John D. Menke is President of Menke & Associates
Employee share ownership serves many useful purposes. For employees, it provides financial security, a sense of personal worth, and an additional form of retirement savings. For owners, it provides a way to retire and sell their businesses without having to sell them to larger companies who may downsize them or move them elsewhere or even abroad. For the economy, it helps to perpetuate locally-owned business and increase employee productivity and company profitability. From a political standpoint, employee share ownership helps to reduce income and wealth inequality, thereby helping to restore the middle class and political democracy.
In the U.S., we now have about 12 million employee owners, which is almost twice as many employees as the number of employees who are union members in the private sector. Yet, only about 10% of the U.S workforce is covered by an ESOP. Naturally, people are always asking, “If ESOPs are so great, why aren’t there more of them”? The answer is simply that most ESOPs are installed by privately-held companies, and the success of these companies is seldom reported on by most business publications, who mainly report about well-known public companies. A second reason is that most companies are bought and sold by business brokers who earn commissions from selling businesses to other companies. These business brokers have typically not had the know how to help a business owner sell his business to an ESOP, and most of them have assumed that they would not earn a commission from selling a business to an ESOP.
But these factors have started in change in the last five years. There are now several ESOP associations, such as the ESOP Association of America, the National Center for Employee Ownership, two dozen so state chapters of the ESOP Association, and five or six State Centers for Employee Ownership that publish news stories and press releases regarding ESOP companies and ESOP success stories. And more recently, business brokerage firms and investment banking firms have discovered that they can, in fact, earn the same kind of commission from selling a business to an ESOP as they would earn from selling a business to an outside buyer.
But to widen and deepen the adoption of ESOPs, we still need more public awareness of ESOPs, how they operate, and how they benefit the owners, the employees and the economy. To some extent, this can be accomplished by private associations, such as the ones mentioned above. But, it would also be helpful if federal and state governments established Offices of Employee Ownership that disseminated information and advice about the benefits of employee ownership.
I would tell them to talk to other owners who have sold part or all of their companies to ESOPs. According to a survey taken in 2014 in the U.S., 93% of business owners who adopted an ESOP for their company were very pleased with the results and would recommend an ESOP to other owners.
I do think that employee ownership will become more prevalent over the next five years, and especially over the next 30 years. Millennials are very attuned to the idea of working in a team environment. Increasingly, they will want to work for firms that are employee owned or that have substantial employee ownership. Also, the concept of employee ownership is spreading around the world, including both Western and Eastern Europe, Japan, China, India, Canada and Australia. In the U.S., the Democracy Collaborative has recently announced their Fifty-by-Fifty initiative in which they have set a goal of increasing the number of employee-owners in the U.S. from 12 million today to 50 million by the year 2050.
The first most important development was the codification of ESOP provisions in the Employee Retirement Income Security Act of 1974. Prior to that, the Kelso law firm, which is the firm that first developed the concept of the leveraged ESOP as a buyout tool, had done 50 or so leveraged ESOP transactions, but the entire authorization for these transactions rested on one Revenue Ruling, which could have been revoked by the Internal Revenue Service at any time.
The next most important development was the adoption of the “tax-free rollover” provisions of Sec. 1042 of the Internal Revenue Code in 1984, which provides for the deferral of capital gain taxation for owners of C corporations who sell their stock to an ESOP, provided that the ESOP acquires 30% or more ownership, and provided that the owner purchases “qualified replacement property” within 12 months of the sale. Several years after this provision was adopted in the U.S., after speaking at meeting of the Wider Share Ownership Council in London, I had a brief meeting with the Chancellor of the Exchequer and recommended that a similar provision be adopted in England. The Chancellor agreed, and it is my understanding that this provision still exists in England to this day.
The third most important development was the amendment to the U.S. Internal Revenue Code in 1996 to authorize the adoption of ESOPs by S corporations, which are pass-through entities that do not have more than 100 individual shareholders. Today, over 60% of all privately-held corporations operate as S corporations. Had the 1996 amendment not been adopted, none of these companies would be able to adopt an ESOP.
There are currently four bills pending in the U.S. Senate (and four companion bills in the U.S. House) that would help to promote greater employee share ownership. S. 1589 would extend the Sec. 1042 tax-deferral incentive that is currently available only to owners of C corporations to owners of S corporations. It would also establish an S Corporation Ownership Assistance Office within the Department of the Treasury, and it would amend the Small Business Act to allow minority-owned firms, women-owned firms and veteran-owned firms to adopt ESOPs without losing their existing preference in bidding for government contracts. S. 1081 would provide $45 million to establish and support state employee ownership centers. S.1082 would provide a U.S. ownership bank that would have a revolving fund of $500 million for ESOP buyouts. S. 1788 would provide a revolving loan fund within the Department of Treasury to provide low-interest loans to employees seeking buy a business. It would also exclude from taxation 50% of the interest earned by a financial institution from making an ESOP loan, and it would close the CEO-pay loophole for public companies that are not at least 5% employee owned.
These provisions would help to further promote the prevalence of employee stock ownership, and I would like to see all of them passed. I would also recommend that similar provisions be passed in England.
I think that employee share ownership has enjoyed cross-party support the UK for the same reasons that employee share ownership has enjoyed cross-party support in the U.S. For conservatives, employee share ownership is a way of extending capitalism to the middle-class, blue-collar and low-income workers. It provides a tool whereby such workers can become more secure and self-sufficient without depending on government “redistribution” programs. Conservatives also assume that employees who acquire stock ownership will tend to become more conservative in their political viewpoints once they become capital owners. For liberals, employee share ownership is a tool for alleviating economic inequality and for providing a way out of poverty. For liberals, it is a way to create economic opportunity for low-income workers, minorities, and other disadvantaged classes that would not otherwise be able to acquire a significant amount of capital ownership.
One’s idea of perfect happiness is, of course, highly subjective. In my view, happiness comes from having a reasonably balanced lifestyle that balances work, family, friends and personal achievement. Most of us will never be able to achieve a “perfect” balance of these goals, but most of us do know that balancing these factors will bring more happiness than can be gained from achieving financial success, professional acclaim or celebrity status.
My most marked characteristic is my ability to work on ESOP tax and financial issues for hours at a time without getting bored or tired. I have been working almost exclusively on ESOP transactions since graduating from law school 50 years ago, and I have yet to get bored or tired of dealing with the infinite variety of issues that arise from these transactions.
My greatest achievement was helping my boss and mentor, Louis Kelso, get the ESOP concept codified into law when ERISA was being drafted by the U.S. Congress in 1974. I was the one who drafted the legal arguments (and the proposed statutory language) making the case for why ESOPs should be authorized by ERISA, and Mr. Kelso was the one who convinced Senator Russell Long to champion the cause in the U.S. Senate. Over the years since then, the ESOP concept has developed into an entire new body of law, and has spread to many countries around the world.
My second greatest achievement was to create a consulting firm, Menke & Associates, Inc. which over the past 50 years has consistently been the most active firm in the country in installing and administering ESOPs for U.S. companies. Over the past 50 years, our firm has installed ESOPs for over 3,500 U.S. companies.
Probably President Abraham Lincoln. He came from very humble beginnings and presided over a country that was hopelessly divided over the issue of slavery. On May 20, 1862, he signed into law the Homestead Act of 1862, which allowed Americans, including freed slaves, to claim 160 free acres of land. Subsequently 270 million acres of land were homesteaded by 1.6 million homesteaders. I grew up on one these homesteads in Texas. The ESOP laws in the U.S. have had a similar objective of providing ownership (in this case, stock ownership) in exchange for sweat equity, and the ESOP provisions of ERISA are sometimes referred to the “Industrial Homestead Act”.
The one living person that I admire the most is Ms. Patricia Kelso, who is now 90 years of age and is still working every day on behalf of the Kelso Institute to promote and support the ESOP concept, both in the U.S. and abroad. Ms. Kelso is the co-author of two of Mr. Kelso’s four books on employee ownership, and over the years has written or co-authored numerous articles on the economic importance of employee ownership. Three of these books and most of these articles can be downloaded for free from the Kelso website at www.kelsoinstitute.org.
Ms. Kelso is probably the most widely-read person I have ever known, including any of the liberal arts professors I studied under as an undergraduate an any of the law professors I studied under at Yale Law School. She was the intellectual soul mate of her husband, Louis Kelso and the success of the ESOP movement in this country and abroad would not have happened but for the collaboration of these two great intellects. In addition, the Kelso institute has also endowed the Kelso Professorship of Comparative Law, East European Business law and European Legal Policy at the University of Viadrina at Frankfort (0der), Germany.