Interview with Christopher Rausch
Interviewer: Andrew Zezas, SIOR
Following is the transcript of a CFO Studio interview between Andrew Zezas, host of CFO Studio and financial executive, Christopher Rausch, CFO of Somerset Tire Service, Inc.
Visit www.CFOstudio.com to read about this interview and to watch the entire on-camera interview.
The Operational and Financial Benefits of Employee Stock Ownership Plans
Zezas: This is CFO Studio and I’m your host Andrew Zezas. In the studio with us today is Mr. Christopher Rausch, Chief Financial Officer of Somerset Tire Service, Inc. Many of you know Somerset Tire as STS Tire and Auto Centers. Mr. Rausch joined STS in 2009 and became that company’s CFO in January 2011. He’s held CFO positions at companies including CDX Labs and Community Education Centers. And has held other finance positions at Quest Diagnostics, LabCorp and Dianon Systems and has spent most of his career in healthcare with a specific concentration in laboratory services.
Mr. Rausch is a graduate of Rutgers College, having achieved a Bachelor of Science and Accounting and he’s a CPA in New Jersey. Somerset Tire Service was founded in 1958 in Somerset County, New Jersey. STS Tire and Auto Centers has taken pride in providing exceptional service and superior value to customers for over 50 years. STS, an employee owned company is the largest independent tire and automotive service company in the Northeast with retail locations throughout New York, New Jersey and Pennsylvania.
Today Mr. Rausch is here to talk to us about the operational and financial benefits of Employee Stock Ownership Plans, better known as ESOPs. Chris it’s so nice to have you here on CFO Studio.
Rausch: Thank you for having me. It’s a pleasure.
Zezas: The idea of Employee Stock Ownership Plans, formalized by ERISA, the Employee Retirement Income Security Act in 1974, but in various forms less formal. Employee Stock Ownership has been around since the ‘20s, 1920s. But under ERISA, ESOPs had three goals; broaden the ownership of capital that was in the hands of the employees, create a source of income which can be used to supplement Social Security and Retirement Plans and encourage and reward increased employee productivity and efficiency. Now since then almost 12,000 companies have elected ESOP form of ownership and that’s affected almost 11,000,000 employees. That’s a tremendous statistic.
Rausch: Yeah it is.
Zezas: But given that, given the history let’s go back, with STS why employee ownership?
Rausch: STS was founded in 1958 by Jack Apgar. In his view it was important for customers to be able to deal with owners. He wanted to make sure the people had a vested interest in the outcome and success of that business. For him it was really a customer focus objective coupled with the practical of it’s a startup company and he was looking to raise capital. Where better to raise capital than with the people that are going to be with you side-by-side, in the trenches fighting to make that business successful.
Zezas: He saw the connection between a customer facing model of ownership and financial reward.
Zezas: Very interesting, very interesting. Going back that far was STS always an ESOP?
Rausch: No, the ESOP came into being for STS in 1984. Really what he was trying to accomplish there was a way to provide for, as the objectives were set in ERISA, retirement benefits for his employees. The idea was to take a percentage of the profits every year and put it aside in the ESOP for the benefit of the employees so that they had some money to retire. That was the idea. Unfortunately in 1986 the ESOP had an additional function for us, which was to help us buy out the Estate of Jack Apgar, who unfortunately died suddenly and unexpectedly in 1986.
At that point the company was in a full crisis. We weren’t sure how we were going to move forward, how we were going to liquidate the estate’s assets, his stock in the company and maintain control of the company. We looked at all of the various options, selling the company; there were things that would come to mind. It turned out we were able to use an ESOP for a leveraged buyout of the estate, maintain control of the company, leave it in the hands of the employees and be able to facilitate that transaction without any interruption to our services.
Zezas: Wow. Okay so it wasn’t always an ESOP. It was propitious that it was. Talk to me about the benefits of becoming an ESOP. There’s a whole bunch of different forms of corporate structure. Why, what are the benefits a company’s derives by doing an ESOP?
Rausch: I think it changes the culture of the company. I could sit here and quote you statistics about how increased productivity is blah, blah, blah percentage over the peer company.
Zezas: Some of that’s problem true.
Rausch: I’m sure it is. What I could speak to is my own experience. This is the only company that I’ve worked at that was ESOP owned. There is a different culture. We have a term that we casually throw out there is, is that person an owner or is that person a renter.
Zezas: Hold on. A renter from a financial perspective or…
Rausch: This is from an employee perspective. This is employee attitude, employee point of view, how they go about their business. Is this going to be the kind of employee who when maybe they’re not as busy they pick up the broom voluntarily, they sweep the floor. Not because it’s expected of them, because that place maybe could look a little bit nicer.
Zezas: And that’s an owner.
Rausch: That’s an owner.
Zezas: Okay, got it.
Rausch: An employee who is not an owner, who’s a renter, may not take that extra step.
Zezas: Who does not have the owner perspective?
Zezas: Who you perceive as a renter.
Zezas: Got it. I understand.
Rausch: It’s a concise way of classifying that a bit.
Zezas: Is that the only benefit to ESOP?
Rausch: No there’s a lot of benefits to ESOPs. I don’t get to touch on all of those, but I think it’s an efficient way to finance the company. We can talk about some of that when we’re through.
Zezas: Okay. When STS moved toward an ESOP it was not always 100% ESOP owned.
Zezas: You moved in that direction at one point. When did you do that and what were the objectives?
Rausch: Over time the ESOP percentage of ownership has grown. It started off very small in 1984 and it’s grown to about 70-75% ownership in 2012. At that point we looked at all of our options and looked at the long term planning of the company and decided one of the things we wanted to do was explore going to an “S” Corporation. The reason why that was important to us as well all know, “C” Corporations have double taxation. The objective was to maybe avoid that through an “S” Corporation which passes its taxes and its earnings through to the owners of the company.
Rausch: In the case of an ESOP owned company, in this case 100% ESOP owned company would be our objective, all of that passes through the ESOP and an ESOP does not pay taxes. You end up avoiding the double taxation, the first tax of the double taxation. It only becomes taxable to the recipients of the money when they leave the company and cash out their ESOP.
Rausch: It’s a very tax efficient and that’s really what we were looking at doing. In 2012 we hired an outside consulting firm to take a look and study this for us, give us what the alternatives were; the pros and the cons. We selected the method we wanted to do and then we went ahead and facilitated the transaction.
Zezas: Wow. You went after efficiency as you were already an employee owned company. There was a retirement plan element to this too, correct?
Rausch: Absolutely. In fact going back to the original idea behind the ESOP, one is to create retirement benefits for our employees. Being 100% only enhances that.
Zezas: Yeah, understood. Chris this sounds like a very complicated process. It sounds expensive and it also, not being an ESOP expert myself, sounds like a process that would once put in place would require a tremendous amount of administration. Is that correct? Is it complicated? Is it expensive and does it require a lot of effort on an ongoing basis?
Rausch: That’s a good question. On an ongoing basis I would say it’s not any more complicated than a 401k. They’re both ERISA plans. You have a fiduciary responsibility as an officer in a company to safeguard the best interests of the employees through these different programs.
Zezas: What about when you’re structuring?
Rausch: To getting there it was a little complicated. We did the transaction; the most recent transactions to go from 70 to 75% to 100%. We had a balancing act. We had the selling shareholders, who were all employees. We were always 100% employee owned, but some folks owned shares for many, many years going back to the pre-ESOP type days.
Zezas: Those are direct shares.
Rausch: Direct shares. So they had a share certificate just like any other share holder would have. They were direct shares, employee owned direct shares. The ESOP was the primary owner, but not exclusive. You had to balance out your fiduciary responsibilities as a corporate officer within the context of your job as a company employee. You had to make sure that the ESOP was represented and their interests were in protection.
Zezas: So truly represented.
Rausch: Truly represented. In fact, we went to the trouble of hiring an outside independent trustee, who in turn hired an outside legal counsel to review the contracts and everything else. Lastly, they hired an independent evaluation firm to make sure that the price paid ultimately was fair and reasonable. The ESOP was represented by three independent entities, making sure that their best interests were kept in mind.
We had the selling shareholders who also had a slightly different perspective on the transaction and because we have bank debt we actually had to open up our credit facilities to allow us to get the transaction through. We had the banks at the table as well.
We had four different parties, if you count the company as one of them. I do believe at the end this was one of those rare events where everybody did well. I think everybody won on this transaction. We ended up achieving our objection of “S” Corporation. We avoided the taxes, single taxation.
We ended up getting the ESOP to 100%, which was in their best interest and the selling shareholders not only did they get to liquidate their investment that they’ve had for a long time in a company that’s not publicly traded. They also had an ability to understand what their cash flows were going to look like and how their exit strategy was going to take place when they wanted to retire. It was really one of those transactions where you look around and everyone is smiling and happy at the end.
Zezas: Everyone was smiling but it sounds like during the process I’ve got visions of the Ed Sullivan show with the guy spinning the plates on the posts. What a tremendous balancing act. Okay, all right, I get it.
Let’s talk culture for a moment.
Zezas: How does an employee owned culture affect STS’s customers?
Rausch: Well again, going back to the original concept; you’re dealing with the owner. Our idea is each one; we’ve got over 150 locations, retail locations throughout the tri-state area. Each one of those is a small community business unto itself. The idea is you put owners in that business, then they’re going to become part of a community, they’re going to the right thing long term.
Zezas: Those owners aren’t necessarily owners of that particular location. They’re owners of the company through the ESOP.
Zezas: Okay, got it. Go ahead.
Rausch: It’s a mentality. It’s a thought process; it’s how you go about your day every day. You think about this, it’s your company, whether we’re talking about that specific location or we’re talking about the company in the whole. It’s about your business. If you’re going to be the owner and really own the business, you’re going to do the right thing. That’s our philosophy and we believe that that’s what’s kept us successful.
Zezas: You see that having a positive effect on the customers, of course.
Zezas: I have to tell you, I’ve been a customer of my local STS store. I see that; I see that mentality. It doesn’t strike me as these people are employees.
Rausch: Right. Hopefully that’s the experience that everyone walks away with.
Zezas: How does employee ownership and being an ESOP specifically help STS in terms of recruiting new employees?
Rausch: It changes the way we go about that. We want to be the employer of choice, so we’ve spent a lot of time and effort and money reaching out to Vo Techs and Community Colleges. Then also there’s a program where trained technicians can graduate from. Part of what we’re selling is the fact that this is a career. You can spend an entire career, and many have, at STS and do well for yourself. It’s not just a job. There is something more there, if you’re willing to put in the time and the effort and own it. That’s why I think we distinguish ourselves among some of the competitors in terms of employment.
Zezas: I remember when we were preparing the interview you had mentioned something about how you’ll see transition in employment, in the ranks of your employment at the early parts of someone’s career, but then they tend to settle in. Do you believe that has to do with the ESOP?.
Rausch: I do. It’s interesting. It takes about six years to become fully vested in our ESOP. What we’ll see, if we take at our employee demographics and our turnover, the way the statistics work is we’ll turn over a lot of employees in the beginning. That’s typical of our business.
Zezas: That’s the nature of the industry.
Rausch: It is. You do see that. Once you get past say three or four years and people are looking at their ESOP statement every year. They’re realizing that’s there’s something here. Something to work for; maybe putting in a little more credence into.
Zezas: Over and above what they’d get elsewhere.
Rausch: Exactly. We try to stay competitive with their salaries and everything else, but this is something that the employees do not have to contribute to. It can result in a very significant balance over time. Once you see that six year period, when people become fully vested and that money’s theirs, you see them make a decision. Either they’re going to decide that they’re going to take the money, leave, and we have to pay them and they’re going to move on to something else. Or they’re in it for the long haul. We have a tremendous number of employees that are six years to thirty-five years. I think the most senior person just celebrated their forty-fifth anniversary.
Rausch: Started in 1968.
Zezas: Wow. That’s tremendous. That says a lot about your company.
Rausch: We’ve got a lot of twenty-plus employees and it’s because of this. It’s this ownership, this feeling that they’re a part of something bigger.
Zezas: I’m sure it’s not just the financial benefit.
Rausch: It’s everything; it’s the culture.
Zezas: It’s the culture of the company. Listening to our discussion, it sounds like employee ownership is great. ESOPs are great. But everything’s got challenges, right? What’s the biggest challenge that you’ve encountered with ESOP ownership specifically?
Rausch: For us it’s cash flow. The one thing you have to remember is these are the owners. Every time your owner leaves you have to cash them out. They own their shares, we owe them that money. If you think about just typical turnover rates, if you’ve got a turnover rate of 10% of your employees that are vested, that does come into play. But if you’ve got 10% of your vested employees turning over, you’re buying back 1/10th of your company that year. You’re buying your company once every 10 years.
Zezas: Every ten years you’re refinancing.
Rausch: If you’re turning over at 7%, you’re doing it every 15 years. The company absolutely has to generate enough cash to sustain that. That’s probably the single biggest challenge. We’ve been fortunate that we’ve been able to generate enough cash to sustain this and there’s no reason to believe that we won’t, especially now that we’ve got the tax savings. In a way, its self funding, because what we would have paid the Federal Government for taxes, now we can use towards expansion of the company, growth funding of our ESOP obligations and whatever other business needs we have.
Zezas: STS loves the ESOP. It works for STS and it will continue. Why haven’t more companies elected? I mean, at the beginning you heard the numbers 12,000 companies. Relative to the number of companies in the United States that’s not a lot of companies. Why haven’t more companies opted for ESOP ownership?
Rausch: I don’t think it’s well understood. I don’t know about you.
Zezas: Say again, you don’t think it’s what?
Rausch: I don’t think ESOPs are well understood. I know when I went to college I never heard mention of anything about an ESOP. I did hear about a 401k, but I never heard of an ESOP. You hear about private equity and venture capital and you hear about publicly traded companies and publicly traded… never once did I hear about an ESOP. The very first ESOP I ran into was right after college I was working for Arthur Anderson and there was a client that was an ESOP and it was unique. It was exotic. It was strange.
I do think that it has a little bit of underexposure in terms of peoples understanding. I think it also suffers from the perception that it’s overly complicated. I believe that transaction that we had in December, it was complicated. There’s no way around that, but on an ongoing basis I don’t believe it’s much more complicated if at all than the 401k.
Zezas: Once you set it up it…
Rausch: You’ve got responsibilities like anything else. Once you institutionalize them they’re no different than anything else.
Zezas: Chris I’ve got to tell you, this has been a very informative interview. I have to believe that as a result of some companies watching our discussion today; they’re going to take a look at this.
Rausch: They should consider it.
Zezas: I thank you very much for appearing with us on CFO Studio. Will you come back and see us again?
Rausch: Absolutely. Thank you so much. I enjoyed it.
Zezas: It’s been great. This is Andrew Zezas, your host at CFO Studio with Mr. Christopher Rausch, CFO of Somerset Tire. Saying thank you very much for watching; we’ll see you again.