Breaking Down the Barriers to ESOP Communications: A Personal Story
June 1998Recently I finished my zillionth series of of communication meetings with a group of new employee owners at an ESOP company. The employees were skeptical and seemed less than interested in learning about this new benefit. They complained about the lack of information and the delays in providing any information relating to the ESOP. After all, in their minds they owned the place now and, as owners, felt they deserved more than they had received. My job was not easy. I had to find a way to communicate with them. I had to explain why those with 20 years of employment with the company would have to work another 5 years to receive anything from the ESOP. Why distributions might be delayed, and all that fun stuff.
The ESOP transaction was rather large. Acting on behalf of the employees, an independent trustee negotiated with the selling shareholders to purchase 75% of the company. Where did the money come from to buy the stock? Why would anyone lend money to an ESOP? Why would the trustee agree to pay x dollars for the stock when he knew it would be worth one half of x the next day? These were all questions that were submitted in advance of the meetings. There were many more. At least I knew ahead of time that this group was not shy.
Not knowing where to start or where I would go from there, I decided to explain why an ESOP was used to purchase the majority of the company from its original owners. I would describe how the tax benefits, the ability to gradually step away, the ability to protect jobs, and all of the other wonderful benefits worked.
Explaining how the ESOP would repay the loan and how the shares would be allocated was easy. Explaining the post-transaction drop in the value of the company stock, however, proved to be a different story.
I began as I usually do when discussing the post-transaction value, talking about the impact of the debt, only to see faces almost immediately wrinkle and began to frown. I knew already that I was no longer communicating. I knew I had to use a different approach with this group or I would leave as unwelcome as I was when I first appeared before it.
So I stopped dead in my tracks and decided to role play. I would be a first-time home buyer and they would all be bankers. I explained to them that I had found my dream home and wanted very desperately to buy it. I was tired of renting, tired of taking care of someone else's home. The only problem was that I did not have any money. I had a good job and had borrowed money in the past and always repaid it on time. I explained to them that I had calculated what my mortgage payment would be and determined I could pay this loan back if they were willing to trust me. I shared my cash flow projections with them. I explained how much my salary was and what my other expenses were. Then I asked them the big question: "In your roles as bankers, would you loan me the money?" I also shared with them the fact that I did not have money for a down payment but felt the value of the house was more than what I had to pay for it. The house was listed for $50,000, and I felt it was worth at least $55,000. There response was as I had hoped. They asked me if I had the home appraised. This was perfect; they were playing right into my hands.
I explained that I had the house appraised and that the appraised value was $52,000. Because I did not have the money for a down payment, I had to convince them that I would take good care of the home; I thus shared with them my ideas for improving it. "After all," I explained, "when you own something you can take pride in, it is much easier to take care of and certainly worth improving." The wrinkles started to fade, and the frowns were almost gone. Heads were actually starting to move up and down as if they understood. I asked those who would be willing to lend me the money to stay and said the rest were free to leave. Fortunately, no one left. "Time for lesson number two," I thought.
Because the analogy seemed to still make sense, I decided to immediately deal with the post-transaction valuation issue—the issue that had prompted my impromptu role-playing when the employees asked why the stock value dropped after the ESOP transaction. I reminded everyone what the house was worth and what I was willing to pay for it. I reminded them that as bankers, they agreed with my assessment of the home's value. I also reminded them that they had loaned me $50,000 to buy the home. Then I asked them what my financial statement would say if the home were my only asset and my only liability. Seeing the looks on their faces, I realized I had used some words they were not comfortable with. I rephrased the question and asked them what value I would end up with if I sold the house today for $53,000. Heads began to nod again and people began whispering to each other, quickly realizing that I would end up with only $3,000 because I was in debt for $50,000.
I was beginning to feel much more at ease. They really were beginning to understand. We talked about how my value would increase as I repaid the loan. We talked about my desire to take care of and improve the home and the effect these actions would have on value.
At this point I felt it necessary to speak directly of the analogy I was using between the home and their leveraged ESOP. First, however, I asked the group whether my messages and approach were helpful. Their response was unanimous: yes, and they wanted to learn more.
I then spoke briefly about the risk associated with the purchase of a home. I spoke from both the buyer's perspective and the lender's perspective. In both instances, there is an assumption that owners care and will do whatever they can to protect their investment. The concept of employee ownership and the fact that banks are willing to lend money to an ESOP is based on the same principle. In addition, I told them that as bankers, just as they scrutinized my ability to repay my home loan, they would study the company to judge whether the company had the ability to generate the profits that would be necessary to repay an ESOP loan. I then shared with the employees the responsibilities associated with owning my home—my responsibilities to myself, to the bank, and to my family. I explained that I was willing to take the risk, but that I also had to accept the responsibility of ownership. If I could do this, I was convinced I would be rewarded. I asked the group if they still understood. Their response was unbelievable. They agreed that they had been given the opportunity to accept the responsibility of ownership, understood what it took to reap the rewards of ownership, yet did not have to incur the risk associated with it. They began to see the ESOP as a benefit.
I now felt the need to discuss ownership in more detail from their perspective—what ownership really means and does not mean. I began by explaining the concept and role of the board of directors. Using a "forest and trees" metaphor, I said the board is the group that determines what forest we should be in. I went on to explain that the board appoints a president to carry out the board's directives and that the president appoints other corporate officers to assist him or her in that role. This is the group that determines what trees to cut in the forest that has been chosen for them. The corporate officers then appoint managers who determine the most efficient way of cutting the trees they have been told to cut. The employees actually cut the trees and hopefully offer suggestions of their own for improving efficiency, reducing costs, and so on. I explained that if everyone had the ability to choose the forest or pick the trees, decisions could never be made. I think they began to understand this as well. Finally, I reminded them of their role as bankers and asked if they had concerns with respect to who was on the board of directors. Again, the movement of their heads led me to believe they understood my point.
Thus far, I had avoided the issue of vesting. Actually, I hoped they had forgotten it. However, when I asked for questions, this was the first one that was asked.
"How do I explain this?" I thought to myself. "What can I possibly say to justify it?" I did not have an answer, so I decided to approach the issue from a different perspective. I began by asking the employees who had been with the company for several years what their expectations were with respect to their continued employment with the company. Each of these seasoned veterans indicated that they hoped to finish their careers there. That is exactly what I wanted to hear. I then explained the concept of forfeitures and how they are allocated to those who stay. I went on to remind them that the ESOP was intended to benefit the long-term employees and that is exactly what the vesting schedule was all about. Finally, I told them that those employees who had many years of prior service would likely have many years of additional service as well and that the vesting schedule would serve as a mechanism to increase their ultimate benefit. Believe it or not, I had actually turned this issue into a positive one from their point of view.
The final issue I had to deal with was the distribution issue and explaining why distributions were delayed until the ESOP loan was repaid. Reverting back to the role playing I had done earlier, I explained why the bank would want to get paid before I started remodeling my house, at least to the point that their collateral was sufficient in the event I failed to make the required payments. After this discussion, they understood the bank's position and the reason for the delay. However, I did explain to them that this policy did not apply to anyone who retired on or after attaining the ESOP's retirement age, and that the vesting schedule did not apply to these individuals. My statements put them at ease.
To wrap it up, I spoke about the opportunity that they were being given and said that the ultimate benefit they would receive was up to them. The meeting ended on a positive note, with several employees coming up to me asking if I would be back to continue the education and communication process. Again, I went out on a limb and told them I would.
The lessons I learned from this experience are enormous. I would be willing to bet that this group of employee owners would say the same. A difficult situation that ended with great success.
About the Author
Peter Prodoehl is a senior consultant in the Retirement and Investor Services division of Principal Financial Group. He is a frequent speaker on employee benefit and ESOP-related topics. In addition to speaking at employee ownership conferences and seminars on a national level, he also provides custom employee communication programs for clients. He has authored and co-authored many published articles. Peter is active in the NCEO and also is a member of the ESOP Association's Administrative Advisory Committee.
Other columns in this series