ESOPs and Ownership Succession
Employee ownership can play a crucial role in ownership and management succession in family firms when there is no son or daughter to assume an ownership and management role. In fact, fully sixty percent of existing Ohio ESOPs were set up in closely held businesses to handle retiring owners, cashing out minority shareholders, and diversifying family assets.
There are two primary reasons for selling closely held businesses to employees.
The first is the tax break: owners who sell stock to their employees through an Employee Stock Ownership Plan (ESOP) or a cooperative can defer paying taxes on the capital gain from the sale provided that the employees hold at least 30 percent of the stock in the company after the sale is completed and provided that the proceeds of the sale are rolled over into "qualified replacement securities" (i.e., stocks and bonds of domestic operating companies). If the replacement securities ultimately pass into the owner's estate, the capital gains tax is avoided altogether.
The second is the loyalty that many business owners feel to the employees who have helped build the business over the years. A sale to a competitor or absentee owner doesn't ensure employees' job security.
Here are thumbnail sketches of five new Ohio employee-owned companies which family owners are selling to their employees. While they all use ESOP tax breaks, their reasons for selling to their employees are as varied as their businesses.

Ownership Succession Planning
In the midst of the Great Depression, the worst economic catastrophe the country had ever faced, Ed Gledhill was optimistic enough to found The Gledhill Road Machinery Company in December 1930. At the time the breadlines were growing, unemployment soaring, and other businesses failing, Gledhill created new jobs for the small town of Galion, OH. Sales in the first year were under $12,000.
Gledhill Road Machinery was conceived as a family business. In 1932, Ed's son, William, enrolled in college at Miami University of Ohio. After taking classes during the day, he would return to the engineering department of the university in the evening to design equipment. Many of his lines are still in use today. After college in 1935, William designed the first Gledhill Snow Plow for the United States Corps of Engineers. Gledhill now markets snow plows throughout the United States and has shipped products to Canada, Iran and Europe.
In 1965, William's son, Garland, became the third generation to join the company; in 1976 he became president. Garland's three children, Michelle, Nicole, and Curt are actively involved in various aspects of the business. In 1998, after his father's death, Garland decided it was time to determine the ownership and who would control the company when he retired. His three children advised him that even though they were involved in the business, they had no desire to run it, so continued family ownership and control was not an option.
Several offers to purchase the business were made by conglomerates and investment firms. Garland had doubts, however, about whether any of them would continue to run the business in Galion and continue to provide employment for the workers who had built the business over the years. The most serious offer came from a firm that admitted that it would shut the Galion facility and move the work out of state. "When I found that out, it was a deal killer," Gledhill told OEOC staff during the ESOP process. An attorney friend suggested he look into selling the company to its own employees. After he investigated how ESOPs work, "I concluded that employees themselves would be the best new owners to continue the business my grandfather started 70 years ago."
Gledhill arranged a stepwise sale of the company to its 60 employees. The first third was sold to employees in 1999, the next third will be sold in 2004, and the final third in 2009. The sale went to an employee vote. Machinist union members voted unanimously in favor, and white collar employees followed suit.
"This town has had enough out-of-town ownership," Gledhill told employees at lunch in March 1999, after he reviewed the five outside offers he had had for the company. "By selling my business to you guys, I know it will be in good hands."

A Multi-Purpose ESOP
In 1997, McIlvaine Trucking's single shareholder, Gregg McIlvaine, began looking for ways to diversify his assets, create a succession plan, and reward and motivate his employees. To achieve these diverse goals, he decided to implement an ESOP.
McIlvaine Trucking is a common carrier providing bulk transportation services to the propane, chemical and asphalt industries, and has a van division that serves distribution centers. It manages over 400 tractors and trailers, 150 employees and 100 independent contractors throughout the eastern United States. Estimated sales for 2000 are $26,000,000.
McIlvaine engaged ESOT Resources of Kansas City, MO to advise and "quarterback" the company through the ESOP's start-up and first transaction. In December 1998, the ESOP purchased 26.5% of the company's shares. This was done as a leveraged buyout with financing provided by Wayne County National Bank of Wooster, OH.
After the legal and financial work of the ESOP was completed, the challenge of educating the employees began. Roundtable meetings were held with selected senior employees to explain the benefits and functions of the ESOP. It is hoped that the employees involved in the roundtable will spread by word of mouth the benefits of the ESOP. Recently, the company returned to a series of company-wide ESOP meetings to provide more education and create enthusiasm among all employees. McIlvaine Trucking's quarterly newsletter and website (www.McIlvaineTrucking.com) also highlight the ESOP.
How has the ESOP worked? From McIlvaine's perspective, it has reached his goal of diversification, and he and management are committed to reaching 100% employee ownership as soon as possible. Additionally, the plan has provided excellent tax benefits to the corporation. The ESOP has also worked in rewarding, motivating, and retaining employees. The company has found that among employees who participated in the company and roundtable meetings, it has helped bridge the gap between management and employees. Of the 32 employees who participated in the detailed ESOP roundtable, 31 remain.
For employees who do not take time or interest in educating themselves, the results are neutral. "The challenge to management is to find ways to get all employees interested and educated about the ESOP," says McIlvaine. "This can only happen through ongoing educational programs with realistic goals. Employee motivation and retention involves many factors: working conditions, benefits, wages, etc. The ESOP benefit is only one of the factors and cannot be expected to be a solution to all employee issues."
"We look forward to continued growth of both the company and its ESOP culture," says McIlvaine. "We would welcome any questions from owners and shareholders considering the implementation of an ESOP."

Sharing Ownership, Protecting Commitment
Stow-Glen Retirement Village was established in 1984 as Baker-Sumser Retirement Village in Stow, OH. In 1989, the original partnership dissolved and David Baker and his son Kenneth took over the company. Today, that partnership has been expanded to include David and the employees through 46% ESOP ownership.
Stow-Glen offers a variety of living options to the senior population primarily of Summit and Portage counties. Its 140 independent living apartments allow residents to enjoy retirement without the day-to-day jobs of upkeep, cooking and cleaning. Its assisted living quarters provide 24-hour supervision and companionship. Cherry Creek Acres, a small, intimate shared living facility, offers more personal attention; sixteen residents receive one-on-one, individualized attention by staff 24-hours a day. The 100-bed Health Care Center, which is Medicaid certified and licensed with the Ohio Department of Health, is available for residents who require full nursing care.
Establishing an ESOP made sense to David Baker for many reasons. The ESOP allowed Ken to cash out his shares. The ESOP provided a retirement plan for Stow-Glen's 100 full-time employees and benefited the company because the debt could be repaid tax-free. For Baker, Stow-Glen was more than a business, it also supported his religious vocation. How could an ESOP company continue to honor Baker's religious commitment?
"After much prayer and many sleepless nights spent talking to the Lord," Baker says, "the decision was made: Stow-Glen would become an ESOP." On January 1, 2000 Stow-Glen became 46% ESOP-owned; David Baker continues to hold a 54% majority stake.
To ensure his religious intent, Nailprint Ministries (set up by Baker to help local para-church ministries to spread their Christian message) will inherit Baker's majority stake after his death or incapacitation, and Stow-Glen's plan document states that 10% of its profits be deposited into Nailprint Ministries. Nailprint Ministries will be governed by Tammy L. Denton, Executive Director of Stow-Glen, Rita Warner, Director of Community Relations for Stow-Glen, and a Baker family member. Nailprint Ministries will establish future increases to the ESOP and oversee the daily operations of Stow-Glen.
"Our next challenge was to educate our staff," explains Denton. "Many of our staff were not even homeowners, let alone small business owners." In the beginning, many could not see how this could benefit them in years to come and would have preferred immediate gratification through a raise. "Our goal," says Denton, "is to get every staff member to think like an owner. We've opened our books, educated them on costs, included them in decisions where possible, answered their questions and eased their fears."

Cashing Out Minority Shareholders
"Treat your customers, suppliers, and employees the way you would like to be treated." This has been the philosophy of Robert I. Yeoman, principal owner of Automotive Distributors, ever since he bought the company in 1985.
Yeoman has "always believed in sharing the growth of the business with the people who helped develop it," says Glenn Martin, Director of Human Resources. Setting up an ESOP in September 1999 was just another extension of this.
Exploration into employee ownership began in early 1999. In April, Martin called the OEOC for more information as well as a list of ESOP service providers. The company chose Tim Jochim of Ellis, Venable & Busam, LLP in Columbus to handle the legal work and Chuck Devereux of Valuemetrics in Chicago to do the valuation.
Automotive Distributors is a major distributor of General Motors and Ford Motor Company's OEM automotive parts. Its 200 employees, referred to as associates, run warehouses in Akron, Cleveland, Columbus, Dayton and Toledo, which handle several other automotive suppliers as well.
Not only did company leadership find the ESOP to be a good fit with its management philosophy, it also found it to be a practical way to create a market for minority shareholders who had reached the point where they wanted to cash in their stake. By selling 30% of the company to the ESOP, all of the other shareholders were able to exit the business and have the option of rolling over the proceeds on a tax-deferred basis into other investments. Yeoman sold enough of his stock to allow them to reach this requirement. A six-year loan for the purchase came from the company's lender, Bank One.
As the ESOP was put together, general managers and a committee with representatives from each location were involved. The ESOP was then announced to the rest of the associates through employee meetings. "Every chance we get, we talk it up. We've handed out T-shirts which say 'Because of the customer, we exist,'" Martin explains. The reaction of the employees has been very positive, especially after they received their first ESOP statements. Along with the statements, participants received business cards with the phrase "An Employee-Owned Company" on them.
One of the biggest challenges faced by the company during this transition is the effort to involve more people in using financial information to make specific improvements in company performance. This requires a focus on targeted financial education for employees as well as the need for some of the company leadership to grow more comfortable with letting the numbers leave corporate headquarters. This approach is being handled step-by-step, beginning with the general managers at the warehouses and their staff. Martin points out, "Everyone already knows that we can improve the business by increasing sales and reducing expenses. Being able to do this requires that people know what those expenses are and which ones are controllable."
The combination of extending ownership to employees and providing more information is having a tangible impact already. Martin has seen a dramatic improvement in the past six months and savings of hundreds of thousands through this increased awareness.
"One of the biggest benefits I have seen since the ESOP was established has been the building of team loyalty," says Martin. "Our employees have always been loyal individuals, trying to do what they considered best for the company; however, different individuals sometimes had different opinions about what was best. Now there is more success at building consensus around good ideas through team loyalty."

Prefunding The ESOP
In 1984, ten managers and engineers purchased the Stow office of Snell Environmental Group from its troubled, Michigan-based parent company. Renamed the Environmental Design Group (EDG), the company's consulting and environmental engineering business prospered under its new, local ownership. It outgrew its Stow space and moved to a bigger facility in Akron (and expanded to Columbus and Charleston, WV); proximity to the University of Akron's engineering school was an added advantage. Today, employment has more than doubled to 80. The original ten owners had grown to 20 as the company's management, as a matter of values and good retention policy, promoted broadening ownership.
While the company repurchased shares when necessary, in 1999, three of the leading "Young Turks" who had taken over the operation in 1984, including company president Bill Bandy, were nearing retirement. Together they owned 32 percent of the company, a sizable chunk of stock for the growing company to buy back. Like most consulting engineering firms, EDG had few fixed assets to collateralize debt. Bandy had no desire to leave behind a legacy of excessive debt.
Instead, with the assistance of Menke and Associates, EDG set up an ESOP to receive company cash contributions to "prefund" the purchase of stock from retiring owners. This system, successfully used by several other Ohio companies including Delta Systems and S. G. Morris, permits the company to minimize borrowing when the ESOP buys the stock by building cash within the ESOP in lieu of stock for several years.
Bandy announced the ESOP to employees and introduced EDG's ESOP committee at an April meeting. "It will ensure the continuation of an independent EDG," he told them. "Indeed, it helps position EDG for growth."
It is also a good fit with management values. Bandy is particularly eloquent on the work the company has done on the Ohio canal corridor and brownfield redevelopment. At the ESOP meeting, Bandy and employees also discussed adding an environmentally sustainable fund choice to EDG's 401(K) plan.

Planning Is Key
"The common denominator of all these cases," commented OEOC Succession Planning Coordinator Alex Teodosio, "is that they involve substantial advance planning. While most—perhaps all—will eventually become 100 percent employee owned, the owners have planned the sale to occur in stages. Sometimes you are looking at a 10 year transition.
"With this kind of advance planning, you don't have excessive borrowing that threatens the firm's viability. You have a gradual management transition, which is more likely to be successful than suddenly catapulting an inexperienced manager into the CEO's chair.
"With sufficient advance planning, including pre-funding the ESOP when necessary, it is almost always possible to structure a successful ESOP transition."