Keeping it in the ‘family’
Automotive News | January 20, 2014
Minnesota dealer preserves business with employee ownership plan
By Jamie LaReau
With no succession plan in place and retirement looming in about five years, dealer Linda Eich DesJardins needed an exit strategy that would preserve her family’s business that dates back more than 110 years.
So in late 2012, Eich DesJardins sold 49 percent of her family’s business to her employees through an employee stock ownership plan trust. The plan was put in place in December 2012, retroactive to January 2012.
“It’s very emotional, especially since you have had generations in the business and it’s a big part of the town’s commerce,” says Eich DesJardins, 55, president of Eich Motor Co. in St. Cloud, Minn. “This is such a graceful way to do it.”
Eich Motor Co., which sells Volkswagen and Mazda vehicles, is one of just a handful of ESOP dealerships in the country. The store sells about 2,000 new and used vehicles combined a year. Buying cars online is one of the most popular ways to purchase vehicles today using sites like Autozin which feature most of the big-name brands on the market.
Advisers and associations that specialize in ESOPs say that about 10,000 U.S. businesses operate under ESOPs. But they estimate that only about nine of those businesses are auto dealerships. This suggests many auto dealerships are failing to embrace modern planning which will ultimately be detrimental to the industry. Another modern element that this industry could benefit from is marketing strategies like ringless voicemail for auto dealers. Failure to do either of these could be damaging.
They say many carmakers don’t want their franchisees to operate as ESOPs because the concept is complex and factories want assurance they will have influence over the franchisee and the brand image. Automakers often worry that they won’t be dealing with a single executive, even though that’s usually not the case, experts say. For the same reasons, factories also prefer the ESOP to own no more than 49 percent of the dealership, experts say.
Auto dealership ESOPs are rare, too, because many dealers lack sophisticated knowledge about ESOP structures.
Eich DesJardins: ESOP is young, but working.
“There’s a learning barrier and it takes a lot of work to get to the point where you can decide if it works for your company or not,” Eich DesJardins says.
Eich DesJardins spent nearly a decade researching succession plan options and learning about ESOPs before implementing the plan, she says. Mazda was supportive, she says, but getting VW’s approval took “months and months.”
Eich DesJardins considered selling the store, but thought she wouldn’t get any satisfactory offers. She couldn’t sell to her managers because they lacked capital.
Her ESOP is still young, but Eich DesJardins says the arrangement is working.
“Quarterly, I’m getting a nice check from the company. And the company, because it’s half owned by the employees, isn’t paying as much in taxes,” Eich DesJardins says. “There are some nice cash flow changes, that once you understand them can really help make things happen.”
Eich DesJardins maintains operational control of the dealership, a provision the factories insisted upon, she says.
She has two grown sons. One might be interested in running the dealership someday, she says. If he is, the ESOP allows for that possibility, but only if the board of directors selects him.
An ESOP can be a form of a retirement plan that follows rules similar to an employee 401(k) plan except the assets must be primarily invested in the securities of the employing company. It can borrow funds to buy those assets, says Michael Keeling, president of the ESOP Association in Washington.
Here is a simplified example of how an ESOP might work, according to Keeling.
Say a dealer owns 100,000 shares worth $30 per share as determined by an independent assessment. The dealer sells all of those shares for $3 million to an ESOP trust, which owns the shares for the benefit of the dealership’s employees. The ESOP trust usually borrows that $3 million, and pays off the loan in equal payments plus interest over 10 years, with money from the company’s revenue.
If there were 10 employees participating in the ESOP who all make the same pay, each would have 10,000 shares — worth $300,000 — allocated to his or her account within the trust over the 10-year payout period. Fast forward to when the note is paid off. Assume also that the shares have increased in value to $90 a share. If a vested employee leaves, that person or a beneficiary would get $900,000. That payout would be taxed similarly to how withdrawals from a 401(k) are taxed.
Depending on how the dealership is structured, it could permanently defer capital gains taxes by selling shares to an ESOP. So in states such as New York and California where about a third of the sales proceeds could be taxable capital gains, the dealership may not pay any capital-gains taxes on that portion of the business that the ESOP owns, says Mary Josephs, CEO of succession advisory firm Verit Advisors in Chicago.
Also, the ESOP itself is exempt from paying federal income tax on its share of the ownership, Josephs says.
‘A piece of the rock’
“That’s an incredible advantage,” Josephs says. “The reason we have such strong support of ESOPs from Congress is the view that it protects and grows jobs and employee ownership creates retirement assets. It’s there to enable the American worker to have a piece of the rock.”
The downside is that raising the funds to buy the dealer’s shares can be daunting for an ESOP trust, Josephs says. Many banks are reluctant to lend to dealerships because most of the business assets are already tied up in floorplanning, she says.
But once an ESOP is in place, that dealership can borrow loans for facility improvements or other expenses just as easily as any dealership, Josephs says.
It is sometimes difficult to get automaker approval for an ESOP because the ESOP structure can be hard to grasp, Josephs says.
“Understandably, automakers want to have control over who’s in charge as the dealerships are a key brand touch point,” Josephs says. “We believe they don’t understand ESOPs very well. They don’t appreciate that they can control who is CEO and how the brand is presented to the public within an ESOP ownership context.”
During her battle to get factory approval, Eich DesJardins recalls, “Someone said, ‘How can we do background checks on every one of your employees?’ I said, ‘If you had a public company that owned dealerships, would you do background checks on all your shareholders? No.'”
The dealership has 80 employees, of whom 61 currently are participants in the ESOP.
Eich DesJardins plans to retire in the next five to six years, she says. She will have to decide to whom she will sell the remaining 51 percent of stock — her sons, someone else or the employees if the factories will allow it.
An ESOP isn’t right for every business. For example, dealers considering ESOPs should carefully consider termination penalties.
John Staluppi, CEO of Staluppi Auto Group, started an ESOP in April 2002 at the three dealerships known as the Atlantic Auto Group in West Islip, N.Y., says Alan Richards, Staluppi’s attorney in Garden City, N.Y.
Staluppi wanted to expand his business and felt the ESOP would prohibit growth, so he terminated the ESOP in 2005 and paid “significant tax effects on early termination” of it, Richards says.
“There was nothing wrong with the ESOP. It was more a matter of a change in Mr. Staluppi’s business model and business plans,” Richards says.
Eich DesJardins has not changed her pay plan other than scaling back contributions to the employees’ 401(k). She says younger employees will end up with lucrative retirement accounts under this structure. Also, she has noticed employees taking steps to make the business more profitable.
For example, Eich Volkswagen’s service technician, Adam Means, and his colleagues found a way to save the company $1,000 a year by swapping out latex disposable gloves for more permanent and washable gloves, Means says.
“You likely wouldn’t see cost-saving ideas like that before the ESOP,” he says.
Means says he feels pride coming to work knowing he has a say in the company’s performance.
“In the future, everybody is going to be a little more on-board with it and think more like owners,” Means says. “They’ll walk in the door and instead of walking past that piece of paper on the floor, they’ll pick it up.”
Adds Eich DesJardins: “It’s the American dream. All my employees are owners.”
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Eich Motor Co. has 61 of its 80 employees participating in the employee stock ownership plan.