ESOP Lessons From One Generation To The Next
A Conversation With
Jay and Tim Rettig
Software Solutions and Intrust IT
In so many of our Leading with Courage® conversations, we speak with one CEO about their ESOP experiences. However, this time we have a perspective we've never had before: A father and son who have both been involved with ESOPs. Jay Rettig was the CEO of Software Solutions, which transitioned to a 100% ESOP in 2004. His son, Tim Rettig, learned much from watching his father's ESOP experience and utilized it to transition his own company, Intrust IT, to an ESOP in 2019. We were eager to hear how the two family members compared and contrasted their respective paths to an ESOP and a Culture of Leadership and Ownership.
Leading With Courage: You both discovered ESOPs and went all-in with them. What makes the ESOP transaction special to you?
JAY: For me, it was the opportunity to grow the business while also doing something for the employees who helped me build it that would be hugely rewarding to them. In fact, I, along with four of my managers, met with a third party that was interested in buying the business. After the meeting, I asked the managers who were in the meeting with me “Do you think this is a good idea or not?" I think they were scared to death of losing their jobs if they said the wrong thing, so they said, "Oh yeah, I think this would be a good idea."
After I considered our options for a few days, I came back to tell them I would be creating an ESOP to own the company. I think they were shocked because I went from a situation where I could've taken all the money off the table and put it in my pocket to transferring my ownership to an ESOP over a period of 10 years. In retrospect, the decision worked very well for them and for me.
Tim, what about you? I mean, you converted Intrust IT to an ESOP and you bought another company specifically to convert it to an ESOP. Can you tell me a little bit about why ESOP transactions are special for you?
TIM: After my father did his ESOP, I understood why he did it and the benefits in it, but, at that time, it didn't fully resonate with me. That was until I had a situation happen with a client of mine, a large billion-dollar company acquiring companies all over the US. Typically, they would acquire a company in some other city and let them operate for about a year independently. Then, over time, we'd fold in their computer system.
They pulled me aside before the next transaction that we were going to do and said that the computer systems at this company were so outdated that they wanted to cut them over into the corporate system right away, as in overnight, rather than waiting. But, they said, 'We don't want you to go in and do anything until the transaction closes.'
So a group of engineers and I flew to the new company that was being acquired. We brought along some equipment and staged it at a nearby hotel for a couple of days. The plan was to go in and get started on Friday night after the transaction closed that same afternoon, working all weekend to set up all the new systems and then have the employees come in Monday to start training.
Over the weekend we installed all the new equipment and set up their conference room as a training center. On Monday morning the employees started coming into the office, and that was when we learned that not a single person had been told what was happening. It was a total surprise and shock to them. Here I was in the middle of it and they were asking me all kinds of questions. The owner had disappeared. He took all of his personal things and left like a thief in the night. He even left town.
Throughout that day more employees started coming into the conference room and were furious. One guy came in, threw his tool belt down and said, "I'm out of here! I've given 20 years of my life to this and this is what he does to me!"
I dealt with that all week. To this day, I don't know if the owner of that company left town because he was embarrassed since he wasn't able to keep the company afloat or if he was ashamed because he took all the money and didn't give any to his employees, thereby breaking all of his promises.
After that experience, I never wanted to put anybody through what I had just witnessed. There had to be a better way. Knowing what my father had done with his ESOP, I started crafting that as a solution. I wanted to take my IT support company towards being an ESOP in the future. That's where the decision came from.
How long did it take you to put Humpty Dumpty back together again after the owner left in the middle of the night?
TIM: I got the IT systems in place and their people trained that week. They were happy that they got all new computers because the ones they had were horrendously outdated and in bad shape.
I had a post-mortem meeting with my customer who had acquired the company and told them we needed to do better next time. I told them next time we needed to have a senior representative from the company there for the announcement, along with an HR person and benefits expert. They were lucky that the employees at this recently acquired company hadn’t all walked out.
Jay, how did you get your start? Talk about your experience with an ESOP transition.
JAY: I worked for another computer services company and they were getting out of business. I was in charge of their support groups I was asked to set up a separate company to support their customers, I eventually ran that new company.
In time, I felt a calling to do something else, to get out of the high-stress business of running a company. I wanted to move to a situation where I'm serving others, which is why I'm a deacon in the Catholic church now.
During our transition, I did a 100% ESOP in one transaction. It was an unusual situation that we had enough cash in the company and we could make this happen, all at once. We became a sub S company, so we don't pay federal taxes. There were a lot of benefits to the employees. I don't even think they even realized how much of a benefit it was to do this all at once. The company has continued to grow and prosper. When I left, it was about 30 people. It's as many as 50 people now.
Tim, this is one for you because you're newer at this. How did you develop as a leader? How did the various organizations you were with help to get you where you are today?
TIM: It was three big influences. One of them isn't around anymore, called HTG – Heartland Technology Group. It was a peer group of other IT companies just like mine and we would meet every quarter for two days to share financials and best practices of running our companies.
The second one was Vistage. I was in that for two years. I got value out of that, mainly because many larger companies were part of it, with retired Presidents and VPs. Then I found the Entrepreneurs Organization and it aligned much more closely with what I was looking for. It was similar to the Vistage peer group, but is an international organization. I have been a member for eight years and I've been president of the Cincinnati chapter and as well as on the regional board.
What do you think about how Tim has managed his ESOP transition?
JAY: I'd have to say that Tim has done a much better job than I did in the post-ESOP world. Since I sold a hundred percent of the business, over a couple of years following the transaction, I stepped away and, to some extent, was pushed out a little bit from ongoing activity in the business. I didn’t help build the corporate culture after it became an ESOP. Tim has done a much better job of getting the buy-in from employees on the whole process from the start. Maybe he learned from my mistakes. If I had to do it over, I'd do that differently.
TIM: And that was one of the things I did talk to (Jay) about – what would you have done differently? He said he would have gotten the employees engaged in the finances and the company's operation sooner, ahead of the ESOP, rather than after.
Is there any advice you'd give to someone going into an ESOP leadership position for the first time?
TIM: The most significant piece of advice is to make sure that the employees understand how the ESOP works and how their actions can improve the value of the company. How cost savings they can identify, additional margin that they can earn from the new products, etc. drives share value. With our market value being roughly six times EBITDA, finding a way to save the company $10,000 a year increases the company's value by $60,000, which correlates directly to our stock price and funds for retirement in the future. That’s a great story to share with employee-owners that helps keep them engaged with our purpose.
JAY: I remember right after we made the transition to an ESOP, some people didn't understand what they were getting into. One person asked me, "Well, does this mean that we all get to be involved?" I'm still not sure that people understood the whole thing because unless you get them involved to see the numbers and share a lot of that with them, they don't see the big picture.
Is there a mindset that needs to be there for successful leaders of ESOPs that may be different than the non-ESOP?
JAY: Yes. You really need to have a clear vision and confidence that you've got the right people in place. I know in Tim's case, he isn't quite as actively involved in the company now as he was a few years ago. To be able to step back like that, you've got to have good people in place, but you still need to be involved in the day-to-day to make it happen.
TIM: Servant leadership is a big thing that aligns well with being an ESOP leader. So does transparency. Those are two critically important things. If you have somebody who's not transparent, doesn't want to share information and wants people to work for you rather than with you, that's not going to work in an ESOP.
I've spoken to other business owners I know who would not be a good fit with an ESOP. That’s because they’re focused on what's in it for them and forming an ESOP strikes them as a lot of extra work for minimal payoff. They're just looking at the dollars and cents of it and missing the other intangibles such as preserving the culture, improving employee engagement, leaving a legacy, etc.
With the staffing company that I recently bought, the previous owners did not share anything with the employees regarding financials or other performance metrics. Employees had no idea if the company was doing well or not. They held everything too close to the vest and you can't operate in that way when you've got employees that have ownership in the company. They have to see what's going on and understand how their contributions make a difference.
What's the biggest challenge ESOP leaders are facing today?
TIM: The coronavirus. It's a lot of uncertainty. We're getting ready to start our budget cycle to put our plan together for next year and it's going to be so challenging to figure out what we're looking at next year. That's the biggest challenge right now.
Before that, it was finding the right people to hire, especially on the IT side, because unemployment was so low. We've been able to maintain staffing and not have any turnover. Other companies that I talk with that are not ESOPs are having turnover problems.
What's the biggest challenge to forming new ESOPs?
TIM: Definitely complexity and regulations. The constant threat of an audit by the Department of Labor and the other obligations of being an ESOP, such as recordkeeping, hiring an outside trustee, and an annual valuation, are a lot to tackle.
For example, when my dad formed his ESOP, he got one valuation from a third party. I had to get a third-party trustee and couldn't use an internal trustee. So I had to get a valuation on the sell-side and get another valuation on the buy-side. Then we had a third-party trustee, a third-party financial planner and a third-party attorney. Then I had my own financial planner and my own attorney. It was almost like any other merger or acquisition transaction. When we're negotiating the terms, I'm using my attorney with the third-party trustee. I think $140,000 was the transaction cost for the ESOP.
JAY: It was much lower when I did mine in 2004. It was $30,000 - $40,000 then.
What do you think led to the huge increase in the cost of formations?
TIM: It's the threat of the audits and the number of audits that actually occur. There have been people who have taken advantage of the system and have gotten inflated valuations. Keeping you out of trouble with regulators over the valuation is one way an independent trustee adds value. Another reason there are less ESOPs being formed is because there's so much private equity money out there. It's ridiculous. I get emailed daily from people who want to buy my company. Most of the time, it's tough to do a 100% leveraged ESOP that allows you to get the cash and walk away. I usually see deals that are 50% seller financing and 50% leveraged bank financing. And the bank is going to place some restrictions on uses of those funds. It's so much easier to take the money from a private equity investor and walk away.
Is there a particular resource or two that you'd recommend to someone who's looking to gain insight into becoming a better ESOP leader? Are there any resources you particularly like?
TIM: I highly recommend the Great Game of Business, by Jack Stack and Bo Burlingham. It's almost a requirement for ESOPs, I would say. Small Giants is the other book I'd recommend, also by Bo Burlingham. And then in terms of teaching your employees accounting, there's this book called The Accounting Game. It's a workbook that you use where you walk through as if you're a little kid running a lemonade stand. It walks you through how to create a balance sheet, track your P & L, etc. All of my employees use this workbook when we onboard them as part of their training to understand our financials.
There’s a lot that goes into creating and strengthening a Culture of Leadership. Like succession planning, self-awareness, employee engagement and understanding the behaviors of what forms a cohesive team and high-performing organization. Where do you even start?
Right here with Leading With Courage Academy. We’ve built customized roadmaps for leaders to leverage their ESOPs toward an unmistakable culture and we’re ready to do it for you. Talk to us today at 312.827.2643 to learn how we can develop assessments and workshops that register a phenomenal impact on your leaders, managers, individuals and teams.