Kevin Mauger is president of NCC Automated Systems in Souderton, PA, a company that designs and installs conveyor systems for optical labs and converted to an Employee Stock Ownership Plan in 2016.
Q: What were your reasons for turning your company into an ESOP (Employee Stock Ownership Plan)?
A: The primary reason had to do with shared ownership. What a fantastic, cultural concept that can benefit and create opportunity for those who work really hard and how it can provide for long-term sustainability of the company.
There are soft reasons, and there are hard reasons. Soft reasons are hard to quantify. They’re decisions made from the heart, based on core values and character and what you want to achieve in your lifetime, be known for and how you want to feel.
Then there are business reasons. Employee-owned companies perform better. Employee-owned companies retain key employees better. Employee-owned companies have better cultures. When everybody’s in it together with a long-term, vested interest, it’s a good situation for an employee.
In addition to that, for personal reasons, it allows me to liquidate a portion of my largest personal asset as opposed to waiting to sell it at the end of my career, whenever that might be. I get to have some benefit from that from a lifestyle and security perspective.
There is some discount for selling to an ESOP at a fair market value versus selling to a strategic acquisition partner. That could be a significant difference.
Q: It’s a win-win where you’re cashing out now while the employees become owners incentivized to make the business successful. Do you retain ownership?
A: Yes. I did a partial ESOP to start. My goal is to make it completely employee-owned at some point. I still own a little bit more than half the company. It’s a 58/42 split.
Q: What other incentives were there for becoming an ESOP?
A: There are a lot of different ways of establishing the value of a company, but essentially earnings times the multiple is what the company is worth. Generally, you’re in the five to six times range with an ESOP, while in a strategic sell, you could easily be in double digits.
You can say that you’re selling for less than half the value, but that’s where the benefits of the ESOP come into play. There would be no strategic partner that would want to buy 42%. They’d want 51% to 100%. In that scenario, we would be owned by somebody else, which would not be a bad strategy to exit in a short-term fashion. Frankly, that’s what most people do to maximize return, but if you plan on staying you then work for somebody who may not have the same vision, ideals, relationships, goals, everything.
For a lot of small business owners, that would not be a good thing. It would not be the best thing for me at this point in my life because I want to maintain the overall control of the company to make sure it’s going in the direction that I know makes sense for us and our employees. That’s part of the deal.
I’m cashing out to a certain degree, getting paid for the 42% now. But I’m paying for it. The company is paying for it with future profits.
Q: What is the process for turning a company into an ESOP?
A: The process I followed was to engage with a consultant who specializes in ESOPs. An ESOP is a trust with a set of rules about how to form that trust and what it can and can’t do. It is governed by ERISA, which is the same part of the government that monitors 401ks and pensions and any type of retirement plan because that is literally what an ESOP is, a retirement plan. There are very specific rules, so you need a lawyer who specializes in ESOPs and a consultant who has the financial acumen to understand all the intricacies.
The consultant I hired did a feasibility analysis, helped me do a preliminary evaluation of the company, told me what it’s worth, what this means to me now, what this means to me in the future, what this could mean for employees based on various scenarios.
At that point, we said, “All right, this makes sense,” so we started the process. The first thing is to establish a legal document, the trust. The trust is a legal entity. A trust has a trustee. We chose to hire a trustee, as opposed to trying to do that internally because it’s just the right way of doing it. The trustee has fiduciary responsibility, which means he needs to protect the members of the trust and the trust itself.
Then you have to figure out how to fund it. There are two different ways you can fund it. You can fund it yourself over time, or you can find somebody to fund it for you now and pay them back over time.
We chose to find a bank to fund it, which meant we needed to show them what it was worth. The trustee negotiated the purchase of the company with us, who were selling the company. Then we found a bank to fund it based on the negotiated amount.
At that point, you’re selling a company, so you go through the same things you would when selling a company with strategic partners. There’s a discovery process. There’s a due diligence process. You have to tell them what the company is, and then they have to establish a value for it. Then you negotiate and go through the process of getting it funded.
Q: How long did the whole process take?
A: I made the decision to engage in the feasibility analysis in October of 2016. I got a report back in two months, asked a lot of questions, went back and forth, and made the decision in the third month. We officially formed the trust in December of 2016. The employees still didn’t know. Then we started the process of the actual transaction, which took four months.
Q: That’s not as long as I thought. You kept it a secret to surprise the employees, but some must have been aware.
A: Only four employees knew, the executive management team.
Q: Can you describe how things changed once you converted the company to an ESOP?
A: I didn’t expect I’d find myself being harder on employees than I had been previously. I have more expectations of them if they’re now a partner. I didn’t see that coming.
From an employee perspective, it’s super simple. It doesn’t cost them anything. It doesn’t require anything. Basically, they keep working. Of course, the harder they work, the more their company’s worth. They have a potential golden ticket, if the company’s really successful. There are stories about grocery clerks who were with a company for 35 years, the company did incredible, and their return was $1 million.
I’m not suggesting that’s going to happen because it depends on the growth of the company. What I am suggesting is that if you’re an employee at a regular company, you can only have so much influence over the compensation you’re going to get. A company that’s ESOP-owned, particularly a smaller growing company, you can have a substantial impact on the value of your company, the growth of your company, and your long-term retirement benefits.
Q: Have you seen employees change in the way they perform?
A: Absolutely 100%. I’ve seen people who were mostly concerned about their area of business step into other areas voluntarily, just to help. I’ve seen a lot of good ideas from people who wouldn’t necessarily normally say something, whether it’s another employee’s performance or a policy that doesn’t make sense, or we’re wasting money. People are showing that when things get tough they are the ones who are going to step up and create change and drive the company forward.
People are literally saying, “This is a company that I’m now part owner in. I want to make sure it’s successful, and if this team member is or is not pulling their share, then I’m going to either help them or make sure it’s addressed.”
Q: Have you seen any financial benefits yet?
A: It’s way too early. The transaction was formalized in May of 2017. There are obvious tax breaks. Profits allocated to the ESOP come off income. They reduce your taxable earnings.
What happens is when an employee leaves the company, they have x amount of shares, and the share value at that time is whatever it is. They don’t get that money all at once; they get it over a period of a few years. The company has to fund that year to year over a period of time. But you don’t have to keep the cash in the ESOP account. It stays in the company, and they let you expense it in that year. Whatever I contribute in that year reduces our taxes for that year. So, not only do I have cash, I have reduced income tax, which allows me to invest further in the company to hopefully provide a better return.
It’s fantastic. The reason the government does that is they want to encourage ESOPs and growth, and when employees cash out, that’s income at their retirement age, so they’re going to pay the taxes then.
Q: Do you have any idea if the new tax plan impacts ESOPs?
A: In general, every party and area of the government is in favor of ESOPs because they’re undeniably good for our country. There’s been nothing that’s been said or discussed about eliminating the concept. If corporate taxes go down significantly, then the benefits of having an ESOP will be reduced because one of them is the tax deferral feature.
Q: What is your customer base?
A: We have two main industries: food and optical. In the ophthalmic world, we are partnered with Satisloh. We are kind of mutually exclusive with each other. We only go to market through them. We are their partner in integration, exclusive partner in North America, and we do quite a bit overseas as well, which is a growing aspect and initiative for us together to bring to the table. That being said, we work both through them and directly with their customers as well, which have become our customers over time. We’ve done hundreds and hundreds of projects, last count was over $30 million. It’s 90% North America at this point, anything from really small labs to the biggest most technologically advanced labs in the world.