Bridge Out Ahead: How to Bring Your ESOP Into the Growth Zone

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I have been working with a couple of clients who have re-organized from a founder owner structure into an ESOP structure.  ESOP (Employee Stock Ownership Plans) have been around since the late 1950’s, but have recently taken on a much bigger role, as many founders of private firms are moving towards retirement and wish to set up an investment vehicle, that when it works well, provides a win win for both the new employee owners and the founding members.  The win is that the founding team can sell its shares to the company for cash, and the employees get a valuable asset for their retirement account that they don’t need to pay taxes on until they sell.  For more details on ESOP’s, please check out this CNN Money piece, or this primer from Wells Fargo.

When the ESOP is established, the leadership team has implicitly set expectations on the firm to consistently grow valuation so that the shares of the whole team appreciate in value.  This valuation is assessed by an outside fiduciary in accordance with very specific legal guidelines.

The good news is that the shared ownership of the firm builds a powerful platform for goal alignment and execution.  The harder truth is that if the growth benchmarks are not met, disappointment will be widespread as well.

The hard side to this is a common set of issues that the new team needs to take on:

  1. Oftentimes, one of the key drivers for the ESOP is that the founding leader and their team is ready to do something new.  Once established, it’s not uncommon for the original leadership team to pursue other interests, and once the founder departs, it is very common for other key leaders to depart as well.
  2. What multiplies the impact of this, is with this changeover, they are losing the people who have the founder’s memory – in other words, the hard work and tough decisions it took to get the firm to where it is today.
  3. The pressure to drive value, and keep things on track for the new team, sets up conditions for a very conservative leadership bias.  The conservatism leads to a focus on operational efficiency that can only take a business so far.  Eventually, earnings will stagnate when market saturation is reached, or when sufficient competition emerges.

How then, does a growth strategist tackle this?  While each situation is different and needs independent analysis, there are common elements:

  1. Reality creates vitality. It’s important to do the math on the valuation side to make sure the growth plan contains sufficient opportunity to meet the organization’s objectives.  By clearly identifying the trajectory for the firm, and then partitioning the earning’s load the existing business can carry, you can develop a very clear view of the necessary additions and commitment.
  2. Time is not your friend.  It is not uncommon for these firms to have a substantial balance sheet, which at the outset feels like an insurance policy.  The truth is that the more time that elapses until decisions are made to establish growth programs, the more your options are narrowing.  Lower risk organic options take time to develop meaningful earnings streams, and if too much time has elapsed, the firm might be pushed into doing some higher risk M&A, which holds the promise for a quicker establishment of earnings, but has significant integration risks attached to it.  Growth is the output of hard work and decision making, and the sooner this is addressed, the more options you will have.
  3. The leadership team will be tested.  Setting the firm on a path of growth will challenge the new management to quickly establish themselves, parse options and make decisions.  It takes significant discipline to establish a good balance of rigor and decision-making, especially if those muscles are reforming in the firm.
  4. A portfolio needs to be assembled.  A well-structured growth plan will include investments in both the core and non-core areas.  In the Growth Zone, I talk about the 4-quadrant model, which provides a nice structure for beginning to develop and build work streams for the growth programs.  By starting early and spreading risk and timing across a well-reasoned group of programs, you can build a robust plan that the board and employee stakeholders can get behind.  The right project, and the right time, will lead to solid results.
  5. It takes a robust cross-functional effort.  Growth programs that move the needle are not something that can be done by one function, or even an individual on the senior management team.  To develop programs that deliver, they need to be built using principles that allow true high-quality opportunity development and decision-making.

The development of growth programs that become part of the operational plan is hard work that demands the best the team has to bring forward.  Just as good advisors helped form the ESOP in the first place, it only make sense to bring on solid advisors who can provide objective portfolio guidance to the team.

If you’d like to talk about how the methodology described in the Growth Zone, and Right Project Right Team and Right Plan can be used to build a robust solution for your team, please send me an email or call me at 847-651-1014.

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