Here’s What Happens When Workers Become Employee-Owners

The perks of an ESOP include more company tax deductions and employee retirement benefits, and businesses that won’t be gutted by outside buyers.

Tommy Silva, the founder and owner of T&T Tinting, started thinking about his retirement and the future of his company when he turned 55 in 2016.

“I don’t have children, nephews or nieces, or anybody that’s in the business that I can pass it to. I’ve been in the business over 35 years already. I’m thinking, ‘How do I get out of this?’ ”

Silva consulted a financial and succession advisor, Marko Mijuskovic of WestPac Wealth Partners, to consider exit strategies.

“The first thing we did was look at a third-party sale,” he says. “There were a couple of companies on the mainland that wanted to acquire T&T because of who we are. We’re No. 1 in the nation most years for auto tinting by far. We do more cars than any tint shop in California or Nevada or Arizona or Florida or anywhere else.”

Didn’t Like Their Plans

Silva talked with several entities but wasn’t comfortable selling to them after hearing their plans. “It included bringing in their people and getting rid of my management staff, swap-ping brands out that my customers have become accustomed to and have lifetime warranties that would become void.

“You know, the deal was good, the money’s good, but I couldn’t sign it. It didn’t settle well with me.”

Mijuskovic then proposed an employee stock ownership plan and Silva said yes. T&T began the ESOP process in 2017 and the plan became official in October 2021, right around the company’s 40th anniversary.

To help with the transition, Silva hired Terry Lee, an ESOP expert who also helped the Roy’s restaurant chain and Teddy’s Bigger Burgers transition toward employee ownership.“

Passionate About It

”Brian Bowers is president of the ESOP Association’s Hawai‘i chapter. Bowers + Kubota Consulting Inc., the construction management, architectural and engineering design firm he co-founded, became a 100% ESOP in 2012.

“The more I learned about ESOPs, the more I became passionate about it. When all the benefits of becoming ESOP were first explained to us, it seemed too good to be true. Like, there’s this great retirement plan for your company, and your company is going to become a tax-free entity. It almost doesn’t even sound right. But it is, in fact, true,” says Bowers.

“I think it’s been remarkably successful. The company has grown well over 10% a year since 2012.”

One reason Bowers advocates for ESOPs is an ongoing small-business crisis. Baby Boomers own about half of all privately held firms in Hawai‘i and many owners need to figure out exit strategies so they can retire. This surge in retirements is part of a series of trends involving aging Boomers that is nicknamed the “Silver Tsunami.”

According to the national ESOP Association, “Employee ownership, including ESOPs and work cooperatives, addresses the Silver Tsunami by providing viable succession plans that lead to job retention and dollars staying local.”

Entrepreneurial Mindset

An ESOP is a type of employee retirement plan that sells all or part of a company’s stock to a trust. As employees become vested – typically after five or six years on the job – they earn an ownership stake. That stake increases the longer they stay with the company. When employees retire, leave or die, their shares are bought back by the ESOP for the value of the stock at that time.

The transition to an ESOP is complicated, so people considering one should hire an expert.

Business owners can separate from the company once the ESOP is set up, or as soon as they feel comfortable. “T&T Tinting is my baby and I plan to stay involved as a consultant to our new CEO (Kyle Horimoto) as well as the management team to help them with any large decisions such as future expansion, etc.,” Silva says.

Change In Attitude

Owning shares in a business can change an employee’s thinking, Silva says.

“The best benefit is you get all your employees engaged in really looking at the business as their own and not the boss’s. ‘I want to pick up that trash on the floor. I’m going to make my bathroom look clean for my client. I’m going to make sure when I walk by everybody’s smiling.’ Everybody’s engaged in all of those aspects that before only the owner would do.”

Employee-owners are motivated to make the business more profitable because revenue growth means higher share prices, which benefits them when they leave the company.

Alyssa Lau, an employee-owner of Austin Tsutsumi and Associates, agrees. “We all have a role to play in the success of our ESOP and when we all contribute to the company, we all benefit,” she says in the January 2022 newsletter of the Hawai‘i Chapter of The ESOP Association.

Another employee-owner of that same company, Tyler Makabe, also has positive things to say. “ESOP is like a reward for helping build the company. The success of ATA truly lies in the hands of all of us, and hard work betrays none.”

Tax Benefits

Beyond protecting the company’s existing workforce, culture and reputation, ESOPs are attractive because of tax benefits. S corporations that are 100% ESOPs are exempt from paying federal and state income taxes, unless the state they are in specifically implements an income tax on S corporations. Hawai‘i does not.

“That was one of the biggest things going forward for them (the employees). Not for me as an exiting owner, but for them as new owners,” says Silva. “They are a chapter S corporation. That is completely tax exempt, no corporate tax.”

Another benefit is that qualifying companies can take loans from existing profit-sharing plans, with tax-de-ductible payments on both the principal and interest. That saves a lot of money in borrowing costs.

Silva says T&T’s employee-owners plan to use the savings to grow and improve the business.

“We’re talking about expanding our automotive paint protection division into doing full color change wraps for cars, vinyl, all of that. They’ve also been looking at possibilities of expansion to the outer islands.”

10.57 Million Employee-Owners

The ESOP Association, with chapters nationwide, says there are 6,549 ESOPs in the U.S., with 10.57 million employ-ee-owners. The Hawai‘i chapter currently has 40 member companies.

A 2021 study by the National Center for Employee Ownership on behalf of Employee-Owned S Corporations of America found many financial advantages with ESOPs. It said ESOPs provided greater financial security for employees heading into and during the pandemic, compared with similar conventional firms. Job retention was better with ESOPs, too.

“Controlling for company size, industry and region, the ESOP advantage is an estimated $67,000 more assets in the average account balance,” the study says.

Hawai‘i is home to 65 ESOP businesses. In addition to those already mentioned, they include HPM Building Supply, Electricians Inc., Ronald N.S. Ho & Associates, Aqua Engineers, Unitek, C C Engineering & Construction Inc., American Floor & Home, and Chart rehabilitation.

“I want to educate people on ESOPs because I think businesses should know they are a viable ownership transition strategy. All companies should at least consider it as part of their succession plan,” says Bowers.