Hall of Fame - Scott Miller
Q: What was your involvement with ESOPs?
The involvement started later in my career when I resigned from a family company and accepted another position in industry. I first obtained my CPA license, and that was just an enormously beneficial decision when I was a much younger man. My mentors said: “Get this professional designation, it’s forever, and you will never regret doing that.”
For many years I really didn’t use the CPA, and I left a family business that was really stressed by the recession in the early 1980s. In the middle 1980s, interest rates went through the roof. The leveraged dealership was being destroyed by financial institutions because interest rates were so high and new equipment sales had plummeted.
My departure was amicable. I looked for another opportunity and secured a position as a controller at a company that had just gone through a leveraged buy-out, and part of the leverage included the installation of an Employee Stock Ownership Plan, hereinafter an ESOP. This was in 1985.
There were very few ESOPs in the early 1980s, and few really understood them, including myself. At the company, I quickly rose through the ranks of being a controller to financial officer, vice president finance, board member. I was also a Trustee of the ESOP. During that time of high energy, it was a very dynamic and younger management team. We took the company from breaking even - really a large job shop not going anywhere - and we migrated to world class manufacturing within about three years.
I was at the epicenter of that rise. Employment grew from about a hundred and fifty employees - so it’s already a sizeable company - but we grew to over four hundred employees in four different locations. Not only did I repay ESOP related debt, I had to finance this phenomenal growth. When you’re in the finance business, it doesn’t get any better than this.
We didn’t just become successful by luck, we had dynamic leadership, and had several outside board members. We really championed and communicated the fact that we’re an employee-owned company. In those early years, we really didn’t have a script to follow. We were doing this self-promotion on the fly.
Financial success was due to the people, and it was incremental steps and process improvement. We do things, we try things, lots of celebrations, bought lots of donuts, gave lots of recognition to people that have never been recognized for any contribution. So, we tried to make it as much fun as we could, and it all worked with tremendous success.
I got to know ESOPs from an industry perspective. I was with the company for several years and became active in The ESOP Association (TEA), and eventually the National Center for Employee Ownership (NCEO). I participated in some ESOP panels as the industry authority and a senior officer.
I did not stay with the company. It was a very engineering-centric firm. I’m not an engineer, and I’m very entrepreneurially oriented.
While the company was good to me, I did leave, and shortly thereafter I started a consulting company in 1993. I did not consult originally on ESOPs. I was a part-time CFO for hire. Eventually, some contacts found out my background on ESOPs, and the direction of the company I started, Enterprise Services, Inc. (ESI), changed immediately. My focus was switched almost entirely to ESOP consulting and things really accelerated. By 1995-96 I was dedicated virtually full time to ESOP valuations.
Coming back to my comments about earning the CPA license, that early career decision proved to be immeasurably helpful when I started ESI. Being a CPA was a statement to the market that Miller sets and achieves goals and knows his technical requirements.
Q: Any thoughts or perspective on what happened before you with Kelso and some of those early guys? Were you able to get into contact with them?
I did not. But the one thing that is a fun story, as I started to get involved with ESOPs I thought - and I was a political science major before becoming a CPA - these guys are pretty interesting. There’s some innovative thinking here. So, when I did traveling, I’d go into used bookstores, and look for out of print coffee table books.
In one large warehouse, I went in the basement which was dusty, musty, dark, and dank. I was looking for the coffee table books, but I found a couple of volumes by Louis Kelso. I found copies of the Capitalist Manifesto, one of them in pristine literally unread condition with a perfect jacket. I also found several copies of a companion book called the New Capitalist by Kelso and Adler. I did not erase the little pencil price on them so the Capitalist Manifesto I picked up for ten bucks and the New Capitalist for six.
The fun aspect is that I did meet Mrs. Kelso. She was going to be at one of the major ESOP conferences. I took both books, and she signed them. I have them on my bookshelf.
Q: Opinions on the books
It was a very innovative approach to getting more people to become participants in a market-based economy. It wasn’t robbing Peter to pay Paul. It wasn’t socialism. It was envisioning a way for employees to earn their way into capital accounts with their employers. The secret at the outset was tax incentives to encourage this behavior on the part of shareholders and companies to permit employees to have a stake in these firms. We’re not taking money from anyone. We’re just giving or providing tools to employees so that they can earn their way into equity positions.
And I walked the talk. I could actually see the benefits where the company I was with just really did well because of the communications and employees were treated with respect and dignity. In many cases those were entry-level positions. We’re not dealing with a lot of highly educated associates. This was injection molding which was basic manufacturing. So my early experience with ESOPs was very positive.
Q: Were there individuals that have helped you developed your thinking?
Yes, I did have wonderful advice. By training and education, I was blessed to attend some really outstanding colleges and universities. With hard work, I made myself into a CPA.
I was well qualified to be a chief financial officer at a large company. I wasn’t entirely happy in that role and thought about starting my own company, Enterprise Services Inc. (ESI). When I was considering the move, my wife (Jayne Ayers) was very supportive. I could not have done it without her support because when you start something the first year or two are just abysmally depressing.
The phone is not ringing. You’re dialing people and sending e-mails. You’re walking around with your hand out saying: “Please hire me, I’m better than I look.”
But I did know that there was a successful business template if I followed the script. Within a couple of years, there was chance ESI could succeed.
So, my wife was very supportive. Another very dear friend, even today, was an employee benefits attorney with a large regional law firm. He just gave me tremendous encouragement when I was dejected and down. I would catch a lunch with Dennis (Dennis Tomorsky), and things would be better for a while. Long enough to buy another month of time to keep working the plan, make phone calls, write letters, and try and get established.
There really was a watershed event that made a huge difference. It was a chance occurrence. I was having lunch with an old college team mate (I was an NCAA lacrosse player). He was a benefits consultant, and at lunch, he said: “Scott, did you know you could buy a list of ESOP companies with contact information?” And my jaw dropped. I said: “You’re kidding!” Here I am trying to do marketing, and now I can buy a prospect list.
So for a couple of hundred dollars, I bought a list of every ESOP Company in the Midwest. I followed with writing letters, making follow-up with phone calls, and visiting prospects. It worked beyond my imagination due to persistence. Some of the individuals that really had an early imprint have also been lifelong friends as well.
Q: So, then right now, you’re mostly on the valuation side and the consulting side of things?
Correct. There’s a key take away. There have been lots of industry honors and awards, and the lynchpin in those awards and recognition is that the decision was made to focus on something I could excel at, something where I could demonstrate real expertise. In short order, that was ESOPs. I quickly obtained valuation training from a couple of business valuation organizations. They were AICPA (American Institute of CPAs) and NACVA (National Association of Certified Valuation Associates).
Eventually, I did teaching, and I wrote books for both of them. By really concentrating almost exclusively on ESOPs that focus led me to turn down virtually all other valuation assignments because it was a distraction. ESOPs are a wonderful discipline because they’re recurring assignments. With that singular focus on ESOP clients, you pick up ten or fifteen clients in the course of the year. You might lose one, but the following year you have ten or fifteen annual valuations and add another ten or fifteen new clients, now you’re up to thirty. Soon you have to add staff to provide the customer support.
With time, ESI has been involved with over six hundred ESOPs, and there’s a team of fourteen of us at the Company. That’s all due to highly focused specialization on ESOPs. Today at ESI we have a distinctive brand within the ESOP community and are well known.
Q: What in your opinion makes a successful ESOP? What’s the X-factor? What’s the secret sauce?
Some of the things that I learned by being a senior officer in an ESOP company and now dealing with hundreds of other ESOPs as a service provider is that success is largely developed by a commitment of the top management to support employee ownership. Some ESOP companies are extraordinarily successful, others not very successful. What I have learned from the very successful ESOPs is a commitment by selling shareholders and the successor management to support the employee ownership and involvement. That takes a commitment to communicate the obligations of ownership. The pay-off is that if we do things correctly, we wind up with a very successful company. The idea of employee ownership is not a “one and done;” you have to continually reinforce it.
An ESOP lesson that I’ve learned is that early on there’ll be a subset of employees that either get it, or they want to understand it, so they’re early adopters. There will always be a lot of skeptics, and with time, many of them will come around and understand how special the circumstances are. Some will never get it. There’s always going to be naysayers and negatives. Don’t let that dissuade you. Support and reinforce those that want to believe in the participation.
Another key thing is that on the part of selling shareholders, they really have to be very pragmatic about valuation. Some of them are totally unrealistic about value. They hear too much “water cooler” information on what multiples are applicable. The accurate information is almost never there. Some of the best candidates are business owners that really research how to value a company. They understand the tax environment. Business owners really have to work with professional advisors, and in the case of an ESOP, there will be a team of advisors, literally by Regulation and Statute. The representatives to the ESOP have to be independent of the shareholders of the company.
In our case as a valuation firm, we can’t have a prior relationship with the shareholders or the company. Our client is the ESOP Trustee. The business owners may have their own valuation or financial advisors; it’s probably recommended. With transactions today there will almost always be ESOP specialists such as ESOP/ERISA attorney, appraiser, a Trustee, there’ll be a third-party administrator - a firm to keep the account balances. There has to be an acceptance that it is a team effort. There’s a complexity to ESOPs, but at the end of the day, the tax benefits are just second to none and can really compensate business owners for the effort that goes into installing an ESOP.
Q: Did you ever have an “Aha! This will work for me, and this will help me” moment?
There really is a stand-out. I can’t mention the company for confidentiality. I got to know a husband and wife team. It was a very substantial firm. It was a training and education company. They were literally market leaders in what they do. The husband and wife didn’t have any children, and they didn’t need more money. They couldn’t spend what they had, so the idea of an ESOP was put forth. The company didn’t have much existing leverage, and back then the S-Corporation option was just becoming available.
As a husband and wife team, they liked the idea of selling to the employees, but they were also possessed with the company vision. It was really a wonderful sense of direction and purpose. They didn’t want to give up immediate control of the company. They still wanted to have a thumbprint on the future. In most cases, if you’re selling a hundred percent of the stock, you’re selling control.
You have to relinquish control if you are paid a control position price. And so the “Aha!” moment was… we can sell one hundred percent of the stock but on a minority price. You’re not getting a control premium, so you don’t have to relinquish control. They didn’t want to be involved forever, but during the time that ESOP related debt was being repaid, they still wanted to have solid input into the direction of the company.
This was explained to them. They did take a discount on the sell price to retain control, but then again, they couldn’t spend the money that the company was worth, so taking a discount didn’t mean anything to them. They wound up being very successful so that not only was the ESOP-related debt repaid with pre-tax dollars, but all the existing debt in the company (related to real estate) was similarly repaid with pre-tax dollars. They couldn’t believe it.
It’s a global competitor now. They’ve really done extraordinarily well. That’s a good one!
Q: What was your involvement with The Department of Labour on Fiduciary Standards for Business Appraisers?
What happens is that by really focussing on ESOPs, I’ve written several books and I did extensive teaching for a mixture of national organizations. I was on a number of Boards and committees. The Department of Labour hatched a thought where they’re going to name valuation professionals as ESOP fiduciaries. In many professional circles, the thinking long term is that this would be a terrible development to the ESOP community.
AICPA really drew a line in the sand. It publically said that this proposed regulation is terribly misguided and cannot stand. It was proposed under Obama administration, and there was a very driven Department of Labour leadership that didn’t like ESOPs.
Due to my extensive work on ESOPs, teaching for the AICPA and authoring article and books, my name appeared as a CPA that could be helpful. AICPA reached out to me and encouraged me to apply for membership on their Forensics and Valuation Services Executive Committee (FVSEC). I joined a team of eight other valuation professionals on that Committee as one of the real authorities on ESOPs. Soon I was asked to assist AICPA researching legal and regulatory issues regarding the status of Federal tax oriented valuations. I met with the legislative liaison team in Washington D.C. for AICPA.
Through involvement on the Committee, I helped the AICPA document their position against the Department of Labor. AICPA was very public and vocal against that proposed regulation. I contributed to the documentation indicating the reasons why the proposed DOL regulations were against current Federal Statutes. The current Federal Statutes for tax related valuations (ESOPs, gift, estates, etc.) require an independent valuation. If you’re a fiduciary, by definition, you’re not independent. The DOL failed to acknowledge this point, my opinion.
Q: What are your thoughts as to how things have changed with ESOPs?
Over time there have been significant changes. When I was at the ESOP Company, only C-Corporations could have an ESOP, and there really aren’t that many privately held C-Corporations. There’s far more S-Corporations, known as tax pass-through entities. The watershed event circa 1999/2000 was legislation allowing S-Corporations to have ESOPs. It was very convoluted legislation and awkward at first, so there was subsequent refinement. Today probably eighty to ninety percent of all new ESOPs are S-Corporations.
Another key development is that the Department of Labor recently negotiated what is now referred to as the DOL Fiduciary Process Agreement that was reached with one of the major Trust companies. This Agreement places substantial due diligence on the part of the Trustee for new installation ESOPs. The Trustee is required to thoroughly vet the experience and competence of their independent financial advisor, most typically a valuation firm. The valuation firm in the eyes of the DOL cannot have any prior relationship with the candidate ESOP Company or its shareholders. All of our clients are ESOP trustees, so they look to us for the support, analysis, and documentation.
ESOPs in today’s world are complex, often because so many new ESOPs are S-Corporations that go to 100% employee ownership. It’s really a mergers and acquisitions environment. Most ESOPs today intend the company to be employee owned. This is a lot different than the ESOP that owns, say, twenty percent of the stock. When the ESOP owns 100% of the stock, we must address corporate governance. We often consider management incentives and retention programs. Questions have to be asked how do we finance this substantial buy-out? There’s a far greater complexity than the early days when most ESOPs were minority blocks of stock in C-Corporations.
Q: What is the ESOP's impact on widening income gaps?
In theory, they do address it very well. I don’t think there’s enough ESOPs currently to really make a material difference. It’s too bad.
When a company is sold to an ESOP, we typically have a situation going forward for many years. The financial value of the company doesn’t just belong to one person, say a private equity firm, for the benefit of a few. By Federal regulation, the employees participate in the growth and the value of the company according to Federal rules that are well understood and documented. This is not absolute equality, people economically participate at different levels depending on what they contribute to the company, and that’s reasonable. That makes sense. The measuring yardstick is typically your W-2. The logic is that if you’re paid more, you’re a greater contributor to the success of the firm and therefore your participation in the ESOP correspondingly is higher. Everyone typically gets the same percentage contribution, but the earning base will significantly vary by position.
Q: Are there any special industry recognitions and honors you have recieved?
Thanks for asking. I’ve been recognized as a board member, an author, speaker, and an outstanding member. There have been many awards for NACVA (the National Association of Certified Valuation Analysists), Exit Planning Institute, Wisconsin Institute of CPAs among others. Those are wonderful acknowledgments, but the most appreciated is the AICPA. That’s the marquee professional organization for me as a CPA.
I have been involved with AICPA as an author starting out writing seminars for them. They were really books, and the seminars were eventually converted to actual books. I’ve been a speaker for AICPA since about 1994.
Being involved with the FVSEC (Forensic and Valuation Services Executive Committee) was the capstone. This is the highest highest-ranking valuation committee on the planet and to be part of that for my three years was an honor. I contributed to the FVSEC on ESOPs, but during my three-year term many position papers were introduced, and we had to review and formally write comments and give feedback. A lot of that work became valuation regulations for AICPA or on a much broader, global stage. That was wonderful to really be part of that process.
Q: Can you tell us about any special or unique or "out of the box" ESOPs?
This question dovetails for me into the fact that ESOPs are in most cases a mergers and acquisitions environment. Because of S-Corporations tax attributes, a one hundred percent S-Corporation ESOP basically does not pay any US Federal or State income taxes. They’re income tax-free entities. Please keep in mind that such companies may not have income tax exposure, but they do have a substantial stock repurchase obligation. These full buyout transactions realize the second to none tax attribute benefits, and some will use those benefits to acquire other companies. In my opinion, they are far more tax efficient than private equity firms. Some of those ESOP transactions have been enormously complex.
Substantial tax planning goes into these complex buyouts. In a heavily leveraged transaction, there may likely be a “debt stack” with senior debt, asset based financing, and mezzanine debt. There are typically different tranches of obligation. Historically, the company cash flows and can service all this debt because of the wonderful tax attributes, and the in-depth due diligence that must be completed. The company is not designed to be heavily leveraged forever. The company is typically designed to be heavily leveraged for about three or four years. In that period of time, chances are that the debt can be reduced by half and we get things to a more manageable level. As the acquisition debt is repaid, the 100% ESOP Company will not be paying taxes, but after a period of time, the ESOP stock repurchase liability becomes a factor.
Q: What is the future of ESOPs?
Some of the good news is that ESOPs have been around since the early 1970s. There weren’t many of them in the early years because they just weren’t that well understood. But with S-Corporations in particular - they’ve been around since about the year 2000. There’s been enough installed where they’re living, iconic success symbols. Some of the firms are stellar corporate citizens and often voted as a best place to work. We have a number of well-established highly successful ESOP companies here in Wisconsin. These companies serve as living symbols of what is possible with an ESOP.
The financial success doesn’t happen overnight. It is the result of a longer term commitment to stay the course and communicate with employees. It’s not like private equity where they buy the firm, cut the costs and flip it in three to five years. That’s not the business model for an ESOP.
One of the biggest challenges for our team is defining the goals of the business owners. We are often one of the first professionals to broach the subject of transition planning. We often begin: “Mr. and Mrs. Business Owner, you’ve founded this company, and the company has grown. What’s your vision of the future?” Overwhelmingly the independence of the company is important for them. With an ESOP, you may not get the highest dollar for your company. You do have to weigh in the tax incentives and consider the totality. But in the longer term, what are the selling shareholders’ goals? We have an opportunity to listen to that story. A huge plus with ESOPs, they’re exceptionally flexible. If the selling shareholders can articulate their goals, there’s a very high likelihood the ESOP can be customized and tailored to meet those goals.
I truly believe in employee ownership. I think that ESOPs are not for all companies. ESOPs are for established, fairly mature companies that are going to be around for a while like retail grocery stores. Other promising candidates are established manufacturing firms and industrial distributors. Engineering firms are great candidates along with other consulting companies. Certain companies are not good candidates. Technology firms are usually subject to such fast-moving technology, rules, and regulations that an ESOP is not a good match. Companies in failing or shrinking industries are poor matches - like many printers.
With an ESOP there’s a unique attribute: the stock repurchase obligation. There’s tax incentives designed to help launch these companies into employee-owned entities, but the incentives that are provided to encourage the stock ownership eventually result in stock has to be redeemed from employees that are leaving the employ of the company. That repurchase obligation is out there. If we do it right, we’re not paying income taxes, but we have this repurchase obligation that has to be addressed.
As long as a company is either growing or stable, we can typically service that repurchase obligation. If the company goes into a slow decline, the repurchase obligation comes back to greet us. It’s a call on the capital of the company, and for a declining position, this is often a problem. That’s what happened with many of boutique printers. The internet challenged them, and then they had high repurchase obligations as they went into decline. For them, the ESOP turns out to be a decided negative. In a market-based economy you have to consider the longer-term prospects for the company. Mostly there are financial winners, but there are a few that do not succeed.
But where they do make sense, chances are that the companies are really tremendously successful. I’m being a champion here. It’s more important to have far more participants in our market-based economy than a few of multi-billionaires. There’s some fabulous wealth concentrated there, but I’d much rather see far more participation with employee-owned companies.
For example, as Kelso indicated, a company with four hundred employees will typically have a market for four hundred refrigerators, probably six hundred and fifty automobiles, and those folks are going to be buying houses and educating children. You have a robust middle class and more participants in a market-based economy. It is much better for everyone as a result.
ESOPs can help deliver on that point.
Q: Anything with your history or your achievements that maybe I haven’t touched on that you wanted to make sure that I got to?
Thanks for asking. There is. Along the way, by speaking and writing, being on committees, doing high-profile volunteer work, I was asked if I would consider being an expert at trial. With ESOPs it’s all Federal rules and regulations. I’ve testified in regional district courts, but that’s like AAA baseball where Federal Court is the “majors” (forgive the sports analogy). The Federal Rules of jurisprudence are exacting, and attorneys and experts must adjust to strict protocols. As an expert, you are really opening yourself up to critical examination. The other side in the litigation can go after you, and they’re really going to try to discredit you. They will probe and may be nasty, and it’s an adversarial situation. But I have agreed to be an expert. I don’t do a lot of that work, but over the years probably eight or ten major trials. Some of the cases involved valuations in the hundreds of millions of dollars. Writing major reports, handling discovery and depositions, having it subject to cross-exam and adversarial parties and then doing well in Court and prevailing is an accomplishment. It certainly helps to be engaged by counsel that is knowledgeable about valuations.
Finally, I think the most significant accomplishment is having the good fortune to find and hire a team of very talented professionals. I have three partners, and I’m in the process of transition to a new partner group that’s younger and very talented. We’re making a statement to the industry and to our client Trust companies that if you like ESI in the past, you’re really going to like us in the future. We’ve addressed the succession issues. There will be a seamless transition at ESI, and that has not been the case with several of our competitors.
Q: What is your advice for new associates?
I can try to serve as a role model and champion. Take the long view, there’s a difference between a founder (in my case a guy that started in his basement, was unsure and took lots of risks) and the Principals needed to take ESI to the next level. We don’t need that absolute entrepreneurial individual, that’s what founders are frequently for, and I recognize that.
We need a collaborative environment going forward for ESI to continue to enjoy or even to expand our footprint within the industry and possibly to develop some additional skills and services. Take the long view. I think it’s a very rewarding place to work.