Good Beer Hunting

The DL on ESOP, Pt. 2 — Insight and Expertise on Employee Ownership


About a dozen U.S. craft breweries have established a formal Employee Stock Ownership Plan (ESOP), with most coming in recent years. As the themes of “small and independent” continue to be used with greater vigor as a separation point between what does and doesn’t define “craft,” an ESOP is one powerful message that is meant to indicate a commitment to employees and today’s business values shared by many in the industry. It’s a metaphorical “not for sale” sign.

In part one of this series, we provided an overview of context beyond the happily-worded press releases used to announce ESOPs. Below, we share insights acquired from several people with expertise and experience in dealing with the plans.

Rocky Fiore, COO of Prairie Capital Advisors, notes that ESOPs are most beneficial as ownership transition tools. Legacy is a really big part of this kind of ownership transition, and “it sends a very strong message to employees as a group and lets them know the company will remain independent and won’t be ‘taken over,’ so to speak.” In the next three to five years, he expects that sentiment to translate into 30 or 40 more ESOPs for craft breweries.

“But where this would not be a great fit is for a craft brewer that is in hyper-growth mode. In today’s world, that’s calmed down considerably, but there are some still out there looking for substantial reinvestment for facilities or increasing brew capacity or opening up brewpubs. All those things may create a restrictive environment for ESOP or the size of an ESOP transition, because, at the end of the day, it’s going to put a lot of unproductive debt on the balance sheet.”

For example, if a business uses $1 million to increase its capacity, the beer made from that new equipment would be productive debt, “but when you do an ESOP, you’re not doing anything productive. That’s debt the company has to service, but it’s not generating income or saving costs for the business,” Fiore adds.

This is where the altruistic language of ESOP announcements can split from their reality. “Although you may read in the paper that a company sold their company to their employees, that’s not really how it works,” he says, because what typically happens is the company is acquiring debt to make that kind of stock purchase happen. “The employees are not writing a check—they’re just receiving shares as beneficiaries of the ESOP being funded by the company’s operations and balance sheet.”

A common way such programs take place is a company will take on a loan, which then funds the creation of stock for the ESOP, which then owes the company money while the company owes money to its lender. But this also sets up a valuable tax advantage for the company.

If shares are bought through an ESOP to allocate among eligible employees, then a company can get substantial deductions based on tax deductible principal and interest on ESOP loans, Fiore notes. Depending on individual state law, savings could be as high as 30-45% on an annual tax bill.

A Holy Grail of ESOP would be the 100% employee ownership model, which Fiore notes can provide a substantial advantage for companies registered as a “S Corp” (small business). As “pass-through” entities with full employee ownership, the sole shareholder is the ESOP, which is tax exempt, and which happens to be represented as the ESOP. In simple terms, if a 100% employee-owned company makes $1 million in income, it keeps that money.

“Imagine these brewers with strong cash flow and they keep every single dollar of income they make,” Fiore says. “The result is they can facilitate repayment of the ESOP debt very quickly, then build up a strong balance sheet and generate value for participants, make acquisitions, or build out a brewhouse. Imagine competing with a business that pays no taxes when your business is paying 25-40% in taxes. Every dollar they can make is fuel for the business. Which one would you bet on in the long run?”

“It's the right thing to do, it's the competitive thing to do, and it's the smart thing to do,” says Jacob McKean, founder and CEO of Modern Times Beer, which set up a 30% ESOP stake in 2017.

McKean says he started to give strong consideration to the move, with a goal of eventually getting to 100%, as a way to get a return to initial investors. “I looked at all the various options and weighed their costs and benefits, and in pretty much every way the ESOP came out ahead,” he says, adding that such a program also aligns with the politics and values of the company, which provide progressive salary and benefits compared to national averages. What’s more, McKean cites research that suggests consumers show strong interest in purchasing products labeled as “employee-owned,” a competitive advantage in a growing beer industry, especially against multinational conglomerates.

At a time of rapid expansion, coordinating ESOP terms with lenders also proved to be beneficial.

“We pitched it as part of a new pending package to about eight different banks, and we were able to get significantly better offers by bundling it all together,” McKean says. “It made us an attractive customer for banks, so we were able to get more of our expansion projects approved this way.”

The other side of that is the challenge of continuing to buy shares in the company to move toward 100% employee ownership. “It's just a matter of being able to afford it. Our success means our equity is expensive, so we have to balance buying back our shares with our various other uses for capital. There's no doubt we'll get there—it's just a matter of time.”

In the meantime, McKean says that the steps already taken have helped to strengthen company values, make Modern Times more competitive, and create a culture where employees are more invested in their work. Along with representation on an ESOP committee, McKean says Modern Times continues to “democratize” as a way to encourage more feedback and that ideas are shared from the bottom up.

This is also the case with Left Hand Brewing, where co-founder and president Eric Wallace acts as trustee for the company’s ESOP participants. As the largest single shareholder with about 25% of the company in his name, Wallace oversees an ESOP that currently owns nearly 41% of Left Hand, which includes about 4% held by the ESOP trust, which represents the large pool of eligible employees. Employees are eligible to join after their second year at the company and contributions are vested in increments of 20% each year until it hits 100% in year six of continuous employment.

Company stock was purchased with a loan in 2015 to begin a series of contributions to the ESOP, but Wallace ways the concept of providing ownership for key employees started in 1998 after the brewery went through a contraction amidst broader industry slowdown for craft beer. To keep four key people as part of the brewery, he pooled equity to offer ownership options.

“That was kind of the beginning—if you want people to be engaged, give them a stake in the game,” Wallace says. Wallace was told by a financial advisor if he wanted Left Hand to create a full ESOP, Left Hand would first need to hit $20 million in annual revenue, a goal that was reached by the end of 2014. The company’s ESOP is set up to provide stock into the employee pool every year.

“Traditionally, ESOPs are set up to get a big chunk of money and leverage the company and hope you’re able to pay it back,” Wallace says. “That’s a bit risky, so we figured we chip away at it. If we do well, contributions will be bigger and if we do poorly, contributions will be less. We say it is an effective way to help teach people that work within the company the joys and less-than-joys of being an owner.”

“The way the industry has turned in the last three to four years, how competitive it is, the number of players, and the amount of resources it takes to succeed, I think it changes the value proposition for a company doing an ESOP in the craft brewing space. It can be much more difficult to continue to deliver shareholder value day-to-day without sacrificing something.”

There are many benefits for companies establishing an ESOP, but that doesn’t mean such a program doesn’t come without risk. In reporting this series, GBH connected with an industry professional who worked at a brewery with an ESOP in place, but requested to not have their name used in order to speak freely and not threaten their ongoing career in beer.

The pro noted they were happy to have received financial help for their future, but came to be worried about the risk of having it so heavily weighted on the success of one company. The undiversified risk of an ESOP didn’t offer broader protections of a diversified portfolio from something like a 401(k), they said.

“There wasn’t a whole lot of understanding of what it really meant,” they told GBH. “Great, we got shares, but it’s not like if you walk out the door you’re cut a check. It gets rolled into other investment vehicles, which is the part nobody was really talking about early on. Exit strategies weren’t really a focus of conversation.”

Instead, a focus was regularly on how motivating the knowledge of being a part-owner can be. Like the viewpoints of McKean and Wallace, the employee and their coworkers felt an ESOP boosted morale.

“Through the whole decision-making process, you feel like you have a voice,” they said. “It was something to look forward to—knowing you can help build and increase your own value.”

It’s a great tool to build culture with entry-level staff, but the more this person came to understand the long term impacts, the more they worried about ESOPs as a full-proof retirement option. Management, who may also be part of the ESOP, had to balance decisions in a similar way as a publicly-traded company, they said.

“You hear about an ESOP and it sounds great. People get to share everything and everyone is tied into the success of this company, and that’s very much the positive side of it. But you are also accountable for the tougher times, and you may not always agree with decisions that have to be made that impact share value. Sometimes funds have to be invested in the business you might not otherwise expect or want to invest.”

Compared to other retirement plans, the pro noted their annual returns from their ESOP share outperformed traditional retirement accounts by 10-12%, but added with flat growth across beer and increased challenges in craft, they’ve heard current returns are actually lower than what might be expected from a 401(k) portfolio. It’s one aspect they want peers to better understand: long-term thinking is important—not just the excitement of receiving company stock.

“Don’t just say you’re part of an ESOP, but really understand how it operates, how it impacts decisions and structure of a company. If you are tied to that future, make sure you have a voice, because it’s not just about your weekly wages anymore. Know how day-to-day choices can impact it all and don’t just punch the clock and assume you’re set. Hold yourself accountable and hold other people accountable.”

—Bryan Roth

The DL on ESOP, Pt. 1 — Examining the Pros and Cons of Employee Ownership Beyond the Headlines

The DL on ESOP, Pt. 2 — Insight and Expertise on Employee Ownership