What’s in It for the Owner? A Skeptical Conversation about ESOPs

Both Jeff Taylor and Jim Kalb run companies with employee stock ownership plans. Jay Goltz is thinking about implementing one — but he’s got questions, such as: Where does the money to buy the company come from?

By Loren Feldman  

The proponents of employee stock ownership plans can make them sound like the greatest thing ever. A business owner can take a big chunk of money off the table—or even all of it—while still getting to run the business. And there are some pretty great tax breaks. Oh, and it will also solve income inequality in America. On the other hand, if ESOPs are so smart, why are there so few of them?

Jim Kalb of Triad Components Group in San Diego and Jeff Taylor of Crafts Technology in Chicago have both implemented ESOPs. Jay Goltz of the Goltz Group in Chicago has reached his 60s without a succession plan, and he’s considering his options. In this 21 Hats Conversation, you get to listen in on a street-smart discussion of ESOPs from the business owner’s point of view. You can watch the full video above or read the edited transcript below.  

Loren Feldman

Jim, I’d like to start with you. Tell us about Triad. What do you guys do? How long have you been doing it? And when and why did you go ESOP?

Jim Kalb 

So we’ve been around about 30 years. We manufacture fuses, circuit breakers, and switches, mostly for the automotive industry, as well as electronics and things like that. And we have 20 people here in San Diego, California, and our revenues are somewhere in about the $10 million range.

Loren Feldman

And when did you go ESOP?

Jim Kalb 

We went ESOP about two years ago. And the real reason I went is because I’m 60 years old this year, and I wanted to find a way—I read Bo Burlingham’s book Finish Big. And it was really impressive to me and put a lot of things in my mind, some ideas. But the real reason was, I wanted to take all of my chips off the table but still work as long as I want—and keep absolute, positive control of my company and not hand over control to anybody else. So I get all of my money out of the business, and I can keep control of the business until I want to retire—90 years old if I want.

Loren Feldman 

I can see by the way he’s shaking his head that Jay has questions already. Jay, hold on to those questions and we’ll get to them.

Jay Goltz  

I’m controlling. It’s like he’s baiting me.

Loren Feldman  

It’s very easy to bait you, Jay.

Jay Goltz 

I know.

Loren Feldman  

Jeff Taylor, tell us about Crafts Technology.

Jeff Taylor  

Crafts Technology is a 127-year old manufacturer of specialty diamond and tungsten carbide and ceramic tooling. We make all kinds of things for the medical industry, a lot of aerospace can tooling, cutting diapers, whatever, cutting tools and wear parts, really high precision wear parts, too. So the company was bought and sold many times over that 127-year period by large conglomerates, but for that whole time, it’s been continuously operated as this specialty niche manufacturer.

So I came here about seven years ago. Day one for me was the first day of the ESOP. I had actually worked with the principals that were running the business, and they were in their 70s and 80s. And they wanted to retire. And they also wanted to sell the business. They had looked for a couple suitors or a couple of prospective buyers, and then they even approached me at one time about possibly buying it, but I didn’t have the capital. So we came up with a different plan. And that was to do an employee buyout. So I came in to lead an employee buyout and move into the CEO role in a succession plan from one of the principals. That was January of 2014.

Loren Feldman

So you’ve been doing this for seven years now?

Jeff Taylor

Right.

Loren Feldman

All right, Jay, what’s your first question?

Jay Goltz

Okay. I know very little about the whole thing. So I just have two basic questions. One is, where’s the money coming from to buy the company? And what’s the upside to the owner for doing it? Well, I guess three questions. And then what’s the upside for the employees? But the first one, I’m trying to understand the math of this. Where’s the money coming from?

Loren Feldman

Jim, why don’t you take that first because you did it as an owner.

Jim Kalb 

It comes from two places, Jay. The first place it comes from is, I was making a contribution of 3 percent to their 401(k) account. And instead of making the 3 percent—let’s just say, for sake of argument, I have a payroll of a million dollars a year. That’s $30,000 a year that I wouldn’t be paying into the employees’ accounts on behalf of the company. And so they would use that $30,000 to buy a percentage of the company.

The secondary where this comes from, as they get percentages of the company, a percentage of the profits now flow to the ESOP trust. And the ESOP trust does not pay any taxes on it. So we would normally, as an S corporation, be making tax distributions to the owners, myself and two others individuals. And we would then use that money to pay our taxes from the S corporation. Well, the ESOP doesn’t pay taxes, so they get to use that money to buy out more shares from the ownership.

So it then becomes a snowball effect. So maybe the first year, they have a couple percentage points, and then we make more contributions every year. And then they, as they own more and more of the company, get tax distributions. And they use those tax distributions to buy out more and more shares. So it’s going to take about 15 years for them to buy out all of—15 to 20 years. And we’re doing it in tranches as well, and I’ll get to the reason why we’re doing it in tranches. To start with, for the first five years, they’re buying 12 percent of the company from my sister. And they’re using that 3 percent only to buy out my sister’s interest in this particular company, and that 3 percent covers almost exactly her payment for five years.

And so that they’ll end up with 12 percent of the company. And then they’ll buy another 18 percent of the company, which gets to a magical number of 30 percent. And I’ll get to that in a second. But they’ll buy another 18 percent, which will take another five years in order to pay that back. And then we’ll go to a bank for the remaining 70 percent. And by that time, the ownership will be in the trust. And they’ll basically take all the profits of the company and be able to pay off that note that we’re going to borrow from the bank. So I hope that answers your question.

Jay Goltz 

When this all started, there wasn’t just you. There were three of you?

Jim Kalb  

It was my brother, my sister and myself. I had 80 percent. I have a brother who has 8 percent and a sister with 12 percent. But going into this thing, it was always going to be structured as 12 percent, 18 percent, and 70 percent. And the reason I like that approach is because 10 years from now, when I sell the remaining portion of my thing, I get the valuation of 10 years worth of growth to the company. So instead of selling it, for the sake of argument, at $5 million today, I get to sell for $15 million, hopefully, 10 years from now.

Jay Goltz

So just talking about the math of it all, you’re confident that you’re getting more money out of this doing it this way than if you were just to go ahead and sell it in 10 years or something?

Jim Kalb 

The answer to the question is, if I sold it to a strategic buyer, I might get 12x or 8x EBITDA? The answer is no, I’m not going to get that if I sell it to the employees. I’m going to get what would be like what a private equity company would buy it for, which is 4x to 6x of EBITDA. So I’m not going to get anything greater than that. It’s not a strategic sale.

Jay Goltz  

But you also don’t have to pay tax on the money. So that is an advantage.

Jim Kalb

We’ll get to that in a second as well. That’s correct.

Loren Feldman  

Just to be sure, your employees in doing this are not taking on any debt. This is all funded out of the profits and out of the contribution that you make. Is that correct?

Jim Kalb

Well, right now they have a small debt. So we borrowed a quarter million dollars to buy out my sister. And then each month, they pay about $4,800, to pay back that loan, but that $4,800 is about what our contribution is for the 3 percent. So our contribution is about $5,000 in order to get the 3 percent. Three percent, by the way, is really important because we also have a 401(k), which just allows us to save some money. So we have what’s called a KSOP, which allows us to continue for the people to put money away in a 401k as well as also have the ESOP as well as part of the retirement program.

Jay Goltz  

So how many employees are there all together?

Jim Kalb

Roughly 20.

Jay Goltz

And how many are involved in the ESOP?

Jim Kalb

Twenty.

Loren Feldman

Jeff Taylor, how about you? You came at this from a slightly different perspective, because you were brought in to run it. Can you talk about how your ESOP was funded and why the owners chose to do it that way?

Jeff Taylor  

What I first would say is, the way that our ESOP was funded is probably the way most of them are actually funded. It’s like doing an IPO. Basically, the only buyers are the employees, and it’s a fully leveraged buyout. So what typically happens, the notes get taken back, usually by the principal, some percentage, let’s just say the principals are going to take back notes to the tune of 70 or 80 percent and typically get a pretty good interest rate. And then the bank finances the down payment, basically. So you bought a $10 million business. I take a bank loan of $2 million, the principal’s get $2 million of that $10 million. And the $8 million is taken back by notes by the principals. That’s typical. That’s probably the most common way. Basically, I look at ESOPs as it’s kind of like, imagine you open a 401(k), and the only company they buy is your company. So it’s an IPO. The 401(k) runs it—we call it a trust, you know, handles the shares. But that’s all any ESOP really is.

Jay Goltz 

When one buys a 401(k) they invest in lots of different stocks, or they spread their risk. Businesses have ups and downs. I think most businesses do, maybe yours doesn’t, maybe Jim’s doesn’t, but I’ve had plenty of times in my business, 2008, where the world fell apart. I’m in the home-furnishings market, and I had to dig in and buy a building that I can’t imagine my employees—I would call them civilians that aren’t used to taking risk—would have been in on. So if business is just steady and goes along, I can understand that. But what about when things get rough, and one has to take a risk. You can’t compare that to a 401(k) plan because that’s spread out between 50 different companies.

Jeff Taylor 

Well, can we put risk in perspective? Nobody ever put any money on the line. There’s no risk. I mean, your employees don’t pay for anything. Nothing comes out of pocket. It’s funded back, basically by the freed up cash flow instead of paying taxes. You’re paying the notes. I mean, no employee ever has risk. They can’t get sued.

Loren Feldman

Well, let me stop you there for one second, Jeff. And this plays off a question we got in chat from Shawn Busse. Jim, you shifted your contribution from a 401(k) to the ESOP. So arguably, that is money that they’re putting up. And Shawn’s question was along the lines of Jay’s question: How do they deal with that risk? And how do you think about that?

Jeff Taylor 

But I would say one thing, if I could interject. Jim’s situation is a little more unique. I think it’s very fair to say that what I’m talking about is far more typical.

Jim Kalb 

So I had a simple question for my employees on this, and I’m not sure if it answers Shawn and Jay’s question. I said, Do you want to put your money into the stock market where you have no control? Or do you want to put it into our own business, where we actually have control, and you can work towards making this grow yourself? And they’ve seen 10 years now of double-digit, 20 percent growth out of the company. And if they work real hard, it can grow faster. And they trust me to lead the company. So they could easily have put it into the stock market where they could have lost all their money in the stock market.

Jay Goltz  

But that’s not true. You can’t lose all of your money. If you put money into 20 stocks, you can’t lose all of your money in the stock market. So you’re telling me in 10 years, you haven’t had one bad year.

Jim Kalb

No, 2009.

Jay Goltz

Okay, that’s, that’s commendable. And I can see why they would be on board for that. 

Jim Kalb  

Even last year, we had a horrible second quarter. We ended up about four and a half percent year on year. So that’s last year, where we were shut down for two months. And we still were able to create a year-on-year sales increase of about four and a half percent.

Jay Goltz  

Well, if one can do that, and they’re in that kind of business, and they’re that smart, and all those good things that go with it, sure, no problem. From what I can see, most businesses have some rough patches along the way. And that’s a tougher sell to go, Hey, trust me, we’re going to keep growing like we’ve been growing. I’ve been in business 43 years. I’ve lost money in more than one year, and I don’t think that would go over great [with my employees].

Jeff Taylor  

Jay, if you buy any business, and you’re going to buy it at a multiple of EBITDA, right? You want to buy it at six times EBITDA? Well, if you put up no money, and you just run the business like it is, in five to eight years, depending on exactly what’s going on, just generally running okay, you’re going to pay off the business. So not one employee has put up one penny. You basically should always buy a good business that’s already structurally sound, and if you just operate it normally, you’re in the equity game. All of a sudden, all of our almost 50 employees are in the equity game. And it’s a tremendous opportunity. I really, I don’t even understand where the downside is. Somebody would have to really convince me there’s a downside for people who don’t put in any money—as long as they run a business decent.

Jay Goltz 

So there’s no 401(k) plan money being diverted towards this. It’s really costing them nothing? They just are on the train ride for the ride, and if things go to crap, they’re okay.

Jeff Taylor 

That’s the de facto standard on how ESOPs are set up.

Jay Goltz 

What about the seller? What if you do the ESOP, and China comes in and they end up cutting your price by 50 percent, and the business gets into trouble. Does the owner come out okay in that deal? 

Jeff Taylor  

No, well, they usually retain the right to take the company back. And by the way, if they just sold a bum company to the employees, they better take it back.

Jay Goltz 

Well, no, not a bum company. It was just fine. I just read today, Paper Source, a Chicago company, they’re in bankruptcy. They were doing nothing but printing money for years, and all of a sudden, they’re in bankruptcy. This does happen. So one day the company’s good. And I just want to be clear on this. So the owner could have sold it for let’s just say, whatever, a million dollars cash. He goes to Florida, and he plays bridge all afternoon. Okay. Versus he does an ESOP. And he’s financing this, and then something goes terribly wrong in the market. Doesn’t he lose? Doesn’t he lose money? He or she?

Jeff Taylor 

Well, by holding a note, they will get the company back, substantially.

Jay Goltz

But the company might be worthless at that point.

Jeff Taylor

Well, then nothing would be different if he held it.

Jay Goltz 

No, no, he could have sold it for real money and cashed the check and put it into a bank.

Jim Kalb

If he wants to retire and move to Florida and play bridge, yeah. But if he wants to stay involved with the business, and—like myself, I want to be here for 15 or 20 more years. And I still want my money today. So I’m going to run it for as long as I want to be here to run it.

Jay Goltz 

Well, for you, that’s no risk then. Your choice would have been: own it yourself and keep taking the risk or do the ESOP. In this case, though, if somebody wanted to sell the company and could have gotten all their chips off the table, they could have been done. Whereas in this case, they’re not really done.

Loren Feldman

But that’s not you, Jay. You don’t want to sell your business and go to Florida. You want to keep running it. And this sounds like an option for doing that.

Jay Goltz

Yes, I’m struggling to see where the upside of it is, though, for me at this point.

Jim Kalb

How would you do it in the future? Will you sell it to a PE company? And then they kick you out in a year?

Jay Goltz

No, I’ve got two options. First of all, as you know, you’re not that much younger than me, maybe we’ll be alive and well in 15 years, and maybe not. So we’re going to keep running it, hopefully, and everything stays good. And one option is, let’s assume that the kids don’t want it—because if they did, that would be the easiest thing. Let’s assume not. So one option would be to go ahead and sell it.

And the other option, in my case, because I carry a lot of inventory, there’s a lot of companies that make more money by having a going-out-of-business sale than by selling the company. If you can get rid of your equipment and your inventory, that would be another option—that at the end of the run, if I can’t find someone to buy it, I could go ahead and have a going out of business sale and again, get my cash out of it.

Loren Feldman

And then your employees don’t have jobs. How big a concern is that?

Jay Goltz

That certainly wouldn’t be my first choice. But if I needed the money that badly—you know, you gotta do what you gotta do. I wouldn’t want to gamble my retirement, and I’m not in that situation. So I own the real estate. But there are many people that need that money from the business to retire, which is why I’ve got options. I own the real estate, and I’m okay if the whole thing blows up one day. But I’m struggling to understand where the upside for someone like me would be because I’m coming to work every day. I still want to flesh that out a little bit. You said in the beginning, Jim, you have total control.

Jim Kalb

Correct. So here’s the way this works. I’ll explain it. The employees aren’t, like, electing a class president to run the company. Basically you have a professional trustee, who is in charge of voting all the shares of the trust. So who hires the trustee? Well, the board of directors hires the trustee. And if you have a board of directors, let’s just say for sake of argument, my brother, my sister, myself, are on the board. The point is, the trustee—even if they were to have voted one of us off the board—there’s still two against one and then all the two do is replace the trustee with someone who is a little bit more favorable towards us. So in reality, we control the board and the board controls the trustee who then basically votes all the shares of the stock. So it’s a very incestuous arrangement for this whole thing.

Jeff Taylor 

Well, I would add to what Jim just said, I liken it to a public company. Basically, you have a board of directors. It’s really like you’re running a public company. So Jay, you lose the prospect that you’re in control relative to if you have the singular owner and the principal. You certainly lose it in relative terms to that. But like Jim was saying, you’ve got a board of directors, but the board of directors can get rid of you. Yeah.

Jay Goltz

Jim, did you start the company?

Jim Kalb  

I did.

Jay Goltz  

Okay. And it sounds like for what you’re doing, it sounds like a great thing. And I’m not arguing—this isn’t a debate. I’m sure this is a great thing for many companies. I also know that from what I read, only 1/10 of 1 percent of companies in the United States are ESOPs. Why?

Jim Kalb  

I have no idea. It should be a lot more, because again, I know personally 10 people who have sold their companies to PE companies. I only know two that it’s actually worked out well for them. As an alternative to selling it to a PE company or a financial type of sale, you keep all the control to be able to make sure that you get paid out. Now I would say you don’t have all the control because the markets control you and all those kinds of other things. I get that. So yes, another pandemic can come and wipe everyone out and such. There’s a certain amount of risk. 

Loren Feldman 

I want to talk about what makes a company a good candidate to do this—and whether Jay’s company even qualifies. So let me ask, what does it take? Do you need to be a certain size? Do you need to be profitable? What are the key requirements to even consider doing this? Jeff, do you want to take a shot at that?

Jeff Taylor

What makes a great ESOP or what makes a great candidate as an ESOP, I think, is generally—and this is arguable—but generally under about $3 million in gross revenue, I think some people will say that it’s too small—based on the cost of setting it up. And also you don’t want to use an ESOP to buy a poor performing business. That’s not gonna really work. 

Loren Feldman 

What about an up and down business?

Jeff Taylor  

Cyclical? You mean that?

Loren Feldman

Yeah.

Jeff Taylor

I’m not sure.

Jim Kalb  

You need to be able to service the loan. And if you don’t have cash flow to service that loan—one year you have a tax loss, the next year you have a tax gain. And it wouldn’t really make sense. It needs to be a steady, profitable business, and I would agree with Jeff in that regard.

Jeff Taylor 

Jay, you say so what other benefits? This is something very important to consider, and I often don’t even see this published in any ESOP writings, and it’s this. In an ESOP, there’s no flight of capital. All the money that is produced in the business stays in the business. There’s no vehicle really—unless I guess you could pay dividends of sorts. But generally, that’s not what ESOPs do. So what happens is, as you pay down the debt, and you’re not paying taxes, man, you get a debt-free business and no flight of capital. It’s unbelievable how you can plow all the money back into the business. So when you talk about risk and upside and all things like that, an ESOP is an uncanny, incredible way if it’s run well.

Jim Kalb   

I will say this, though, before you say something, Jay. There is one flight of capital, Jay, and that is, you do have to buy out the people who retire. They’re going to have stock, and you do have to create a nest egg to pay them out as they leave the company.

Loren Feldman

That’s a great point. I’ve heard Jack Stack of SRC, who’s written a book about all this with Bo Burlingham, talk about this. And he has said that that’s the thing that has kept him up at night—worrying about having that money available. Has that been tricky for either of you?

Jim Kalb  

I’m the oldest person in the company, so it’s not going to be a problem

Loren Feldman 

But people leave for other reasons. Right?

Jeff Taylor  

From what you said, what Jack Stack said, that is the thing that does keep people up when I read about it. But again, if you’ve bought a quality business, if you bought it at five times EBITDA, and you’re three years into it, and you’ve paid down the debt substantially, it’s not very complicated to get it to run right. I think, Jay, you bring up a good point, though. So what happens when you do buy a business with an ESOP, and then one year into it or like you said, it’s cyclical, Loren. Or something goes awry. And then that can hamper things. But remember, the only thing that’s different about an ESOP—different than any of us buying a business—is you’re just letting the employees do it. They’re in the equity game at that point. And so part of the equity game is risk.

Jay Goltz  

Well, let’s be clear. If you sell it to a company, you get the cash. So you’ve convinced me from the employee standpoint: great thing for you, great thing for the rest of them out there. All those people behind the wall, they’re all happy. I can see that. Jim, from your perspective, correct me if I’m wrong, it sounds like because of the tax implications and the magic of compound interest, that you will end up with more money this way, after 15 years, than you would have if you just went to sell it. There’s nothing wrong with that. Right?

Jim Kalb

Well, so I didn’t even talk about that. So one of the reasons about that 30-percent threshold is now I get to do what’s called a 1042 exchange. And so every dollar that I sell the company for, and they pay me for, along the way, I get to put now into the stock market or the bond market in individual issues. And I do not pay taxes on that exchange. So for every dollar I pull out, if I pull a million dollars out of the business, and I put it into individual stock issues, or municipal bonds, or whatever I decide to put it into—I can’t put it into a fund. I have to actually put it into individual issues—I don’t have to pay taxes on it. If I have a dividend-paying stock or a coupon is paying on a bond, I can live off that interest forever.

Loren Feldman 

The money you’re talking about pulling out, that’s the money your employees are paying you to buy the company step by step. Is that the money you’re referring to?

Jim Kalb

Only once it gets over the 30 percent threshold. My sister cannot do that. She only sold 12 percent. So she couldn’t do a 1042 exchange. She had to take the money.

Loren Feldman  

So you get past the 30 percent. As the employees buy you out, you can take that principal, and you get it without having to pay capital gains tax on it. And if I heard you correctly, you can then invest it in another investment and not have to pay taxes on your gains for that investment, either. Is that what you’re saying?

Jim Kalb   

So if you do an exchange, basically, your company stock for IBM stock, for instance, or Exxon, whatever I choose, I can then put that into stocks. If I sold the company for 5 million bucks, I put it into the stock market. The stock market pays me 3 percent. And I make $150,000 a year to try and live on forever. I do have to pay taxes on the dividends and the interest. So that’s taxable income to me, but not the original sale. I defer that pretty much forever. It goes into my estate.

Jeff Taylor  

So Loren, I don’t think we’ve convinced Jay.

Jay Goltz  

I can totally understand why it’s working great for both of you, but everybody’s situation is different. And when I start hearing things about trustees and voting, my skin crawls. I get up every day knowing I am fully—if I do great, it’s because of me. And if I screw up, it’s because of me. And there’s no politics. And I can do whatever I want whenever I want. But you’ve given me food for thought, which is, if I structure this, and I was sure that my kids really didn’t have any interest in running it long-term, could I get more money out of it this way because of the unbelievable tax advantages of this. And certainly that’s food for thought. And I never knew that.

I do want to read a comment on the chat here, though, that really, I think, is important. Jen Briggs—you’re out there?—Jen says, “This adds an important aspect of strategic workforce management. Workforce planning, hiring, and retention are a factor in business planning in a way that is not a consideration for other firms. ESOP firms really do regard talent as an asset.” Really? I don’t regard talent as an asset. I think that’s a fallacy, and I just want to flesh that out. Let’s not say that, Oh, if its employee-owned, everyone’s really more invested, and we’re gonna be a better, nicer company, and everyone’s gonna be valued more. I mean, I don’t think that’s accurate. I absolutely believe my employees are our assets. And I do regard talent as an asset. So I don’t think all ESOPs are wonderful, everyone loves each other and works harder. And if the owner’s running it, it’s all about the owner. I don’t buy that concept.

Loren Feldman  

Jim, you made the switch fairly recently. Do you think there’s been a change in the way your employees view the company since going ESOP?

Jim Kalb 

We started our company, almost, with open-book management. So that was already a culture in what we do. We don’t share individual salaries, but we share everything in there. About once a quarter, we go through the financials completely, and I spend a lot of time and energy training them on what a financial sheet looks like and such. So they also know that if we don’t do something or we do do something—if we spend some money on a party, and that party costs the company $1,000, well, they’ve got a 5x valuation on their own personal stock. And so therefore, there’s a multiplier that they have in their own stock account based on our company. So it’s like $5,000 worth of bottom line to the value to the company. And believe you me, they know that. So they understand that completely. Now do they second guess me? Do they say, “Hey, why are we hiring this marketing guy and adding to our team. That’s just overhead. If we don’t hire this, and I do the extra bit of this job, could we save this money?” I do hear a little bit of that second guessing. I get that. Jeff?

Jeff Taylor 

I would echo Jim’s comments. And not that you’re wrong on this, Jay, because I think you’re right that you value talent. But unleashing some of that pent-up input or extra productivity. Let me just give you a number: We doubled the size of our company with barely one or two more people. I mean, that’s when we became an ESOP, right? So where was all that productivity?

Jay Goltz

Wait. Were you working there at the time before that?

Jeff Taylor 

Well, I have all the financial records.

Loren Feldman  

He joined at the time of the ESOP, right?

Jay Goltz 

No, I’m saying, maybe you did a really good job. And maybe the old owners were thinking back in the 1960s and didn’t do anything modern. And maybe you brought a new perspective to it and did a really good job.

Jeff Taylor   

That’s what I’m going to talk about on the next podcast.

Jay Goltz

I’m just saying it wasn’t necessarily all due to being an ESOP. The old owners got out of the way, and you probably brought some new thinking to the company.

Jeff Taylor 

That is a fair comment. You have been around for a while. You know what you’re talking about. There’s part of that that is true. But you know, everything is, it’s a mosaic. So I don’t think I would have had as much success. Let’s say that.

Jay Goltz  

I accept that. Absolutely. I just don’t want to paint ESOPs as a magic bullet.

Jeff Taylor

I want to say something else to Jay. I think that we’re missing the mark on something. A lot of people don’t want to just jump in the water. They want to just stick their toe in the water. Right? You know, Jay, have you considered that as a seller, you could sell 40 percent of it, right? Then you could run the company. You would be the highest wage earner, shares are distributed commensurate with the wages. So if you’re the highest wage earner, you’re earning the most shares. So if you retain that business, after you sell 40 percent of it as an ESOP, you run it because you own 60 percent of it. You earn shares in the shop that you’re running. And those shares become—once the ESOP is sold to somebody else—those shares are essentially in what would be a 401k or an IRA. So you could actually, it’s a little bit like double-dipping as a seller where you get to earn back shares at the very company that you just sold. It’s just something to think about, because maybe you don’t want to give up total control. And by the way, if you sell 40 percent of it, and it does work out well, well, then you’ll be queued up to sell the rest of the 60 percent or another 30 percent. So just consider that you can set this up according to the way you feel comfortable. There’s not a 100 percent one size fits all. Jim’s story is different, and yours could be different.

Jay Goltz

And Jim, I do not do a full blown open-book management, but my manager certainly sees the books and knows where we’re at on it. And I also, when someone says, Well, we do open-book management—except they don’t see the salaries. To me, then you’re kind of doing open-book management, because given that, in some companies, the labor could be 30 percent of a company, not knowing the salaries is kind of blind. And then in some cases, the owner’s pulling out a tremendous amount of money. And no one knows about that. So I always—it’s either full blown, or it’s not. And that’s a whole other discussion.

Jim Kalb 

Let me clarify. We have departments, and so we say sales is costing us X amount of money in salaries, marketing is costing us this much money, administration’s costing us this much. So, we blend these things so they see the total compensation, and they see the department’s things. But they don’t know if it’s Steve or Betty or Mary, how much individually they make for this. And one thing about Jeff—I don’t know, because we’re progressive out here in California. We have some sales people that are highly compensated, well into six figures. We like that. And I don’t actually get the most amount of compensation. But because of that, we said, Look, we want to flatten this out from the lowest worker to the highest worker, so we cap the amount that they can contribute to $150,000. And then our lowest person probably makes $40,000 or $50,000, somewhere in that net range. So the difference between the highest wage earner and the lowest wage earner, if they’re capped at 150, is now about 3x.

Jay Goltz 

Wait, you mean the amount that they can buy into the company, right?

Jim Kalb

Correct. The amount of stock that will be allocated towards them.

Jay Goltz  

Okay, so does every employee know how much money you’re making?

Jim Kalb  

Probably, yeah. I tell people exactly how much because I know I’m under market. So they know how much the salespeople are making. They just know the commission percentage, they don’t know the dollars.

Jay Goltz 

Because I’m sure that wouldn’t go over great. I’ve got outside sales people. It’s never a great thing when they hear how much the outside sales …

Loren Feldman  

I don’t want to go too far down the open-book rabbit hole.

Jay Goltz  

But when you’re talking ESOPs, they’re owners. So I think it’s all, your honor, I think that that’s all open because it’s fruit of the poisoned tree here. It’s an ESOP, they own it, they should know that the sales guy’s pulling down 350 and maybe worth every penny. I’m not saying they’re not.

Loren Feldman

Go ahead, Jeff.

Jeff Taylor 

This is a good topic, though, in the sense that I would not draw a direct correlation with ESOPs being open-book management. Remember the way I looked at it. It’s like a public company, right? So yeah, maybe in some large public companies, they do publish what the highest earners, the CEOs earn, and stuff like that. But in general, you run it like you’re a public company. Everything we’re talking about is up for debate on how you want to set it up in your company.

Jay Goltz 

I think that’s a surprise to a lot of people, because in my mind, I hear employee stock owned company, I assume they have access to the full books. And now you’re saying, not necessarily. That’s eye opening.

Jim Kalb  

Maybe that’s just because we want to do it. But we were doing this before we were an ESOP. Because we believe that that helps the productivity. It’s the Jack Stack approach to this whole thing—with or without the ESOP.

Loren Feldman  

We don’t have a lot of time left. There are a bunch of questions that we got. Some of them are in chat, in the QA, and I got some questions in advance. I’d like to try to run through a couple really quick, rapid fire. Number one, how about firing an employee who’s a part of the ESOP. Any issue with that? Is that any more difficult because it’s an ESOP?

Jim Kalb 

No different.

Loren Feldman 

How about starting a business as an ESOP? Does anybody do that? Can you do it as a startup?

Jim Kalb 

I wouldn’t think so. Because it doesn’t have any profitability to pay. How would you pay off the notes or anything?

Jeff Taylor  

I’m not sure.

Jim Kalb 

Who would be the ownership? They’re just, they’re starting a business. They’re capitalizing the business with, let’s just say, $100,000 or whatever it happens to be. Then immediately they get their capital back. It doesn’t make sense.

Loren Feldman  

Okay. How about this? Is there a concern once the employees reach a certain level of ownership that they could actually sell to a private equity firm or something like that?

Jeff Taylor

Impossible.

Jim Kalb 

Not impossible. So the trustee has to do what’s right for the business. So if all of a sudden the valuation team is doing an annual evaluation, and say you’re 5x or 6x, and somebody comes along and says, Look, we’re willing to pay 20x for your company, the trustee has to look at that and say, I have a fiduciary responsibility to the shareholders, who happen to be the employees, to sell the company for that type of multiple. So if someone were to come in and offer a significant number for all those employee shares, and turn those guys into what used to be, they had a million dollars, and now they have $3 million worth of stuff. That’s something you have to look at.

Jay Goltz  

How much does the trustee make?

Jim Kalb

About 10k a year? Oh, by the way, we didn’t talk about the cost of setting this up. But I’m on the trustees, because I haven’t sold any shares yet. So until the point where I’m actually selling my own shares, I can be the trustee for the first five years or something like that. It cost me, by the way, it cost me about $40,000 to set it up.

Jay Goltz  

And where does the trustee come from?

Jeff Taylor

A lot of banks have services that they do this for.

Jay Goltz

That’s really reassuring for me, because I’ve had nothing but positive experiences with the employees that work at banks. So that’s exciting for me to think about—that my entire life I’ve called my own shots and now I get the assistant vice president of the bank involved with my business,

Jim Kalb 

The board hires the trustee, and there are independent trustees all over the place—just like there are third-party administrators and just like there’s valuation companies. 

Loren Feldman

And what if you end up with a bad one? What happens?

Jim Kalb  

The board dismisses the trustee.

Jay Goltz  

I have to tell both of you. You’ve done a really good job of—I learned a lot about this whole thing. I’m not dismissing it at all. It is interesting. And I’m just surprised with all the years I’ve been going to seminars and reading articles that there’s just not a whole lot about this out there. And, and I didn’t—just yesterday, Loren says, “Well, you know, you don’t pay tax.” “Loren, that’s not possible. You must pay tax.” And I am flabbergasted. I would have bet him $1,000 that was wrong.

Loren Feldman

Now you tell me.

Jeff Taylor 

Wait a minute. The taxes are paid sooner or later. Okay, right? Go to cash out …

Loren Feldman 

When the employees cash out. Also, you’re not paying tax, but you’re setting money aside for when people pull their money out. So there is a trade off there as well.

Jim Kalb

Now, the owner doesn’t pay tax, potentially, if you set it up right, if you do all the right things. So the owner sells the company for $20 million. They can actually work it in so it goes into their estate and their estate could be part of a trust. And the trust can be perpetual. And there’s all kinds of other estate planning that can be done. So there’s maybe never any taxes ever paid on that 20 million that the owner cashes out.

Loren Feldman 

I’d like to ask another quick question of both of you. What was it like rolling this out? Did you tell your employees right away? Or did you tell them after it was a fait accompli? Was there instant acceptance? Did they have to be convinced that this was a good thing? Jeff, you’re smiling. You go first.

Jeff Taylor  

Okay, out of all the things we’ve talked about, this is one of the stranger things. In my mind’s eye, it’s like, one day you show up to the employees and you say, Guess what, you bought a company. You don’t need their permission, per se. Obviously the logic prevails that if everybody didn’t want to, they’re all gonna quit if you make them buy your company. Of course, it just doesn’t work like that. It’s more like you spring it on them in a sense. Don’t take me literally on that, but it’s kind of like that.

Jim Kalb  

But part of that is the education. We believe really strongly in education. So I had to create a 20-slide deck to go through and talk about what it is, and what did they actually buy, and how does it really work. And they really thought as an employee-owned company, they were going to be able to elect the president to run once I left. It doesn’t happen that way. And I needed to be really clear about that—that there’s a board that actually runs the company and that it’s a retirement benefit for them. And the longer that they’re here, the more that they help to create profits in the company, the more they will walk away with when they retire.

Jay Goltz  

Very interesting.

Loren Feldman

I got one last question for each of you, Jeff, starting with you. Have there been any moments when you thought, Oh, man, this was a mistake. I’m really sorry I did this?

Jay Goltz  

He had nothing to lose, though.

Jeff Taylor

I’m from the buy side, you might say, right? So you’re right in that I already understood the ESOP. Basically, there was no risk. I was all upside for me.

Loren Feldman  

But you could theoretically have been running the company and said, you know what, this is more difficult than it would be if I were running the business and it wasn’t an ESOP. That could theoretically have happened.

Jeff Taylor 

Yeah, I’m running the business with a bunch of co-presidents, you know, co owners, shareholders. So you can feel like that sometimes, but then you settle into it.

Loren Feldman 

I think you just put the last stake in the heart of Jay’s dream.

Jay Goltz 

I don’t even understand. It’s like he went to Chinese.

Loren Feldman 

All Jay heard was co-president.

Jeff Taylor 

Yeah, because that’s the elephant in the room. You think you lose control.

Jay Goltz 

I just want to be clear about something. I can’t think of one time in 43 years with my key people that we ever had a disagreement, and I go, Well, it’s my company, and here’s what we’re gonna do. We always come to an agreement. I run a collaborative company, and that’s why I’m not saying I would never do this.

Jeff Taylor  

Yeah, we should all be co presidents so to speak, you know? So I think that’s the right way to do it anyway.

Loren Feldman

Jim, how about you? Has there been a moment when you thought this was a mistake?

Jim Kalb  

No, because it’s actually been everything I could possibly want.

Loren Feldman 

All right, last question, Jay. You’re clearly not leaping at this. Is there something that could get you to do it?

Jay Goltz  

This is very eye opening. I didn’t understand the basics of how the whole thing works, and it’s very interesting. What I’d like to do is, I’d like to talk to the people that did this that rue the day they made that decision. We’ve got two happy people here, which is great. I’d like to hear from two that did this that woke up and said, Oh my god, what did I get myself into?

Jeff Taylor  

That’s uncommon.

Jay Goltz

Is it?

Jeff Taylor

Yeah, the Department of Labor actually, the biggest, typical reason that somebody gets in trouble with a bad ESOP is because they overvalued it in the sale. So it’s interesting. The people who you find who rue the day is some owner might overvalue it and sell it to their employees overvalued. And you can’t even sustain it.

Jay Goltz 

No, this has been very eye-opening. And I can’t tell you there’s one particular reason that there’s no way I would ever do this. I would not say that at this point. I’m going to put this into my maybe pile.

Loren Feldman 

Thank you all: Jim Cobb, Jeff Taylor, and Jay Goltz. Thank you for taking the time. I really enjoyed the conversation.

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