Improbable Schweitzer Engineering ESOP Story: Growth Company That Stayed Put
Peoria, Ill., without Caterpillar (CAT)? Benton Harbor, Mich., without Whirlpool (WHR)? Columbus, Ind., without Cummins Engine (CMI)?
One of America’s under-appreciated relationships is the one between smaller cities and bigger companies, an often-happy exchange of quality-of-life for the combination of well-paying and skilled jobs, economic growth and stability, and corporate generosity to support cultural and educational institutions.
For every Cummins Engine, approaching its 100th anniversary in 2019 as civic benefactor to Columbus, however, there are scores of middle market and larger companies, based in smaller cities, that have sold to larger competitors and then packed up their factories and left town. The effect is devastating.
That makes the story of Ed Schweitzer, founder of Schweitzer Engineering Laboratories, all the more remarkable. The company, which makes sophisticated equipment for the global electrical power industry, is based in Pullman, Washington, population about 32,000. More than half of that count comes from the students at Washington State University, so Schweitzer’s 2,000 local employees (out of a total worldwide of about 3,800) account for more than one in ten permanent residents, powering the local economy, hiring WSU grads and many others, and supporting local institutions.
Pullman sits about 75 miles south of Spokane, in Eastern Washington, and it’s safe to say that, without the university and Schweitzer, it would be a far smaller and less interesting place to live.
The year 2009, then, was crucial for Pullman. Ed Schweitzer had already sold 49% of the company, beginning in 1994, to workers through an Employee Stock Ownership Plan. Ed was nearing retirement age and selling his remaining and controlling stake was on his mind. Over the years, “I have considered all the possibilities – going public, selling to a strategic buyer,” Ed tells me.
Let’s consider those two possibilities and the fortunes of Pullman for a moment.
An IPO would have kept Schweitzer Engineering, which had 2014 sales of more than $600 million and has been profitable each of its 31 years, independent, at least temporarily. But as a public company, its board of directors would have been compelled to consider any outside offer for the company, and Schweitzer’s enviable market position and record of growth (it expects to exceed $1 billion in revenue within 5 years) would certainly have made it a target of larger companies. It doesn’t take too much musing to see a big offer, reluctantly accepted, and the buyer moving Schweitzer’s operations out of Pullman.
Selling directly to a strategic buyer could have hastened that outcome, it seems.
“It would be horrible,” says Glenn Johnson, Pullman’s mayor.
Well, thankfully, these are all very theoretical what-ifs. Ed sold the remaining 51% to the ESOP, making Schweitzer Engineering 100% employee owned. And in doing so, in my estimation, Ed secured his own legacy and also laid the groundwork for a bright future for both his company and for Pullman.
It’s a story middle market company founders, nearing time to decide on an exit strategy, should consider. Ed’s prime motivation seems not to have been price, but rather creating a stable company for customers, employees and the community of Pullman. But middle market owners should know that, in my experience – I have personally advised more than 200 company founders on ESOP transactions – owners can realize a better return than from private equity buyers by selling to an ESOP. That isn’t because the buyers – employees, in the case of an ESOP – pay more, necessarily, but because the tax treatment for owners selling is more advantageous.
What’s more, a wide survey of research concludes that ESOP companies go on to outperform competitors with other ownership formats.
To understand Ed’s decision, and Schweitzer Engineering’s remarkable success, it helps to appreciate his engineer’s wonder at how the world works. A Purdue University graduate, he worked for the federal government for five years and, having moved out west, decided on Washington State for graduate school because of its electric power expertise. For a class, he picked up a book about protective relays in electrical systems – akin to your home’s circuit breakers – “and I couldn’t put it down,” Ed tells me.
Back then, the relays, which measure current and voltages and shut systems down when something goes awry, were large mechanical devices. Ed wondered whether they couldn’t be digital and thus more precise and reliable. It was the subject of his dissertation and he built a prototype. It worked, but would the utility industry buy it? Ed joined WSU’s faculty and later founded Schweitzer Engineering in his basement. Acceptance in the market was slow.
“Few would entrust a power system to a device built by a professor in his basement,” Ed says, summing up the initial reaction of potential customers. But one utility, Otter Tail Power, in Fergus Falls, Minn., had some peculiar needs. It had problems in its transmission lines but couldn’t find where they were. Ed’s equipment helped pinpoint the problems. He had his first major customer and Schweitzer Engineering was on its way.
(Ed’s grandfather, by the way, was a founder of S&C Electric – he was the “S” – a major manufacturer of power system equipment, too, and also an unusually innovative and progressive company owned by an ESOP.)
Ed, his wife and three kids were upstairs, and in the basement, in a room roughly 12×24, were half a dozen employees. Later moving into an 1,800 square foot building, in Pullman, it was clear Ed had no intention of moving the company elsewhere. “I love it here,” he says.
Market resistance persisted for some time. Bob Morris, today vice president of national operations at Schweitzer, joined in 1991 as employee No. 71 and, even then, recalls potential customers telling him, “ ‘Oh, we can’t buy anything from you – you’re the college students who work for the professor in Pullman, Washington.’ ”
But steadily, Schweitzer products gained acceptance. The no-questions-asked 10-year warranty helps. Schweitzer has never charged a customer to repair or replace a unit, says Joey Nestegard, chief financial officer. The company promises to fix units within 72 hours or, failing that, replace them. The policy reflects the engineer’s mind of Ed Schweitzer. “If (the malfunction) is something we’ve caused, we want the information” so the glitch can be avoided at other customers, Nestegard says. “Even if the customer caused it, we want the information.”
Any big company in a small town will tell you that recruiting can be difficult. Schweitzer Engineering tackles the problem from all sides. It runs an intensive paid internship program – 169 interns on the premises, as of this writing – to introduce highly qualified engineers and others to Schweitzer. Half or more wind up hiring on, Ed says.
The company hires more WSU electrical engineering grads than any other employer, even though it’s competing against far larger and better-known companies.
Schweitzer Engineering, unlike some companies, doesn’t have a leave-and-you-can’t-come-back policy. Bob Morris, the vice president, took a chance on a venture capital-backed company in 2000. “It was the values of the company and the value of the ESOP that brought me back,” he says. Morris tells his own story in recruiting.
And rather than insist on hires being pre-trained by former employers, Schweitzer Engineering has its own training and continuing education program, and uses it to find, well, diamonds in the rough, who might for the first time realize their full potential at the company. Sara Arar had spent 10 years running a small housecleaning business, barely making ends meet, and certainly not saving a dime for retirement. Hired as an assembler by Schweitzer Engineering six years ago, Arar has risen swiftly, with constant training, now supervising 20 employees in manufacturing and testing printed circuit boards.
Along the way, Arar has learned some lean manufacturing techniques and other methods to boost productivity and make jobs at Schweitzer Engineering less monotonous and more rewarding. “Dignity of work is one of our values,” Arar says. Boosting productivity is one of the main aims that every business should aspire to have, as if this increases, then the success of the business will also increase too. By checking out an event-based architecture programme such as the one you will find on – https://vantiq.com/platform/ can ensure you get well on your way to achieving this.
Circuit board testing, for example, requires the use of many fixtures, some of them heavy boxes, and they’re moved around as needed. Previously organized by number, one worker on Arar’s team, Devin Griffin, suggested reorganizing them, with the most-often-used ones placed closest to workers. The heaviest ones were also placed at waist level to make hoisting them less awkward. The change saved Arar’s team an estimated 90 miles of walking in a single year, helping boost boards tested to 60,000 a month from 45,000.
Arar’s team member, Griffin, was promoted in part based on the project. “You get out of it what you put into it,” Arar says. Efficiencies, she notes, don’t translate into layoffs. “SEL has never laid off a single person,” she says. “We’re trying to do away with hand-placed parts” on circuit boards. When tasks are automated, those who assembled by hand are told, “now you’re going to be a machine operator.” Higher skill.
The ESOP, given Schweitzer’s growth and profitability, has outperformed the S&P 500 since Ed Schweitzer sold a 30% stake in 1994. There were 133 employees at the time. Some have attained considerable wealth, as a result, and the company is investigating ways to help them diversify over time. A 401(k) plan, separate from the ESOP, has 53% participation and the company is trying to lift that. Overall, Schweitzer Engineering employees are far better set than comparable workers at non-ESOP companies.
Why an ESOP? Ed didn’t at that point particularly need personal liquidity and the company didn’t raise any money for itself in the transaction. Ed says that leading up to 1994 he’d been mulling how to further involve employees in the company and its future. “How should a company be owned in the long run? The products we make are very serious. Employment is a very serious matter,” Ed says. Studying the options like the engineer he is, Ed settled on an ESOP.
Fellow founders should know: in addition to the productivity boost typically realized when workers become owners, ESOPs also have significant tax benefits. A C-Corporation owner selling to an ESOP can defer, potentially forever, paying capital gains taxes, which can claim 23.5% in other exits, by reinvesting the proceeds in qualifying investments, such as stocks and some bonds. If the ongoing business is, or becomes, an S-Corporation and is 100% ESOP owned, it doesn’t pay federal or most state income taxes; instead, taxes are paid by the owners when they withdraw their wealth in retirement, much like the tax treatment of an IRA or 401(k).
The latter benefit allows ESOP-owned companies to heavily invest in R&D, expansion and acquisitions. Schweitzer Engineering invests more than 10% of its revenue in R&D. “We have research facilities you just don’t see in other private companies,” says Luis D’Acosta, a 10-year Schweitzer veteran who succeeded Ed as CEO last fall. “That is because of our ability to reinvest 100% of profits back into the operation.”
D’Acosta says the ESOP structure allows Schweitzer Engineering to take a longer-term focus than he was accustomed to seeing at larger, publicly traded companies in the industry. High levels of employee engagement also allow the company to implement new ideas more swiftly; employees aren’t as defensive and it’s a safer environment because of the policy to redeploy workers who might be displaced by automation and by gains in efficiency. Indeed, a Schweitzer Engineering program allows front-line supervisors to independently commit relatively small amounts of time and money to improvement projects. When the projects work, they’re adopted company-wide, D’Acosta notes.
Ed Schweitzer continues to work hard on new products, client relationships, recruiting and other activities. “I’m still not an exit guy,” he says.
I’ve characterized Ed’s management approach as the analytical engineer, and he’s certainly that. But Ed explains his approach quite differently: “We try to run the business the way our moms would want us to.” He sees a moral responsibility to employees and to the community in and around Pullman.
Says his admirer, Mayor Johnson: “Ed set a fine example of what a company should be like. Grow the company. Treat employees well. Innovate. Pass it on.”