anchoring businesses & good jobs with employee ownership

by

Attorney Deborah Groban Olsonand

Robert Chiaravalli

Michigan Labor Management Association Conference April 19, 2012, Kellogg Center Michigan State University

Principal Financial

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Employee owned companies are subject to all the stresses of traditional companies

But, statistically, they are more successful at surviving and thriving as employers

Employee owners innovate rather than laying themselves off

There are successful unionized employee owned companies

Unions can play an important role in creating robust employee owned companies

ESOPs and c0-operatives are two forms of EO that work well in unionized companies

Inventors & their patents can also be used to anchor jobs

Key Concepts

What is a “successful” company?

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Which Company Stakeholders matter?

Shareholders ?Employees ?Community ?

Law and tradition only distribute profit & give voice to shareholders

Majority employee owned companies usually protect the interests of all three –because they are intertwined

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My definition of success

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Capacity to evolve as market conditions changeSustainable GrowthIncrease in stock valueIncrease in employee compensation or benefitsJob creation, or at least preservationIncreased labor/management harmony or decrease

in grievancesSurvival of the business with a union contractIncreased employee participation in decision

making leading to increased quality, productivity and profitability

Employee Owned Companies are 3 to 4 times less likely to lay off or lose workers

From 2010 General Social Survey – table used with permission from National Center for Employee Ownership Employee Ownership Report p. 6 March-April 2012

Worker ownership makes people healthier & happier, not just wealthier

Attorney Deborah Groban Olsonwww.esoplaw.com

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David Erdal’s 1999 PhD Thesis at St. Andrews “The Psychology of Sharing” provides preliminary evidence (not conclusive proof) that those living in a community with a large percentage of worker cooperatives are healthier, better educated, have less crime and more social participation than people in a comparable Italian town with fewer worker cooperatives.

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Co-operative town worse

Co-operative town better

Caption: the graph shows the differences on the following measures:

Crime: victimisation (C1), policing (C2), confidence (C3), feeling of security (C4), domestic violence (C5)

Education: level attained (E1), age leaving school (E2), truancy (E3), expected truancy (E4), post-school training (E5), perceived importance of education (E6)

Health: physical health (H1), emotional health (H2) (also measured: mortality)

Social Environment: perceived gap between rich and poor (SE1), helpfulness of authorities (SE2), supportiveness of social networks (SE3)

Social Participation: membership of clubs (SP) (also measured: voting, blood donation)

Participative employee ownership leads to successful job creation & retention

Mondragon: 50 years from 0 to 100,000 jobs and assets of 38 billion euro

Emilia Romagna – 8,000 worker coops = 7% of Italy’s population; 12% of exports, 30% of patents

Maryland Brush – old, inner-city employee -owned company makes the leap to green economy product

EBO – diversification through active employee ownership – from mining equipment to recycling equipment & medical devices – tripled business in 5 years

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Ongoing support & co-op resource sharing leads to more successful start- upsWell funded & staffed support centers provide ongoing

assistance with accounting, legal, business plansMuch more support than our small business

development centersSaiolan Start-up center at Mondragon University

Started in 1980’s89% of its start-ups are still in business 5 years later83% are still in business 10 years later

US system – 1 out of 5 start-ups is alive in 5 yearsC2BE seeks to create support cooperative for start-ups

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Ohio manufacturing job loss 2000-2008Ohio ESOP Survey – Kent State University

29% overall1% Employee Owned Network

Reasons:Far less likely to outsourceHave avg. 2x higher rates of capital

investmentMore employee participation in making business

decisions

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Employee Ownership Trends

From NCEO analysis of US DOL data -used with permission from National Center for Employee Ownership (NECO )Employee Ownership Report p. 7 March-April 2012

Extent of US Employee Ownership

From 2010 General Social Survey - used with permission from National Center for Employee Ownership (NECO )Employee Ownership Report p. 6 March-April 2012

Increase in Employee Owners’ Stock % and Value 2006-2010

From 2010 General Social Survey - used with permission from National Center for Employee Ownership (NECO )Employee Ownership Report p. 6 March-April 2012

The Power of Ownership


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ESOPs appear to increase sales, employment, and sales/employee over what would have been anticipated, absent an ESOP. ESOP companies are also more likely to continue operating as

independent companies over the course of several years.

ESOP companies have sales growth 2.4% per year faster in the years following their ESOP than would been expected, based on the match-up against competitors in the pre-ESOP period.

Employment increased 2.3% per year and sales per employee, 2.4%.

Source: 2001 Study by Dr. Douglas L. Kruse and Dr. Joseph R. Blasi, School of Management and Labor Relations at Rutgers University

Ongoing, successful, unionized employee owned company examples

Homeland Grocery Stores – UFCW

Maryland Brush Company – USW

AWG bought stores in 2002 bankruptcy & turned them around

2011 AWG created HAC to sell 100% ownership of s 76 stores + expansion stores to employees thru ESOP

Employer sought to terminate UFCW’s DB planUFCW negotiated:

New DB planESOP participation for union membersSignificant role for union on company board of directorsCBA covering any new stores opened by the company

UFCW & HAC Partnership to Increase Employee Owned & Unionized Stores

Maryland Brush Company (MBC)Specializes in custom designed power brushes

Started in 1851

At the beginning of 19th Century, the brush business was largest employer in Baltimore

MBC was part of PPG Industries since 1904Had 750 employees at its peak with PPG

Established in 1990 as 100% employee owned USW ESOPNow has 30 employees. Majority of the 70 former

employees retired or left on their own accord

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MBC cooperative governance structure – in a 100% S corporation ESOP4 internal board members

MBC presidentLocal union president1 selected by salary group1 selected by wage group

3 external board members1 appointed by USW district director1 appointed by MBC president1 nominated by USW, affirmed by MBC

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Maryland Brush mature marketsSteel industryNonferrous metals industryTruck Tire retread industryIndustrial distributor marketSpecial machinery marketWelding industryBy 2007 - Maryland Brush Company knew it

needed newer products.

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Old, inner-city EO companyleaps into new economy MBC decided to diversify outside of the brush

industrySought professional helpIt took 2-3 years to select the right consultantIt took 2 years to select the right investment

opportunityExpanding its product line from mature,

declining market to new solar energy market2010 MBC bought the IP and manufacturing

rights for Photensity

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MBC co-operative values informing diversificationCompany sees itself as long term community

asset

Reinvest in company

Maintain cash reserves for potential investment in core business or diversification opportunity

Balance risk to protect investment of older workers & jobs needs of younger workers

Involve employees in all major decisions

Retain any competitive edge

Maintain relationships

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Union role in MBC diversificationMBC sought & received funding from the

State of Maryland and the US Department of Energy

Needed all its political connections in this effort

USW helped MBC get necessary government attention for its application

2009 USW and Mondragon Cooperative Corporation (MCC) announced intent to create unionized co-op companies in the US

2012 USW, MCC and OEOC published “Sustainable Jobs, Sustainable Communities: The Union – C0-op Model”

2012 Pittsburgh Clean & Green Laundry – union- co-op set to launch

2012 Cincinnati Union Co-op Initiative – feasibility studies underway for 3 companies

USW & Mondragon Union Co-op Agreement

Labor - patent strategiesA US patent holder has the "the right to exclude others from

making, using, offering for sale or selling the invention throughout the United States or importing the invention into the United States.”

Inventors often have trouble getting large companies to respect their patent rights. Labor and inventors can work together to protect jobs and inventors.

A labor-friendly entity holding US patents could exclude low-wage, non-union and non-domestic companies from making, using or selling in the US, or importing into the US, any products covered by its patents.

Hawaii Sustainable Business Corporation Act enables such entities which can also be accomplished with L3Cs in Michigan

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2006 – Detroit and Hawaii-based Ingenuity US, L3C (IUS) formed to implement labor-patent strategies

2008- 2012 Numerous IUS pre-feasibility studies on potential living-wage businesses to develop in Detroit

2006-08 – Hawaii Ingenuity Corp. Act passed and vetoed twice by GOP Governor

2010 – Labor summit at UAW in DC on labor-patent strategies

2011 - Hawaii Sustainable Business Corp. (SBC) Act passed & implemented

Inventors as labor allies & potential partners in worker owned businesses

Job Creation/Protection Significance of Hawaii SBC law from Chief Patent Judge Paul Michel (retired) November 2011 white paper

"Key provisions of this new law harness the right to exclude conferred by patents creating and retaining good jobs in communities, upholding human rights and protecting the environment, while simultaneously increasing the asset value of the underlying intellectual property."

Types of Employee Ownership Traditional Corporate & LLC forms can be used

Need not include all employees, nor maintain EO

Securities law issues

Worker Cooperatives

Usually include all full-time workers & majority ownership

One vote per person

Member supermajority vote on selling to outsider

Some tax benefits

Capital financing can be difficult

Employee Stock Ownership Plan (ESOP)

ERISA Plan – Trustee decides about sale to outsider

Can own any % of Co.

May have substantial or limited EO voting & voice

Many tax benefits to seller, company & employees

What are Employee Stock Ownership Plans (ESOPs)?


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ESOPs are:

• tax-advantaged (to seller, company, employee)

• employee benefit plans

• operating through a trust

Company makes tax-deductible contributions of stock or cash to buy stock.

Stock is allocated to accounts for individual participants.

Participants receive stock or its cash value on retirement or termination of employment.

Employees vote stock through a trust.

Some are highly democratic, some are not.

Best Uses of ESOPs


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Sale of a family owned businessSale of a majority interest in a companyWhere payroll is a high % of operating

expenseWhere broad based employee ownership

is desiredWhen Company & Sellers have use for

tax deductionsWhere independent valuation is

acceptable to sellers

Major Uses for ESOPs


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Cheap capital for business investment, expansion or divestiturePrincipal and interest tax-deductibleDeduction for dividends to employeesDeduction for dividends used by ESOP for debt retirementDeduction for dividends reinvested by employees

Creating a local market for selling stockholdersAnchoring jobs and business in local communitiesLocal control over future investment or

disinvestments

ESOP Varieties Presented


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Basic stock bonus (non-leveraged)Leveraged ESOP in C CorpRollover capital gains deferral ESOP

(1042)Sub S ESOP

ESOP Advantages for C Corp. Seller


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Tax deduction up to 25% of payroll to repay stock purchase loan principal +

Unlimited tax deduction for payment of reasonable interest on ESOP loan +

Dividends tax deductible – if paid in cash, used to pay debt, reinvested by participant +

Tax on capital gains postponed indefinitely through rollover (for Subchapter “C” Company) to an ESOP or Eligible Worker Owned Cooperative

Solution for business succession & provides market for closely held stock

Increased cash flow and working capital

Majority control can be maintained

Greater productivity and motivation from employee owners

ESOP Advantages for Employee/Owners


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Opportunity to share in company’s growth and build capital

Deferral and reduction of taxesStock can be received at no risk or expenseESOP can save jobsDividend income

Advantages to Majority ESOP of Sub S Election


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• ESOP exempt from tax on its portion of Company income

• Income grows tax free in ESOP & is only taxed to participants upon distribution

• ESOP may distribute benefits in cash, not stock

• No dissolution of S corp. due to ESOP distribution

Basic Stock Bonus ESOP (1) Stock Contribution


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ABC Co. ESOP

Employees

1. Contributes stock

2. Allocates and distributes stock

to employees

Basic Stock Bonus ESOP (2) Cash Contribution


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ABC Co.

1. Contributes cash

ESOP

Employees Owner

2. Purchasesstock from

owner for cash

3. Allocates anddistributes stock

to employees Sells s

tock

to E

SOP

ESOP Financing – Subchapter C Company Borrows Funds to Issue New Stock and/or Purchase Stock from Owners

Attorney Deborah Groban Olson www.esoplaw.com41

BankSubchapter C

Company

Loan proceeds

Pledge Collateral

Loan Payments

ESOP

Sale of stock

Tax deductible

principal and interest

payments Loan Payments

Mirror lo

an

proceeds

contrib

uted to

purchase

stock

Sellingshareholders

EmployeesSale

of st

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Cash

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Resale of stock

upon retirement

Gradual allocationand vesting of stock

Employee Accounts

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Stock ValuationContributions & AllocationsParticipationVestingDistributionTaxesGrowing your ESOP balance

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Contributions to the ESOP

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Employees do not contribute to the ESOP Board of directors determines contribution

amount each year – discretionary, but must be regular

Except – if money borrowed thru ESOP, allocations must be made to employees as loan is repaid

Allocated to account as of end of plan year Employee portion typically based on your

eligible compensation – can be flatter Stock must be valued annually by an

independent appraiser

Vesting

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Below are legal limits, plan can be more generous:

Year of service = 1,000 hours Prior service may count

6-year graduated schedule or 3-year cliff schedule

Exceptions Retirement, death, or disability

Forfeit unvested balance

Distribution Start Timing

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Retirement, death, or disability No later than one year after end of

final plan year Any other reason

No later than five years after end of final plan year

Distribution Method

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Most distributions are in cash In some plans employees can demand

stock Right to demand cash if company is not

publicly traded Single lump sum, or Annual installments

Over not more than 5 years

Taxes on ESOP Distributions

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Defer taxes by rolling over IRA, or Other qualified retirement plan

Take the cash 20% federal withholding 10% early withdrawal penalty

Stock distributions Net unrealized appreciation Sell back to company – Put option

How Employee ESOP Balance Can Grow

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More shares of company stockAdditional shares contributed by company Shares forfeited by partially or non-vested participants

who leave employmentShares redeemed from retirees re-contributed to ESOP

Value Shares can increase in value with greater employee

participation and continued product/service innovation based on long-term stake

Value can decrease due to market pressures, poor management, or catastrophe– but participatory EO can turn these around

Elements for Success

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Truth, honesty, open dealing, forego politics & historyWith all people & facts affecting the decision to

buyBuying and running the companyCreating & operating a meaningful participation

systemStock purchase based on careful, honest

business plan, and fair valuationAdequate capitalTechnically competent managementManagement & employees educated on & willing

to participate fully in participation system

Elements for Failure

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Insufficient capitalLoss of key people or functionsFailure to innovateLack of clarity in stakeholder

expectations – sellers, management or workers

Dishonest valuation, fiduciary breach

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When to consider employee ownership• Viable business lacks a successor owner

• Potential business buyer is likely to close the facility, and take viable work elsewhere

• Profitable facility or product line will be closed because it no longer fits the corporate strategy of the parent company

•Privatization is happening and workers create a company to bid on their jobs

•A group of employees have a product idea that the company is not interested in

•An inventor has a marketable idea and seeks help realizing it

•Start as early as possible!

For more information contact

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[email protected](313) 331-7821

anchoring businesses & good jobs with employee ownership

Documents

employee compensation

robust employee

successful unionized

shareholders majority

worker ownership

successful company

fewer worker cooperatives

comparable italian town