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More professional firms are embracing employee ownership

BALTIMORE – The ownership of Ayers Saint Gross has changed hands four times, all while keeping the design firm intact and in Baltimore for more than a century.

But when it came time for yet another transition, the owners looked for a less traditional way to keep the firm going without selling stock to new leaders, merging with another firm or selling to a competitor.

“It would have been easy to sell out and take our money and leave,” said Jim Wheeler, a principal and president of the 150-person firm, known for planning and design projects at universities, museums and hospitals. “But we didn’t want to lose our identity and everything we created.”

A new chief financial officer had experience with employee stock ownership plans and suggested taking that route.

ESOPs, a type of employee benefit plan that was almost unheard of before the early 1970s, have become the most common form of employee ownership in the United States, covering 13.5 million workers at 7,000 companies last year, according to the National Center for Employee Ownership. They’re becoming an increasingly popular option for professional firms facing an ownership change.

Companies establish an ESOP to buy out the shares of current owners, borrow money or offer a worker benefit. Typically, a company creates a trust fund and can make tax-deductible contributions of new shares or cash to buy existing shares. The trust also can borrow money to buy new or existing shares. Shares are allocated to accounts of employees. When workers leave or retire, the trust buys back shares at the current value.

Several companies in Western New York have been transferred to employee ownership through ESOPS, including Ferguson Electric, Great Lakes Orthodontics, Printing Prep, Stedman Old Farm Nurseries and others.

A 2000 study by Rutgers University researchers found that companies with ESOPs see increases in sales, employment and sales per employee at a rate as much as 2.4 percent higher than at those without an ESOP.

“We immediately said ‘This is the ticket,’ ” said Wheeler, who made the decision with fellow principals Adam Gross and Glenn Birx. “We could transfer 100 percent of the stock with an ESOP and become employee-owned and have a tax-efficient way to do things.”

ESOPs work best for companies with strong cash flow, needed to finance the acquisition, and strong management teams to continue running the business and in cases where employees are key to the business’ value, said Steven B. Greenapple, an attorney with Steiker, Greenapple and Croscut, a Philadelphia-based firm that advises firms on ESOPs, and which worked with ASG.

“Architecture and engineering firms are perfect examples. ... Employees are the only asset the company has,” he said.

The structure works well when owners have reached an age where they want to start transitioning out of the business, either quickly or over a period of years, Greenapple said.

And ESOPs offer strong tax benefits, he added. For instance, C corporations can elect to defer paying taxes on gains from the sale to an ESOP, and S corporations owned by an ESOP essentially operate tax-free, allowing the company to pay off debt more quickly. Also, a company’s contributions to the ESOP, in the form of stock or cash, are tax-deductible, similar to retirement plan contributions.

Many more professional firms, such as architecture and engineering companies, are making the jump to ESOPs compared to a decade ago, said Michael Keeling, president of the ESOP Association, a trade group. Advisers are increasingly recommending the route for companies, he said.

ESOPs face some risks specifically related how they’re structured, Greenapple said. ESOP transactions can overvalue the stock, which then requires an excessive amount of the company’s cash flow to pay off debt.

“The way you avoid that is you get a good valuation and work with professionals who don’t overvalue it,” he said.

“The second risk is you don’t have a management team that can take over when the founder leaves. The ESOP is a financial buyer. It doesn’t run the company.”

ESOPs are not a panacea for corporate woes. If a company fails, the employees stand to lose what could be an important part of their retirement savings. In a bankruptcy reorganization, for instance, shareholders, whether employees or not, have a lower priority than creditors and rarely see a payout.