Veterinary ESOPs: A sale option to consider
“The Roman Arena was technically a level playing field. But on one side were the lions with all the weapons, and on the other the Christians with all the blood. That’s not a level playing field. That’s a slaughter. And so is putting people into the economy without equipping them with capital, while equipping a tiny handful of people with hundreds and thousands of times more than they can use.” – Louis Kelso, economist and creator of the ESOP.
You might think starting an article with the above quote means that I am a socialist or even a communist. In fact, the quote is from a committed capitalist and economist who believed that new business models could both improve profitability and improve the lives of a broader group of people.
Why should veterinarians care about Louis Kelso?
Louis Kelso was an economist, businessman, and attorney who realized that lack of capital to start and buy in to businesses was a huge disadvantage to many hard-working individuals. He also realized the strength to businesses that could come from a committed and engaged workforce that had “skin in the game”. He developed the first ESOP, employee stock ownership plan, in 1956 to help a retiring newspaper owner sell to his employees.
Kelso strongly believed that this new development could strengthen capitalism by making more people capitalists. Employee Stock Ownership Plans (ESOPs) were legally recognized with bipartisan support in the 1970s. According to the National Center for Employee Ownership, There are now close to 7000 ESOPs in the United States covering 14.4 million people.
Trying to keep Veterinary practices veterinary owned
While running our hospital, my partner and I had hoped we could eventually sell our hospital to our employees. At the time, we were really just thinking about how to provide ownership opportunities to other DVMs. This was partly because the laws in Washington theoretically limit veterinary practice ownership to veterinarians. We did offer part of our company for sale but due to our fast growth rate and our associates’ lack of capital, less bought in than we had hoped.
Buying a fast-growing large hospital can be daunting due to both costs and complexity. However, many practice owners would like their practices to remain in veterinary hands. In turn, many associates would like equity in their practice but are nervous due to debt, family obligations, and lack of business training. Many practice managers and technicians would also love equity in the practices they have worked so hard to help build but often have limited capital. While laws theoretically limit ownership to veterinarians in some states, corporations have found loop holes for purchases that could be used for broader based ownership. I did not fully understand ESOPs at the point we sold our practice but now believe they could be promising for larger veterinary hospitals.
What is an ESOP?
An Employee Stock Ownership Plan is a trust vehicle that allows owners to sell to their employees either all at once when they retire or over time. The first step is establishing the ESOP trust, which will hold the company stock for employees. Next, the company is valued to set a stock price. The trust then allocates shares to its employees. All employees become members of the plan but usually vest in over a one to six-year period. While all employees are shareholders, the number of shares allocated per person is usually based on compensation. Owners sell stock to the plan, which can be a tax-deductible event, and funding for the sale usually comes from a bank loan and/or company profits. The tax savings from this type of transaction can be significant for owners. In fact, in some transactions both the interest on a bank loan and the principal are deductible. Furthermore, a 100% ESOP owned S-corporation would never pay income taxes.
Many business consultants talk about the strength of an engaged workforce and how powerful it is when employees act like owners. Numerous studies have shown that this is even more powerful when employees actually ARE the owners. In June of last year, The National Center for Employee Ownership put together the Employee Ownership Index. This is an index of 28 publicly traded companies that either have an ESOP or have company granted equity to most or all full-time employees. The Employee Ownership index provided a 30.3% return this year, double the S&P 500! At the same time, workers in businesses with an ESOPs make on average 5-12% more than workers in traditional businesses, providing a win-win for all.
Veterinary ESOPs
Could this structure be used in veterinary practices? There are legal, accounting, and regulatory costs to both set up and maintain an ESOP so they do not work well for small hospitals. However, they could be a viable option for profitable hospitals with 20 or more employees.
A veterinary hospital in Michigan set up an ESOP as a buyout strategy 4 years ago when an owner wanted to leave. Annette Engler, LVT, CVPM, CCRP, the hospital administrator, was able to do the research and hire the legal and accounting help to make this veterinary ESOP a reality. In this veterinary ESOP, all employees who work more than 1000 hours per year are eligible. Employees vest in to full share ownership over 6 years.
The ESOP does not create a sense of ownership on its own. It has taken education on what it means and why it is valuable. Payouts to departing employees have also demonstrated to employees the value of the plan.
However, for this ESOP owned veterinary hospital, revenue growth has increased more than predicted. While hard to say if the growth is due to increased employee ownership and engagement , Annette believes that it has contributed.
For more information on ESOPs:
https://www.nceo.org/articles/esop-employee-stock-ownership-plan
https://www.nceo.org/articles/esops-complexity-selling-business
https://www.familyownedbusinessadvisors.com/2017/08/esop-an-exit-strategy/
http://www.esopassociation.org/explore/employee-ownership-news/resources-for-reporters#statistics
