t want to deal with it.” The difference is, if this was in place and it was able to pay back the seller, which would be my family, okay, they’re going to get their money. They just might wait for five years, but that’s okay.
Peter Koehler:
And I do want to speak to something Jimmy mentioned. It sounds like Jimmy has warrants in case of a future sale, post-ESOP, to someone else, which is cool. We talk to owners, and they say to us something similar. They say, “Well, if the company keeps growing really well, I want to participate in that upside.” And so, some ways that we’ve tackled that is—there’s been a couple: One, we’ve structured earnouts as part of their buyout, so that the amount they get paid out will vary based on company performance over the coming years.
The other is a phased sale. So, let’s sell part of it to the trust now and then part of it in seven years, when we think we’re going to have higher revenue, higher earnings. We’ll be worth more. We’ll use a higher valuation at that time. So those are two ways that owners, if it’s important to them, can participate, quote-unquote, in that upside that’s kind of compatible with the trust sale.
Jay Goltz:
I mean, the reality is—and I didn’t know this until you just said it, Jimmy—that you were growing it. I didn’t realize that all this time. We’re in very different situations. So it doesn’t make sense that we’d both have the same solution because we are in very, very different situations. So in your case, it does sound like the ESOP’s a great solution. In my case, my two options are: Do nothing or do this. And it seems like doing this might be the best option.
Jimmy Kalb:
Or the We-SOP.
Jay Goltz:
Or the We-SOP, right. That’s still on the table too, where I take a few key employees, and I work a deal with them. That’s a good point. So that’s one of my options at the moment.
Loren Feldman:
Peter, Jay asked you a couple of times about: What doesn’t he know? What could go wrong? And I want to ask it in a slightly different way, which is this: There aren’t that many of these employee ownership trusts. You gave me the number the last time you were on. Was it around 50? Is that what you said?
Peter Koehler:
Around 50 of the purpose trusts, to use the more broad term, yeah.
Loren Feldman:
So my question to you is: Is there a big enough sample size? Do we know what can go wrong with these? Or is it too soon to answer that question, really?
Peter Koehler:
Well, first of all, there’s 50 in the U.S. There’s a lot more in Europe. Of course, that’s a different set of laws and rules, but roughly the same, in terms of structure. And it’s been going on for much longer there. I do think your question has merit. What are we going to think of this landscape in a decade, two decades?
To that point, I don’t necessarily want to call it a risk, but a question for me is: How do these self-governed companies that are stewarded by the people who work there and by a trust stewardship committee comprised of who’s ever on that committee—and that could be existing employees. It could be the founder, while the founder’s still alive. It could be an independent person, kind of just like a normal board might be.
But how does that self-governance go after that first generation of leadership turns over, then that second generation, then that third generation? How does it persist and evolve in a way where companies can continue to not get stale, continue to grow and thrive and be flexible and nimble? And my inkling is that that’s going to be less about the trust structure and more about the actual company culture and more specific to the company. But that’s a question I have.
Jay Goltz:
The point is, none of this is foolproof. I mean, it just isn’t.
Loren Feldman:
Well, Jay, I wanted to ask you, did your heart skip a beat when Peter used the term “stewardship committee”?
Jay Goltz:
No, because this is all about options. The other option is: I keep doing exactly what I’m doing, and there’s no committees. But I know that’s not a good long-term option for the day after I’m dead, so I recognize that I can’t have it both ways. I could be ignorant, like I’m going to guess 75 percent of business owners are, which is why businesses just disappear one day. I could stick my head in the sand and say, “I’m not doing anything,” and drop dead at my desk and leave a nightmare for my wife and kids. Or I can do something that has some stewardship. So no, I didn’t cringe when I heard that word, because I recognize that that’s part of what I need—but not too much of it.
Jimmy Kalb:
Loren, at this point in time, you should ask Peter: What should an owner expect to pay for an EOT?
Jay Goltz:
Yeah.
Loren Feldman:
That’s a great question.
Jay Goltz:
There you go. Peter, you still there?
Peter Koehler:
Yeah, I’m still here. [Laughter] It is a good question. So, I mean, to Jimmy’s point, we encounter different types of clients. We encounter clients who are very capable and interested in a more DIY approach. And then we have folks who aren’t. They’re either very busy running the business, or they don’t feel they have the knowhow or interest, so they want more of what we call a “concierge service” with someone who really guides them every step of the way, and project manages their whole transition. So that really changes the fee structure from a consulting perspective, for a consultant like myself, who might help with the transition.
But in any case, you’re gonna have legal fees and CPA fees, and then you’ll have ongoing administrative fees. So for legal/CPA, depending on the complexity of the deal structuring and the financing plan, we typically say: Budget $15,000 to $30,000 for the transition. And then for the consulting fees, if you’re going DIY to concierge, budget anywhere from maybe $15,000 to $60,000. And that time frame we’re talking about is, we say budget six months at the minimum, from we’re starting this process to we’re actually having a transaction.
Jimmy Kalb:
That is way more reasonable.
Jay Goltz:
I wrote down numbers before you said it. That’s right in my ballpark. I think that’s very reasonable. It makes sense.
Jimmy Kalb:
Absolutely.
Loren Feldman:
I kept you longer than I promised. I appreciate your hanging in there. This was really interesting. My thanks to Jay Goltz, Jimmy Kalb, and Peter Koehler. Have a great week, everybody.
