Beyond Rainbows and Unicorns: The Case for Talking About ESOP Companies as Businesses
As an ESOP CEO, Daniel Goldstein has a wealth of expertise on the joys and challenges of leading an employee-owned company. In this article, Daniel outlines the lessons he learned in how to communicate about business cyclicality, with all of its ups and downs, and what other ESOP leaders can learn for their own companies.
When I first came to the ESOP community, I was initially disturbed by how almost every presentation I saw seemed to be about endless double-digit year-over-year (YOY) growth without difficulties or downturns, although I know the NCEO has covered these issues before in publications and conferences. Where were the stories about cyclicality, or worse, about steep downturns and recoveries? I took over as CEO of an ESOP company in financial distress. During my first two years as CEO, we had precipitous declines in share price. I did not know how to address this because I had never heard another ESOP company CEO talk publicly about going through a substantial share value drop, how they addressed their employee-owners, what steps they took, and how they turned the situation around. I sought out private conversations and mostly had to make it up as I went along.
Spoiler alert: we did turn it around, but not overnight.
Along the road to turning it around, I also ran into other business issues that I had not heard spoken of very openly in the ESOP community. We had to do layoffs to correct imbalances between overstaffing and drops in demand in some of our businesses, and we had to close divisions that were not profitable. A few years ago, I suggested doing a webinar about ESOP company layoffs. Matt Hancock from Praxis Consulting Group was the only person to take me up on the offer. Afterward, Matt and I received private messages from other ESOP company CEOs thanking us for the webinar because they were facing potential layoffs and now had some ideas on how to do them in ways consistent with their employee ownership cultures.
In the past few years, I have also been addressing another issue that has not been talked about much publicly in the ESOP community: safety. Often what you hear is impressive records of long stretches of no lost time incidents or no recordable events (which is itself problematic, but that will be for another article). What you don’t hear much about is incidents, near misses, the consequences of employees who work long careers with repetitive motion causing injuries that ruin their bodies, and fatalities in the workplace. In closed-door roundtables, I have found that employee-owners are eager to finally have a safe place where they can talk about these safety issues, new approaches to safety that build capacity, and how to change old paradigms that are just not working. Recent research shows that employee-owned companies are safer, but we can and must do better.
Of course, ESOP companies do tend to do better in terms of performance and culture and, I suspect, safety. And it is a lot more fun to talk about successes than challenges. But employee ownership by itself does not make our ESOPs immune to the cyclicality of the economy, variability of our specific sectors, shifts in our geography or demographics, ups and downs in demand, health and safety issues at work, or other factors that affect all businesses. It is warm and wonderful to attend meetings of ESOP companies because employee-owners tend to be collaborative and generous in sharing. The energy they bring to events is authentic, and there is a strong sense of belonging. Sharing what works is great for giving ideas to those who are new or in need of new energy. Sharing what was difficult, and how we navigated through it, would make us all stronger to face the normal and expected volatility of business.
Our Buildup and Decline
Folience’s roots start in the early 1880s with the publishing of the first issue of the Cedar Rapids Gazette newspaper. By the time the partial ESOP was started one hundred years later in 1986, the company included print and broadcast media. The company continued to be successful. During the first 20 years of the ESOP, share value only went down twice and never by more than 4% in any one year. The smoothed compound annual growth rate (CAGR) over the first twenty years was about +8.5% per year. While this is not quite the double-digit YOY growth mentioned above, it was a stable, long-term, and reliable growth rate. In retrospect, that may have led to assumptions used to make some poor business decisions.
Looking back, there were two forces at play that I have seen or heard of from speaking to those who were there at the time. The first was that there was a sense of “what could possibly go wrong?” After celebrating its first centennial, the family owners put in place a partial ESOP and saw a continued stable climb with CAGR of 8.5%. What could possibly go wrong? During that time, the majority family leadership in control of the company made a very large investment to build what they hoped would become a regional print center. The costly investment included a 210,000-square-foot building and an enormous printing press, neither of which would ever be used to capacity.
The second relevant force was a massive and unforeseen technological disruption: the internet. While we all try to imagine the forces that could disrupt our businesses, some are just not on our radar. I don’t know anyone who had a plan in place before 2020 for how our businesses and lives would be disrupted by a sudden and widespread global health pandemic. The total disintermediation by the internet of how information is collected, transmitted, and consumed was not something that was foreseen, certainly not to the extent that it changed the world of print and broadcast media.
The combination of these two forces were further aggressively impacted by the global financial crisis of 2008. After a 20-year run of stable growth, the ESOP share price saw five out of six years of declines ranging from 6% to 46% per year. It was at the end of that period that the company bought back the remainder of the family’s shares, fully financed by subordinated seller debt, thereby making the ESOP the 100% owner of the company.
Over the next few years, following the second stage transaction to become 100% employee-owned, the ESOP share price again went up YOY, arriving to be at about 54% of its previous high from 10 years before. The share price increases have been described to me as mostly a function of paying down debt and retiring shares.
In 2015, the CEO negotiated a deal to sell the company’s television station for a 100% premium to its ESOP valuation. The station, started 62 years before, was a standalone television station competing against national networks that had better economies of scale on buying power and audience reach. With a hotly contested presidential campaign shaping up for 2016, a national network offered the substantial premium because they saw they could get more value from the Iowa feed to their network. The employee-owners were cashed out at a high premium, kept their jobs with their new employer, and the station went on to thrive as part of the national network. Meanwhile, the ESOP paid down all its third-party senior debt but not the subordinated seller notes and greatly strengthened its balance sheet. The problem was that they killed their cash flow. The share price increased by 84% immediately following the transaction because of the high premium paid.
I was hired in April 2016 to become president and CEO within a year from hire. Within my first month in my role, I joined the then CEO to announce our share price increase of 84%, knowing full well it was going to come down, and fast. I was new to the company and new to the ESOP world. I was personally terrified that the message we gave was, in my opinion, misleading because we were well assured there would be an impending decline.
Think of our financials as an hourglass with sand in it. The sand at the top of the hourglass is the company’s assets. The flow rate of sand falling to the bottom was the rate at which the company was losing assets. Selling the television station at a premium had added a substantial amount of sand to the upper chamber of the hourglass. However, selling the revenue of the television station meant the company had negative EBITDA (earnings before interest, taxes, depreciation, and amortization) with a high cash burn, so the flow rate of the sand from top to bottom was rapid. Running out of sand meant going out of business. It was easy to see how quickly the sand would finish to flow out of the top chamber.
I had been hired with the charge of setting up a holding company to invest the remaining proceeds from the sale of the television station to acquire new revenue sources. The concept sounded reasonable in a very academic sense, but there were two problems. The first was that the company had to be entirely reconfigured to create the proper holding structure. The second problem was that there were no proven internal skills or competencies to look for acquisition prospects, negotiate deal terms, integrate acquisitions, or operate the acquired companies.
To take care of the first problem, we set out to reconfigure and restructure. There were legal implications when setting up a holding company with separate corporations and LLCs, but there were far greater practical implications and actions needed. The prior company had not been structured for selling components of its total business. The sale of the television station was done in a very tightly compressed time frame. Considerable effort and cost to disentangle what was sold from what was kept continued after the close of the transaction. Servers had to be separated and duplicated. Teams that had worked collaboratively were now working competitively to sell advertising. Physical spaces and other assets had to be divided with new agreements for cost sharing and use. The year following the sale of the television station saw enormous costs to reconfigure and restructure, with little to no improvement in revenue.
A little less than one year into my transition, I was named president and CEO. Shortly after, I had to do the next annual share reveal. The ongoing cash burn meant that one year after a meteoric 84% share price rise was announced, I had to announce a subsequent 21% decline. But the decline did not stop there.
In my second year, Folience made our first large acquisition, Life Line Emergency Vehicles, a custom manufacturer of ambulances, located in Sumner, Iowa. While that was, and is, a successful deployment of capital to acquire profitable revenue and diversify our portfolio, it was not enough to stop the cash burn. The flow of sand in the hourglass slowed but was still falling from the top chamber. With some failed investments being written off, the next year saw another decline, this time 37% in one year. In total, the share price dropped 50% from where it was following the sale of the television station.
By then, I had attended many ESOP conferences and events. I never once heard a presentation on how to address a 50% drop in share price. So, I crafted my strategy and message.
I knew Folience was in trouble, but I also believed we could turn things around. The elements I find most essential in addressing share price declines are:
- Don’t BS!
- Give a clear path forward.
- Stop focusing on share price, focus on building ownership.
- It’s all about employee ownership.
Don’t BS!
Employee-owners deserve to know what is going on, and anyway, they see a lot more than you think they do. It does not matter if your ESOP is producing and selling widgets or delivering services. Your employee-owners are close to the work and see how much is going through production or how much is being delivered in services. Be honest with them. We did not use completely transparent open-book management, and I would happily debate whether doing so gives employee-owners greater insight into how to improve the business or reasons to panic and flee when the financials are at their absolute worst. Even if you are not using full open-book management, be honest. Be sure to communicate indicators of financial health, whether it be topline numbers, percentages, YOY changes, something to let employee-owners know what is happening. As the adage goes, in a vacuum, most will connect the wrong dots or simply imagine a story that is possibly worse than reality.
Give a Clear Path Forward
Businesses and economies do have cyclicality, so while it is expected that your ESOP company will also have ups and downs, it is necessary to show a clear path forward. Paths usually take time and sometimes meander or have setbacks. Lay out the path, with some timing and milestones. Help employee-owners know where they are on the path and what they can do to work together to move in the same and right direction. Keep track of progress along the path and communicate it to employee-owners. The message needs to be in terms that people will understand.
When I gave the first share price decline, I used the analogy of building a coffee shop. Spending money to reconfigure and restructure what was left following the sale of the television station was analogous to spending the money to build the coffee shop, purchase the necessary equipment, and furnish it. That first year we spent time and money to build the coffee shop, but it was not yet opened for business, so it was not yet producing revenue. The success of the coffee shop was not yet known. Money spent, no new revenue, no indication yet of future success = share price decline. But the path forward was to open the coffee shop and start earning revenue.
We had a tough second year, and when I gave the second share price decline, the message was about timing of the opening of the “coffee shop,” or in our case the timing of the acquisition of Life Line Emergency Vehicles. The acquisition process was both long and costly, and we acquired the company late into that second year which meant there were a lot of costs and little addition to revenue and EBITDA in that year. That was a tough message, which tested some people’s trust in the path I had outlined the year before. Fortunately, by the time we were ready to share the prior year’s share price, we were several months into the following year. I could share where we already were in that year’s operations, and we were moving down the path that had been laid out, in the right direction. The following year’s share value stemmed the hemorrhaging and saw a very modest 3% increase.
Lay out a clear path, make it understandable, track progress against it, and keep focused on where you are headed. Of course, it helps greatly when you carry through!
Stop Focusing on Share Price!
Share prices can go up and down. ESOP companies are businesses, they are not rainbows and unicorns. It was at about this time that I shifted my message from share price to building up ownership. When your share price drops 50% in two years, guess what consumes everyone’s thoughts? Employee-owners don’t think about adding new units of ownership with each year’s allocation. Or that when share price declines, keeping the allocation percentage constant, they actually add a greater number of units at the lower share price (which can then become worth considerably more with a return to prosperity and an increase in share value).
If your ESOP share price is $10 and it remains $10 every year for 10 years, you will still add units of shares to your ownership every year over the 10 years. If you then leave at the end of 10 years, you leave with the value of your accumulated units of shares times $10. Had you worked for those 10 years at a non-ESOP company, you would leave with nothing. There is value to building ownership regardless of share value appreciation. Make sure employee-owners understand this. ESOPs are not get-rich-quick plans. It takes time to earn a meaningful number of shares. It takes time to 100% vest. Focus on the long-term accumulation of units and vesting, and then focus on how to drive up share value. The more an employee-owner accumulates in units, the more they will focus on driving up share value. Switch the focus!
It's All About Employee Ownership
I once heard the CEO of a successful ESOP company say that they offer a shared financial benefit for employee-owners to complement their strong employee-owner culture. When the financial benefit is the lead story, particularly when the share value is emphasized, then culture comes second, undermining a key strength of employee-owned businesses. I have often said that I doubt any long-tenured employee-owner opens their ESOP account in the morning, looks at their balance, and then gets motivated for their day. When we lead with culture, we develop safe, participative workplaces where employees get engaged, find fulfilment, and produce the competitive advantages which ESOPs enjoy. And the kicker is that they share in the financial value.
Building back from a decline in share value requires greater engagement and participation from all the employee-owners.
Layoffs and Closures
As we continued down our path to building out the holding company portfolio, we had only one more down year, caused primarily by a drop in interest rates. The decline in interest rates caused a swap we held to go further underwater, and the method of valuing ESOPs which assumes extinguishing debt at fiscal year-end (even though we never would have paid down the swap early, taking the penalty) created a decline in share value. The difficulty we faced was not just about declines in share value.
We had some more painful decisions and actions to make during those years. The outsized investment in the over-capacity for the never-realized regional print center was finally addressed by reducing the workforce in that division to match the drop in business. Our full-service advertising agency, born out of a prior failed attempt to capture digital media revenue, was rationalized to almost breakeven and won numerous awards. However, it would never be a driver for profitability, so it was unwound. The print business continued to decline, notwithstanding the reduction in workforce, and it was finally deemed unsustainable to continue. Its remaining employee-owners were let go, the business shuttered, the assets sold, and for the first time in 138 years, we outsourced the printing of our newspaper.
In 2018 we had acquired Cimarron Trailers, a high-end horse and livestock trailer manufacturer located in Chickasha, Oklahoma. The acquisition was successful, 2019 was a banner year, and the business was ready for expansion. When COVID-19 hit, their business immediately evaporated overnight. To protect their core business, a 25% reduction in workforce was quickly done, with almost all the rest of the production staff being furloughed for three weeks. More on their evolution in a moment.
Every effort was made, during these difficult decisions to follow the same strategy as outlined above: don’t BS, give a clear path forward for the business that continues, focus on long-term ownership, and make it all about buy-in from engaged employee-owners. While layoffs, downsizing, and closing divisions may be business realities faced by your ESOP company, what is most important is how you adhere to your culture and values. In our case, outplacement packages and services were arranged to help those leaving so they could move on to find new employment with dignity and assistance.
Return to Prosperity
COVID-19, as a silver lining, provided us with unique opportunities. In the first year, we did an early redemption at a very steep discount of the remainder of the 2012 second-stage ESOP transaction subordinated seller notes. That year we saw a 115% increase in share value to a new historic high for the then 34-year-old ESOP. Cimarron Trailers went from protecting its core, to building back, to rapid growth and expansion. In the three years following their March 2020 layoffs, they grew from a low of 90 employees in their one location to over 200 employees in two locations, having established a second manufacturing facility in another state. They went from being the smallest company in the Folience portfolio to the largest. The other businesses have done well, the ESOP has done well, and a recent sustainability study forecasts continued profitability and growth. We are back to YOY share value increases since hitting that new historic high in our 34th year as an ESOP company.
The strategy and messaging remained the same even while continuing with prosperity: don’t BS, give a clear path forward, focus on building ownership (and then the share price), because it is all about employee ownership culture.
The Case for Talking About ESOP Companies as Businesses
ESOP companies are businesses. Downturns happen to businesses. Businesses are sometimes faced with the need to reduce workforce to balance capacity and demand. And, in some cases, divisions must be closed if they are no longer profitable. As a community, we need to talk more, and more openly, about how ESOP companies can survive the volatility of business cycles and how to call on strengths and resources specific to employee ownership for navigating the difficult times and to return to prosperous times.
I could have used that discussion and sharing several years ago, and I am betting that some others out there could use that now.