Fostering Sustainability at ESOPs

Business Life Cycle: ESOP Sustainability – Succession

Shirtsleeves to Shirtsleeves in three Generations

By Jack Veale, President, PTCFO, Inc

The Business Life Cycle of a company involves not only an internal organization’s evolution, it also involves the company’s ownership transition and governance dynamics.  The title of this article is about an “American proverb” that shows up in other countries and cultures.  When Andrew Carnegie coined the term in the late 1800’s, he was describing the actions and behaviors of a typical family owned business with high wealth.  Almost every language has a common philosophical view of wealth and enterprise.Italy’s translation, for example, is “from barn stalls to the stars and back to barn stalls.” Great Britainhas the phrase: “from clogs to clogs in three generations.” For ESOP companies, we describe it as “from nonexistence to nonexistence in 3 generations.”

What these phrases mean is the founder of a successful business started “in shirtsleeves” or a nonexistent business, and by the time the third or last generation of owners finished their ownership, the ensuing generation ended up in “shirtsleeves” or “nonexistence” with the company.  Statistically, less than 15% of Family-owned and/or ESOP companies survive the passing of the torch three times.  Family businesses describe these transitions from one generation to the next as a “family business legacy.”  For ESOPs, the word is “Sustainability.”  The “typical” generational transition profile for any company is usually described by the following: “first generation starts the business, second generation builds the business, and the third generation harvests the business, so their offspring are back to “shirtsleeves” again.

In the ESOP world, the word “Sustainability” reflects the same condition as family businesses; ESOPs do not survive many years or generations after the debt of the founder is paid off.  Statistically, in 1995 there were 9232 ESOPs filing 5500’s in the US.  By 2010 there were 6,664 ESOP filings.  In other words, the number of companies forming a new ESOP was less than the number of ESOP companies no longer filing tax returns as an independent ESOP. Why?  ESOP companies usually falter during the transitions to a new management team or style with a new vision that doesn’t work.  In some cases, the value driven by management is less than what the market will pay.   What these ESOP’s lost was the ability to grow in new directions and increase stock value.

In my next post, I’ll discuss aspects of each generation.