Interview with Dickson C Buxton
On Founding Private Capital Corp
I formed Buxton Associates that was later merged into Private Capital Corp after my discovery in 1969 that trying to buy out a major shareholder of a private company with after-tax dollars was virtually impossible.
I was running a large diversified financial services organization in the Bay Area and we had a number of divisions, such as estate planning, employee communications, capital finance. We specialized in succession and exit planning for private companies and had a client who was trying to buy out his majority shareholder, which wasn't working out very well. We couldn't make it work with after-tax dollars.
One of our associates introduced Louis Kelso to the client and, about a year later, the 7th ESOP in America was installed. A couple of years later, the company ran into trouble; I went on the company board to straighten it out and had an eye-opener when I discovered that the ESOP would have been fine had it been structured with proper financial expertise. I was on the board of another good-sized private company and the CEO/founder wanted to go public. I suggested going public internally through an ESOP, which we implemented a couple of years later.
This is when I created a division in my organization that would specifically deal with ESOPs. The major auto-makers approved ESOPs as an acceptable stockholder after I had a number of meetings in Detroit. I then flew all over the United States lecturing groups of big auto dealerships on how to make a market for their stock. Eventually, this division of Buxton Associates occupied the overwhelming majority of my time so I sold off the rest of the divisions, and went full-time in private company investment banking. I co-founded Private Capital Corp in 1976 with a securities lawyer partner.
On Forming the First National ESOP Association
In 1977 we decided there had to be an association that would protect ESOP legislation that was part of ERISA.
At the time, it was under attack from various administration departments, especially the Department of Labor. That year, we founded the National Association of ESOP Companies. We later acquired Kelso & Company, the earliest ESOP pioneer.
We formed our first private equity group in 1979 and two years later discovered that with 22% interest rates in a weak economy we couldn't buy companies. Our consulting business was also in trouble, so PCC sold the private equity subsidiary and up streamed some of the consulting business. There was too much capital chasing too few deals, so we became as an intermediary for private equity groups for several years, until I co-founded another private equity group with a good friend of mine, John Menke.
By getting into ESOPs that few people knew much about I found the solution to many of America's problems. ESOP’s could help the have-nots earn an interest in their company, so they would pay more attention and put more effort into helping their own company survive and prosper . We were asked in 1979 by Senate Finance to do the first ESOP productivity survey, which helped convince Chrysler Corporation to adopt an ESOP that ended up saving the company at the time.
Later, the unions demanded that the board get rid of the ESOP and adopt a defined benefit pension plan and the company hasn't done so well since. This happened after the union called a strike and only Canadian workers went on strike. American workers kept going to work, because they had an ESOP, and this scared the hell out of the unions. The company went back to having employees on one side of the fence and management on the other and ended up in trouble again.
An article I co-authored in 2003 gives a history of ESOPs, and the research we did at the time shows that over 40,000 ESOPs have been adopted over the years, but only 10,000 of those were still in effect. I had given a speech in London in 1987 on the phenomenon of American stock ownership, and found we had 8,000 active ESOPs.
In 2003 we only had 10,000. Over 1,000 of them are adopted every year and in 2009, we only had 11,000 active. In another 5 years, many those will probably be gone and the reason for this is that people are implementing them as tax shelters and not as ways to go public internally.
There is going to be a huge influx of retirements, as the Baby Boomer generation comes of age. About three years ago boomers started to sell companies they founded so we decided to expand our involvement in private equity. Hundreds of millions of dollars are looking for a home in leveraged buyouts. We didn't want to create just another private equity company since there are thousands of them, however, very few of them have marketing departments. Since we have a network of affiliates and contacts all over the country, we serve as an intermediary that matches older founders and stockholders with private equity willing to invest. We also have an affiliation with executive search firms and we can bring in CEOs who acquire part ownership of the company. Management rallies around the CEO and raises money for a buyout, in a process that we describe on our website.
On Major decisions at PCC
I got into this game because I felt that broadened ownership was an absolutely essential part of assuring the succession of a company. The greatest accounting and law firms would have never been built without partnerships, the greatest companies would never have been built without stockholders and partners. I built three regional financial service organizations with life insurance companies as my prime banker, and there would be no life insurance industry had they not developed a compensation system where the agents owned their business.
Partnering is the answer to succession and survival. My associates were employees for a short period of time until they no longer needed subsidy and were owners. This is how I built fine agencies and is how the insurance industry built trillions of dollars of assets through a field force of franchised agent owners. America was founded because people could own something and the Homestead Act spread ownership in America westward. We still have company officers thinking that one man or family can own it all, and employees will just sit there saying “Okay master, give me what I need, I'll just be your slave,” and that's ridiculous.
Moreover, the Social Security system is going broke and people are retiring with very little other income. Unless people have an interest in the company they work for during their lifetime, it's very hard for them to retire with any meaningful assets. After I understood ESOPs I saw that they were really like defined benefit pension plans which were a specialty of ours. Future value is the value of shares of stock in an employee account. We would never dream of implementing such a plan without a funding mechanism, so that when people retire, there's money to fund repurchase. Companies failed to do that with defined benefit plans, which is why ERISA was adopted in 1974 mandating that there be funds in retirement accounts.
However, there was and is no requirement to fund an ESOP. I went on my first ESOP company board (the 7th in America. Louis Kelso had set up 6 of them and 3 had gone broke). The bank got concerned when they saw the money flowing out as people retired, and called the line of credit. It was like a small, in-house Social Security problem. I went to the bank and showed them the primitive funding plan we'd developed; they accepted it and refinanced the company. Our funding programs are far more comprehensive today and we can better forecast liabilities.
In 1976 we hired computer programmers and invested a significant amount of money to develop a proprietary software program we call “The Focus Study” where senior officers could focus on different aspects of ESOPs.
One of the issues was repurchase liability. We show the present value of annual ESOP distributions, assume a certain return, and see if it's financially feasible to install such a plan and the appropriate size of the ESOP.
We would not implement ESOPs until the client would agree in advance to fund it. This was the first critical decision that cost us a lot of business, since many companies had an attitude of “Oh, don't worry about it.”
Many competitors would install a plan, but would not tell clients about repurchase liability and risk losing business. We walked away from 9 in 10 deals because of this, since I didn't want to be on the receiving end of a lawsuit where I misrepresented the virtues of a plan and fudged on the drawbacks. The drawback of an ESOP is not the upfront cost, it's having large unknown costs in the future. It's an obligation that you will have to face, if you don't want to go broke. Insisting on proper future planning and turning down clients that refused to do it is probably the most important decision we made in those early days, and we lived with it. We still do.
The second decision we made was that we would not install an employee stock ownership plan unless it was part of an overall, comprehensive perpetuation plan. If you have an ESOP and you don't have depth in management when key management staff leaves the company might go broke, and this is why a company isn't a good candidate for investment unless it has a deep management bench. This is why we do a very comprehensive feasibility study, using the current version of our proprietary software to project a company's future financial status under different assumptions of growth, decline and size of transaction.
In other words, we don't design an ESOP unless we would personally buy stock in that company. If private equity gets involved, they insist on a long range strategic plan, because they're absentee owners. Private equity invests money in the company, and while they can try to make the company profitable, they can't control what's done with the money – the board does. We insist that a company have a quality board.
We approach this as if we're taking a company public internally – as a banking transaction, not just as a device to sell stock to a trust that you control. The Department of Labor is suing hundreds of companies because they install ESOPs without proper planning that results in ripping off their employees.
On Developing ESOP software solutions
We developed the Focus Study computer program between 1975 and 1980. It took us five years to develop, and we had a huge investment, since it had to be credible with banks, private equity groups and outside boards. We typically dealt with larger companies that could afford to spend the money and study the situation thoroughly.
No one was doing this in 1975. I was investing a lot of money in Private Capital Corporation, and a lot more in Kelso & Company. We were doing business on a national basis and had substantial overhead. We would not install an ESOP unless it met our criteria, and would not work without an advance retainer to do a total study.
We were paying outside actuaries to do the actuarial work, and it was so expensive that we could only deal with large companies. We had to develop an internal system program for smaller companies that could provide us with the same quality of information.
We only recruited people who are sophisticated and most have run companies. We also recruited analysts that came out of the investment banking community. The program we created wasn't one that could be used by any MBA student and required significant financial sophistication to even explain to clients.
If you are talking to a CEO about a major transformation of their company, you’d better have the maturity and seasoning to become that CEO's trusted advisor.
On Legislative activities and ESOPs
The most important legislative activity that shaped the modern ESOP was assuring that the present legislation – ERISA – could be protected. In 1976, shortly after I gave up a very profitable business, co-founded Private Capital and worked with several people who had done a number of ESOPs working with Louis Kelso, someone in the Department of Labor proposed regulations that would kill ESOPs.
We were about to be out of business so I called a friend of mine, Bob Packwood, later to become Chairman of Senate Finance Committee, and asked him what was going to be done about this. He said that a lot of Senators were very upset about this and that I'd better rally ESOP companies and tell them to call their senators and congressmen to get this proposed regulation reversed.
That's what we did – focused on getting CEO's with an ESOP to contact their congressmen and senators to tell them that they were taking away ownership from their employees with this legislation. The regulation would have stated that the Employee Trust was merely an extension of the corporation and that any sale of stock to the trust was tantamount to a dividend and taxable as ordinary income; that the corporate contributions to an ESOP would be considered as non-deductible dividends. Shortly thereafter, the Senate sent the proposed regulations back to the White House with a unanimous voice vote, instructing them to refrain from doing anything that would adversely impact ESOPs in the future.
This is what led me to decide that we should have an ESOP association. I went to three CEOs of companies on whose boards I served, and proposed forming an organization. They became the Chairman, President, and Executive Vice-President of the National Association of ESOP Companies. I then went to an old friend who was about to retire as an executive at IBM, and he agreed to accept the budget I had prepared, then go out and build an association.
NAEC was founded in 1977 and in 1979, the board of the Association voted to invite members of the ESOP Council, a group of service providers and some ESOP companies, to join the Association. They changed the name to “The ESOP Association of America,” They now have about 2500 members and a fine staff.
This, in brief, was my first legislative involvement to protect ESOPs.
The second was in 1978, when there was an attempt to force the vote pass through to all employees on all issues, regardless of whether the company was ready to do it, or had enough employees so they could have an investor relations department. If you tell a CEO they're going to have an ESOP where their employees are going to vote and see if they stay on the board, who's going to agree to implement an ESOP? I spent a lot of time in Washington D.C. with our clients, and we got legislation passed that restricted this rule to situations where there was going to be a sale of most of a company's assets, so that employees would get the right to vote on that.
This way, if someone is trying to rip off a company, they would have to disclose their plans but the simple act of installing an ESOP would not expose a company to a union buying stock and trying to organize employees to pressure management.
On The ESOP Association
The Association started as a grass-roots effort to protect ERISA ESOP provisions, but then it took on a life of its own. Now, there are 17 or 18 different pieces of related legislation on the books – some of them protect employees and participants, some are to induce companies to install ESOPs.
Who were some of your key hires and associates?
My partner, Joe Schuchert, a securities lawyer, was the first key person. We could never have built PCC without him. Joe understood that an ESOP wasn't just some benefits plan; that this was in essence taking a company public internally. When we had to sell Kelso Capital because of the high interest rates in 1981 on debt incurred to build up a national company he stayed with Kelso Capital and became chairman. After he retired, one of our partners at Private Capital became chairman. They have now done $39 billion of private equity deals.
We recruited Ron Gilbert in 1978 as vice-president of Kelso. He has since founded his own company, ESOP Services, and has co-authored some of the articles on our website.
Cameron Carlson was with my financial services firm in the '70s and joined PCC in 1981. He has a law degree and is also a CFC and CLU. He designs the funding strategies for our clients in connection with their estate and business planning.
Claudia Reimer joined us as Controller and Julie Buxton as my personal assistant in 1981. Claudia is now retired and Julie, who got her Masters in Financial Services while at PCC, is a successful investment advisor specializing in 401k plans.
Colonel Joe Rafferty (US Army-Ret) joined us in 1992 specializing in ESOP design. He recently retired but represents PCC on the ESOP Assn Legislative Advisory Committee.
Ullie Steinecker joined us in 2000 as the assistant to Jeff Buxton, who managed our analytical services division. After he passed away in 2001, Ullie became Manager.
Colonel Bryan Golden (US Army-Ret), formerly co founder of a firm created through an ESOP oriented LBO joined us in 2002 specializing in ESOP and MSOP design.
Michael Harmon, former CFO of a large NC company joined PCC in 2003 to head up our M & A activity.
Patrick Flynn, CPA, former CFO of a PCC client firm, joined us in 2004 to manage some of our more complex business succession projects.
Maggie Reimer, Controller and Colonel Brian Buxton (US Army-Ret) Treasurer, joined us in 2006.
David Flynt (Southeast) and Joseph Destein (Northern California) joined us in 2009 to head up our business development activity in those areas.
John Menke helped me get the ESOP Association formed, was with me when we were trying to protect ESOP legislation, and we co founded another private equity group. He is a brilliant lawyer and good friend.
Roland Attenborough has done the legal work on more ESOPs than almost any other lawyer in America. We've worked together for over 40 years that he has been our special ERISA counsel. He's a tax lawyer and a CPA with a Master's in taxation.
There are a small group of ESOP Pioneers who go way back and a number of other very key associates have joined PCC in the last 36 years.
What Advice would you give to ESOP advisors?
The next generation of advisors should be credentialed and understand that ESOPs should be very carefully prescribed. It's strong medicine, and, if given to the wrong patient, could kill them.
Credentialed means they should have the formal academic background, knowledge and experience to get into this field. This is either a law degree in the advanced fields of securities or employee benefits, a CPA with special expertise in that field or a Chartered Financial Consultant with small business planning experience.
In other words, they need to understand how a company is built and endures; not just the ESOP concept!
An ESOP is an 800-pound gorilla of a shareholder, and ESOP consultants will find this out if one goes bad. The Department of Labor could come after them and chase them all the way to their grave. It's a very serious undertaking, and too many people deal with it like “Oh, it's just a benefits plan.” There are numerous potentially thorny corporate governance issues that you need to understand and help a client resolve.
You can't practice law, accounting or medicine or engage in financial advisory activity without a license. Yet, anyone can say they're an ESOP expert. Success ESOP transactions and operations requires many different disciplines.
A company needs a quarterback of a team of people who are experts, know each other and keep the clients interests primary. Sometimes a CEO or CFO that wants an ESOP goes to their accountant, an attorney and a benefits advisor. These people may not know each other but all may try to see who can impress their client the most. This can result in a very costly and possibly dysfunctional plan
We have our own in-house team that we've assembled very carefully over a long period of time so we can manage and coordinate a very complex process.