How SDG’s Founders Sold Out…To Their Employees Via ESOP

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Solution Design Group (aka SDG) is a rare Minnesota tech company, one of the few who have successfully implemented the ESOP method of ownership liquidity and transfer.

According to our article underwriter, Redpath & Company, the employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit plan designed to invest primarily in the stock of the sponsoring employer, providing employees with a beneficial ownership interest in the company.

Since the 2015 transaction, SDG has increased revenues by 19% and headcount is up 28%.  We spoke with one of SDG’s founding partners, Jeff Daniel, to learn more about the details of why and how ESOP:

Why did you decide to become an ESOP?

We were looking for an exit strategy for our partners in 2014. Specifically, one of the original owners was coming up on retirement and the remaining two partners, including myself, wanted a fair way of valuing and transferring his ownership over a future period, which sent us down the path.

We also wanted to maintain our culture as opposed to selling the company to a separate new company and risk losing our essence. We built the company with the foundation of our core values and used them to make this decision.  We want the company and its values to live on past its original founding partners.

How long did the process take?

We started talking with the lawyers probably a year before we became an ESOP.

What was the process like?

It was one step at a time…questions to ask, answer, and consider. For example, the company must be big enough to make it work in the first place. It takes professionals — a lawyer, accountant, valuation expert, and a trustee.

What was the cost to become an ESOP, upfront and recurring?

I think when we added it up it was less than a couple of hundred thousand dollars. There are some ongoing requirements – like audits and valuation – that operationally cost under $50k each year.

How many employees did SDG have when the transaction occurred?

It was recorded Jan 1, 2015 and we had right about 140 people.

How many employees do you have today?

180.

How has it been received by your employees?

Like any changes, you’re going to have the dynamic where ⅓ will jump in, ⅓ will be wait and see, and ⅓ will be skeptical.  Really an ESOP is a retirement plan, like a 401k, except for the currency is company stock.
It’s 100% company funded, so the employees have no money of their own in the game, but at first it was mixed results because we suspended our 401k match program to drive down the ESOP debt.

That approach has been successful since we’ve seen greater than a 50% increase in our stock value each year over the past three years. Once the debt is relieved, our plan is to resume the 401k match.

There was some heartburn about that switch, but they are starting to warm up to it since there’s evidence that the transition is paying off. I think the trick is to help them to understand the details about how it works and why it works. We’ve also been transparent about the steps we need to take to turn the 401k match back on and they seem to want to help the company get there because after all they are employee-owners.

Has it had any quantitative or qualitative impact on the business?

We don’t really feel there is a direct correlation between becoming an ESOP and our revenue growth. But where we have definitely seen a difference is in our employee turnover, it was about half our normal rate in 2017.

I think our employees are engaged as ever; our turnover rate last year was one of the lowest rates we’ve had as some are waiting and watching for their stakes to grow. From a retention perspective I think they like it and it’s a unique tool for us in terms of hiring. We are looking for people who want to be part of a community and have an interest in the responsibility of being an owner. It also helps us to identify the next wave of leaders who are taking over new roles and responsibilities. We have exceptional employees and they have always acted like owners so this was a natural step forward.

If you were to go back and do it again, would you do anything different?

We achieved what we wanted to and did it as transparently as possible. I wouldn’t change anything as the outcome is right where we wanted to be.

From a partnership/exit perspective, did you accomplish the initial objective?

Our original partners got their opportunity to put their chips on the table and cash out and we’re on a ten-year plan to pay off the owners, currently ahead of the game on that strategy.

Why don’t you think more technology companies, specifically service-based ones, are not ESOPs?

The easy way out would have been to put up a for sale sign and sell off to a 3rd party buyer as I’m pretty sure we could have earned more money as partners if we went that route.

But, I just don’t think the mindset is the same with other companies as is ours. Like I said in the beginning, we have a set of core values and that hasn’t changed from day one.

 

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