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Pride of Ownership: ESOPs in electrical distribution

Oct. 7, 2016
The employee-owned electrical distributors that thrive and grow very likely would thrive and grow under a different form of ownership, if they had the same executive team leading them.

Given the prevalence of desire to be “an entrepreneur” and run their own businesses among young people in school and entering the workforce today, it would seem there’s a widespread demand for careers where rising talent can earn a stake in the action. How many of them dream of owning an electrical distributor? Probably not many, sadly, but the widespread use of employee stock ownership plans (ESOPs) and other forms of employee ownership among thriving electrical distributors suggests they may want to give the industry a look.

Quite a few strong, successful electrical distributors are employee owned, either entirely or in part. Some of the most prominent employee-owned electrical distributors include Border States Electric, McNaughton-McKay, Van Meter, United Electric, Kriz-Davis, Dakota Supply Group and Omni Cable, and the list goes on. We wondered what the benefits are, and what it’s like to lead an employee-owned electrical distributorship in 2016, so we asked around.

Not that employee ownership is radically new in these parts. Graybar Electric, St. Louis, began its adventure in employee ownership in 1929, for example. Of course, even more of the industry’s biggest, strongest distributors thrive under more conventional forms of ownership by families, private partnerships or public stockholders, so it’s not that employee ownership in itself gives a company an unequivocal competitive advantage.

We talked with executives running some of the industry’s employee-owned distributors to get a sense of what’s different, if anything, about the way they work. And maybe some clues about why ESOPs seem to do well for distribution companies.

For business owners looking to transition out of the business, an ESOP may make sense but it’s unlikely to be the most lucrative option. There are tax and other financial advantages to ESOP ownership, but the valuations possible in a private sale are potentially greater. So, why do it?

Many executives running employee owned electrical distributors will tell you all the advantages they have gained because of having employees as owners, and those advantages are undeniably real, but in large part those advantages are not necessarily inherent in the ESOP itself. They come from the way the company is run.

The employee-owned electrical distributors that thrive and grow very likely would thrive and grow under a different form of ownership, if they had the same executive team leading them. At the same time, the executives leading employee-owned electrical distributors see profound advantages to including employees in their ownership structure.

“In all forms of employee ownership, the employees have a greater sense of purpose about what they do in their organization,” says Matt Geekie, Graybar senior vice president, secretary and general counsel. “Folks here come to work thinking, ‘What can I do today to make things better for my colleagues?’ It’s more than just owning stock, but owning the business together. It’s a long-term view, not just focused on quarterly analyst reports.”

Dakota Supply Group started down the path to an ESOP in 1995 (for the second time) and became 100% employee-owned around 2006. In 2014 the company was named the ESOP Company of the Year by the ESOP Association. Dakota CEO Todd Kumm says one reason many distributors embrace employee-ownership plans may be that the cash flow patterns of distribution fit well with the way employee owners are compensated.

“Especially in the distribution business, the way the cash flows in distribution works well for ESOPs,” Kumm says. “Manufacturing companies tend to be more capital intensive and cash flow is up and down a lot year to year, but that shouldn’t happen so much in a distribution business where there’s more rhythm to the cash flow. The company’s stock price stays steadier that way.”

If you’re an owner considering how to transition out of the business, it would make sense to look closely at the ESOP options, in far more detail than we have space to cover in a magazine article. But in general the financial advantages may not be enough on their own to tip the balance.

“Choosing an ESOP is a philosophical and cultural decision as much as it’s a transaction,” says Jeff Siegfried, CEO and majority owner of Omni Cable Corp., which began its transition to employee ownership in 1999. “There are financial business advantages, tax advantages, all sorts of things that are helpful in evaluating whether or not to do an ESOP. However, none of the advantages are enough to do it unless you have the cultural, philosophical need and build that you want to share the ownership with the people who are working with you, you want to help build other people’s portfolios, you want to keep the business the way it is and growing the way it is. You end up doing an ESOP for those reasons, not for the financial and tax reasons or any of the strategic reasons that might be attached to it.”

In a study published in 2013 on the performance of ESOPs in closely held companies, Douglas Kruse and Joseph Blasi of Rutgers University found that ESOPs appear to increase sales, employment, and sales per employee by about 2.3% to 2.4% per year over what would have been expected absent an ESOP. ESOP companies are also somewhat more likely to still be in business several years later, their data showed.

One area where employee ownership can set a distributor apart is recruiting and retention of top-quality employees. Whether a young recruit really believes in the value of employee ownership varies across the spectrum. Some are fixated only on the paycheck and compensation that they can’t spend now doesn’t improve the picture for them. Others, however, especially in the Millennial generation, embrace the idea, says Kumm of Dakota.

“I think it’s an appealing thing. It makes a compelling case for how we’re a team, that we’re all going to get rewarded for what we do together — especially with younger candidates,” Kumm says. “We still have to pay market value, but it’s a nice benefit on top of that. Older people like that we have a pension-type plan.”

You can’t expect employee buy-in to be universal. Many employees will wonder, what’s the catch? A rule of thumb in ESOP circles is to set a goal that 25% to 30% of employees over the life of the ESOP will actually understand the value of having a long-term stake in the business and begin acting and thinking like an owner. But that’s no small thing.

“In a company of 200 people, if 20% of the people actually get it, that means 40 people show up for work and act differently and work differently than they did before and maybe motivate and manage the people around them differently. That is extremely powerful,” Siegfried of Omni Cable says.

Employee ownership also makes a difference in mergers and acquisitions, says Geekie of Graybar. “A significant driver in evaluating potential acquisitions, compared to other strategic buyers or financial buyers, is culture. Organizations driven by a sense of employee-ownership have a different culture. While we may have a lot of different companies we’re looking at, the first hurdle is, what’s their culture like? Does it sync up with ours?”

Employee ownership is certainly not without its risks. For employees, saving for retirement by investing in their employer runs contrary to the fundamental investment principle of diversification.

“There is nothing quite as ugly in the employee benefits world as an ESOP gone bad,” says a Wells Fargo publication titled, “A look at the good, the bad, and the ugly of an Employee Stock Ownership Plan.”

“Of course, an ESOP is only as good as the company’s stock, and the worst-case scenario is the ESOP of a company going into bankruptcy. In this situation, not only do employees lose their jobs, but their ESOP accounts are worthless,” Wells Fargo warned.

Cognizant of this diversification risk, ESOP companies such as Border States Electric also encourage employees to invest in 401(k) plans and other retirement-savings vehicles. At the same time, CEO Tammy Miller also points out the value of investing in a successful employer.

“We established our ESOP at Border States in 1984 and became 100% ESOP owned in 2000. We have a long successful track record. Our company has never lost money in a fiscal year,” Miller says. “Over the history of our ESOP, annual contributions have averaged 13% of eligible compensation and our stock value growth consistently outpaces market benchmarks. Border States stock is a great investment for our employee-owners. As I like to say, bet on the horse you’re riding.”

Invest in the right employer and the payoff can be a well-earned and comfortable retirement. “We’ve had people whose lives have been changed by their ownership and by the value they’ve been able to create,” Siegfried of Omni Cable says. “It’s very rewarding for me and our company when our long-term employees retire and the value they built in ESOP shares through hard work can support them in their retirement. It’s really life-changing and important for people’s long-term lives.”

Employee ownership alone will not transform your company into Graybar or Border States. But if you have a certain cast of mind, a transition to employee ownership can be a positive way to unify your organization, ensure its continuity as a growing business, and share some of the benefits of ownership more broadly.

“If strong management is in place, the ESOP is an effective ownership succession strategy. It provides an exit strategy for the owner and an opportunity for all employees to share in the ongoing success and capital growth of the company. What a great legacy for the exiting owner,” says Tammy Miller of Border States.