SES Advisors and SFE&G are members of The Business Exit Forum, a nationwide network of subject matter expert Preferred Advisors who are preeminent trusted advisors to mid-market companies at all stages of organizational growth and exit. The featured presenter at the May 13, 2013 Business Exit Forum's Profiles in Growth event was Joe Mattos, a third generation owner of Pro Finishes PLUS, a company his grandfather founded in 1928. He shared his experience of implementing a 100 percent ESOP in 2003. Following the presentation, Joe joined a panel of BEF Preferred Advisors, including Steve Greenapple, Principal of SES Advisors and SFE&G, and with them, took questions from the audience in an interactive panel discussion.

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A Special CEO/Business Owner White Paper
Profiles In Growth: Joe Mattos
The Business Exit Forumʼs Profiles in Growth series
showcases middle-market business owners who have exited
their companies. Our featured presented at the May 13 event
was Joe Mattos, a third generation owner of Pro Finishes
PLUS, a company his grandfather founded in 1928. He
shared his experience of implementing a 100 percent ESOP
in 2003. Following the presentation, Joe joined a panel of
BEF Preferred Advisors, and with them, took questions from
the audience in an interactive panel discussion.
Joe Mattos
President, former 3rd generation
owner, and present ESOP participant
Pro Finishes PLUS
Joe was a 3rd generation family
owner of Pro Finishes PLUS, a
company founded in 1928 by his
grandfather. When it became clear
no 4th generation family member
would take over the business, the
three owners evaluated the options
and elected to transfer ownership
under an ESOP. Ten years later, the
company is thriving—and employing
many people, including Joe.
Pro Finishes PLUS was started in 1928 by my grandfather, just ahead of
the Great Depression. But he was smart enough or lucky enough to
start the business in Washington DC, because in DC, when the
government runs out of money, they just print more. So the business
actually flourished through the Depression. Back then my grandfather
sold any kind of paint he could get his hands on. In addition to
automotive, he sold industrial, commercial, and house paint, which back
then was distributed through specialists. He grew to the point where, in
1943 the DuPont — which was and still is the largest manufacturer of
automotive paint — came to him because of his reputation and his
presence in the industry and asked him to become an authorized
distributor, which he did. Shortly after World War II ended, his sons (my
father and uncle) came home and followed in their father's footsteps into
the family business.
Lesson 1: Family dynamics can affect wealth transfer
The business prospered, growing with the post-war boom. We
expanded into the Maryland and Virginia suburbs, and then in 1958, my
grandmother passed away. Up until that point, my grandfather was sole
proprietor. He hadn't thought much about succession planning, but her
death gave him a new perspective, and thirty years after establishing
the business, he incorporated. He gave his sons stock in the company,
and made a decision then that was to benefit me and my cousin 45
years later: my grandfather made it very clear all along that stock in the
company should only belong to those family members who actually
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worked for the company. My dad and uncle adopted the same thinking
when they took over the business.
We opened our seventh branch store in 1973, the year I came into the
business. My cousin joined a few years before me. We followed in our
fathersʼ footsteps, and complemented each otherʼs strengths the way
our fathers had. I was an operations guy and my cousin was a born
salesman. I also have a brother and sister, who were never interested in
the business. Because my grandfather had set the precedent early on,
they never held stock in the company.
Joe Mattos
President
Pro Finishes PLUS
“My grandfather made
a decision then that
was to benefit me and
my cousin 45 years
later.”
Lesson 2: Creating the right culture now can pay off later
By the late 90s, we were up to 14 stores, and some of those stores
were far flung. But managing them was never a problem. Weʼd created
a family-business culture, which helped us manage these remote
locations in the days before instant communication. We hired people we
believed in, who believed in our values—and they tended to stay with us
for a very long time. My cousin and I were third-generation owners of
the business, and by the mid-90s we began looking at the fourth
generation and who might step up to take over from us. I have three
daughters, none of whom had any interest whatsoever in the business.
My cousin had a daughter and she had no interest in the business,
either.
In the mid-1990s I was in my mid-40s. My father passed on, but my
uncle was still around and in the business. We were looking forward
15-20 years, and that was key. At that time, we were one of the largest
distributors in the country. With 14 stores and around $50 million in
sales, we were a very attractive target to purchasers. We were
approached many, many times to sell the business.
When offers started coming in, we asked ourselves if we were in it for
the money or because we loved the business and the culture weʼd
created. I have been happy to go to work every single morning that I've
been with the company, and most all of our people can say the same
thing. We are very proud of that. When we looked at the potential
buyers, we did not have much confidence in any of them keeping that
culture in place, so my uncle, my cousin and I decided we were not
looking to just make as much money as possible. We wanted to ensure
continuity for this very special organization.
Lesson 3: ESOPs give owners flexibility in the transfer
We started thinking about ownership transfer in 1995, and it took us
eight years before we started the ESOP. Back then ESOPs were less-
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“That stock will be
there for them when
they retire and are
bought out, giving them
funds to roll into an IRA
and to live happily ever
after on.”
well-known alternatives. Finally in 2000, my CFO was at a seminar.
The speaker asked this question: “What do you think the income tax
rate is for an S Corp under an ESOP?” My CFO heard the answer
“zero.” He brought that back to me and that's what really started us
looking at ESOPs and we decided we could sell the company to our
employees. This would allow my uncle to take cash out for retirement,
and for my cousin and me to maintain that culture. We were about 50
years old and did not plan to retire, so we could continue to run it,
build a management team to carry us into the future, and give it to the
fourth generation, which turned out to be the employees.
We put together a 100 percent ESOP in 2003, borrowing about half
the money from the bank and taking back the other half in notes. We
are paying off the ESOP over 15 years. Every year I go out and
deliver the statements and administrative communication about the
ESOP, telling everyone about how many shares they received that
year and what their account value is worth. I show them high-level
financial statements and walk through the six things that must be
managed properly to ensure success in our industry. This way, all of
the qualified participants have at least some idea of how their job
affects the performance of the company, which affects the value of the
stock. That stock will be there for them when they retire and are
bought out, giving them funds to roll into an IRA and to live happily
ever after. ➧
Joeʼs Keys for Growth
Growth
1.
ESOPs give ownership flexibility in the transfer: Pro
Finishes PLUS owners went through a long process of
analyzing options before deciding an ESOP would best
serve each stakeholder.
2.
Creating the right culture now can pay off later:
Having the right people, processes, relationships and
leadership in place helped ensure the success of Pro
Finishes PLUS's ESOP.
3.
Family dynamics can affect wealth transfer: Prior to
the ESOP, Pro Finishes PLUS was owned by three family
members, each with different immediate and long-term
goals.
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“We asked ourselves if
we were in it for the
money or because we
loved the business and
the culture we’d
created.”
Interactive Panel Discussion Q&A: Highlights
Panelists:"
"
David Garbarino"
Senior Vice President
BB&T
"
"
"
BEF Preferred Advisor
"
"
"
Commercial Banking
"
"
ESOP Specialist
Steve Greenapple"
"
Partner, Steiker, Fischer,
Edwards, and Greenapple
Mark Schweighofer"
Principal
Stein Sperling
"
"
"
Corporate Law
Adam Goddard"
Senior Vice President
Morgan Stanley
"
"
"
Wealth Management
Jack Skeen"
"
"
Owner
Skeen Leadership Group
"
Moderator:
"
Executive Coaching
Host:
John Starling" "
"
"
Founding Partner
Smith Growth Partners
President, The Business Exit Forum
Growth Specialist
Question: What negatives came out of this for you or your company?
Joe Mattos: It's a question along the lines of what would you do
differently? I've been mulling that over, and I honestly don't think there
is anything I would do differently. There are a lot of ways you can make
the ESOP favor certain people, but I made sure that we did ours in a
very plain-vanilla fashion that went along with our culture. There were
no special deals. No one got anything special, and I think that has
been a key to its success. To the highest degree possible, the ESOP
reflected our corporate values.
Question: What is your plan to totally exit, because you really havenʼt
exited?
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Joe Mattos: It wasn't my plan to exit operations; it was my plan to exit
ownership. We quite consciously focused on the ownership transition
rather than a management transition. We performed an acquisition
about three years ago, and one of the reasons was to bring in some
younger managers in our same industry. She is 40. I'm 60 and I want
to work as long as I'm still having fun and contributing. I'd like to help
her focus her management team. The ESOP was very helpful in
attracting them to us.
Question: Has anyone on the panel seen a circumstance similar to
Joe's in which the former owner stays employed at the company?
Steve Greenapple
Partner
Steiker, Fischer,
Edwards, and Greenapple
BEF Preferred Advisor Steve Greenapple: Thatʼs a typical practice. In
many cases, management stays in place. An ESOP is an ideal tool to
develop another tier of management. Good people are attracted to join
and stay with the company because they get the benefits of ownership.
An ESOP can draw in people who are committed to the long-term.
Question: Conventional wisdom holds that banks are not lending.
Could this deal be done today in 2013, and is every bank equipped to
deal with ESOPs?
BEF Preferred Advisor David Garbarino: The short answer to the first
part of the question is, yes. Our own lending grew 33 percent and 26
percent respectively in the last two years in Baltimore. And this is
growth in the loan portfolio. You can get a loan in today's environment.
Banks in general are looking to lend for the right reasons. Because of
the size of the loans we do, we are a little more careful to consult
closely with the client in order to size the ESOP loan properly.
The answer to your other question is, no—not every bank can handle
them. These transactions are fairly complicated.
Question: Over time, youʼve probably had participants leave
employment. They have to be bought out, correct? And where
does the buy-out money come from?
David Garbarino
Senior VicePresident
BB&T Bank
Joe Mattos: We have a fund set aside for that repurchase obligation,
but it basically comes out of operating cash flow. We also have some
flexibility because of the income tax status. The ESOP is a tax exempt
shareholder. For example, about a year ago, we sold a piece of
property that had appreciated significantly for a considerable profit,
without tax. That helped us to build the fund.
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Question: S corporations have an advantage in terms of taxfree income after the transaction, but C corporations have a
great advantage to the selling shareholder up front. Did you
ever have a discussion about considering a C corporation
conversion?
Dr. Jack Skeen
Owner
Skeen Leadership Group
Joe Mattos: We put a twist on how we did our transaction. We
leveraged the company before doing the ESOP. We had valuations
done for purchase planning purposes and had a pretty good idea what
the company was worth, so we went to the bank and borrowed 50
percent of the money to buy the shares back from me and my cousin.
Now the company owned all the shares. We used the built-in equity in
the company to reduce tax liability. When we compared that to the
other options, it was a fairly simple way to go.
BEF Preferred Advisor Steve Greenapple: If you sell shares of a C
corporation to an ESOP, you can elect not to recognize any gain on the
sale. In order to accomplish this, you have to reinvest the proceeds of
the sale in like-kind investments, which is the debt or equity of the U.S.
operating company.
Question: If you were to convert to a C Corp for the
transaction, how long would it take to convert back to an S
Corp, and what are the tax consequences?
BEF Preferred Advisor Adam Goddard: Five years. The company
would pay tax, but it would have a huge deduction of principal and
interest. A C corporation has the benefit of deferred tax. Let's say you
have $10 million in gain, and you buy qualified replacement property.
You can borrow against that 90 percent and pull tax-free money out of
a company.
BEF Preferred Advisor Steve Greenapple: You don't have to guess
what the difference between C and S status would mean to you. Your
transaction analysis should illustrate what it would look like if you
stayed an S or converted to C and did a 1042. The lines generally
cross at some point.
Adam Goddard
Senior Vice President
The Capitol Bay Group
at Morgan Stanley
Question: Did you consider selling less than 100 percent under the
ESOP?
Joe Mattos: We considered a number of things, but the cash benefit of
the zero tax liability helped us decide how to fund the plan. This
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decision making illustrates one of the benefits of having only three owners. We
could make decisions very quickly, without having to create buy-in from a group.
Question: What is the fastest ESOP you've ever done?
BEF Preferred Advisor Steve Greenapple: Last year, due to the change in capital
gains tax, we got very busy at the end of the year. We started on December 4
and we closed at about 7:30 p.m. on New Year's Eve. This was a good-sized
deal involving twists and turns with charitable trusts that made it especially
interesting and advantageous to the sellers.
John Starling
President
The Business Exit Forum
Question: Does a company have to be a certain size before an ESOP makes
sense?
BEF Preferred Advisor Steve Greenapple: The tax advantages to an S
corporation are so huge that Congress established a special rule to make sure
that people don't take advantage of it for personal benefit. As a result, it is
mathematically impossible to have an S corporation work with fewer than 11
employees. In the real world, anything less than 20 employees is cutting it very
close. Generally we think of 50 employees as being the minimum for an S Corp.
I have one company that stayed a C Corp. They would've loved to have become
an S Corp but they had only 14 participants. If you shrink below a certain
number, you have to convert to a C Corp anyway.
Question: Any threats to this favorable tax situation for S Corp ESOPs on the
horizon?
BEF Preferred Advisor Steve Greenapple: It comes up every time Congress
looks at taxes, but as of now, the only bills pending are ESOP favorable.
BEF Preferred Advisor Mark Schweighofer: I agree. Congress seems to want to
promote employee ownership. ESOPs are not the right fit for every organization.
It does depend on size, culture, the ability to service debt load, and the ability to
fund buyouts when employees leave. For the right company, however, an ESOP
is a great way to go about it.
Question: When an ESOP is not the right fit, what other options do you
recommend?
BEF Preferred Advisor Mark Schweighofer: For a traditional exit event, by
working with some of the good folks in this room and finding a strategic buyer,
you can really drive a premium. It's really never too early to start thinking about
an exit. One of the great things about an ESOP is that it gets everyone on board
early. There are other methods to do that, including stock option plans. You lose
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some of the tax advantages of an ESOP, but you can transfer real equity to
employees by this and other means. Nonqualified deferred comp plans come in
one million and one flavors and are probably the most common alternative in
situations where ESOPs are not a great fit.
Question: What is the cost to operate the plan on an ongoing basis?
Joe Mattos: We have to have a valuation done every year, and in addition to
that, the administration of the plan costs just a few thousand dollars. Iʼd say less
than $15,000 on an ongoing basis.
Mark Schweighofer
Principal
Stein Sperling
Question: From the employee standpoint, it sounds like a great deal.
Was it difficult to convince the employees, and if so, what were their
concerns?
Joe Mattos: Our culture was really a perfect fit for an ESOP, so we didn't have
much difficulty or many concerns. One thing I learned in studying ESOPs before
we started ours is that good communication is key. First, I made sure all of my
management team was very well-versed in what the ESOP was all about. They
already knew the financial situation of the company and what factors made us
successful. Then, I made it a point to hold small meetings with the employees,
walking them through the ESOP idea. What I found in my research, and what we
actually saw in our own case, was that it took four or five years before the
employees totally bought in. I assumed this was because their initial annual
statements were not worth very much. Around the time average account values
hit about $10,000, they got it and were increasingly bought in.
Question: It sounds like the culture really determines the success of an
ESOP. What if you want to do an ESOP, but culturally your company is
not ready?
BEF Preferred Advisor Jack Skeen: That's a great question. People tend to
develop a sense of entitlement quickly. Business owners do nice things for their
employees, and after a while it doesn't feel like an extra benefit to them—it feels
like a requirement, and people get angry when it doesn't happen. If you create a
culture where people really understand what you're doing, and you articulate
and exemplify your values, employees will believe you are honest and treat you
fairly in return.
BEF Preferred Advisor Steve Greenapple: Joe's company is a poster child for
how an ESOP should be; he created real engagement and involvement. An
ESOP's benefits are maximized when it can be used not just as a financial tool
but also as an HR tool. We have clients who approach it differently and want to
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know what they have to share with employees. The answer is: you have to give
them a summary plan description and you have to give an account statement.
The account statement must show the number of shares and the amount vested
and the value per share. They never need to see the financial statements or
valuations.
Question: If the bank is essentially cash-flowing the ESOP, the bank is
basically betting on the management teamʼs ability to service the debt. What
makes a bank feel confident that the plan will have the ability to make good on
its debt?
BEF Preferred Advisors from left to
right
Dr. Jack Skeen (far left)
Owner
Skeen Leadership Group
Deborah H. Diehl
Partner
Whiteford, Taylor & Preston L.L.P.
Harvey Widger
Founder
Fulcrum Transitions
Frank S. Jones, Jr. (far right)
Partner
Whiteford, Taylor & Preston L.L.P.
BEF Preferred Advisor David Garbarino: Banks walk a fine line. Our goal in the
covenants is not to go over that line and try to tell the management team how to
run the company. We already bet on them to win. One of the most important
things we do is redistribute capital, and we do it in as efficient a manner as
possible. We are very careful about who our clients are and with whom we are
doing business. In regard to the covenant, if the risk associated with that loan
changes, we will need to have a new conversation.
Question: If you're doing a valuation every year, and one valuation seems too
high or too low, do you get a second opinion?
BEF Preferred Advisor Steve Greenapple: The trustee is actually responsible for
determining the value, even though there are financial advisors helping with the
valuation. Every now and then we get a valuation that management challenges.
There will be a conversation, but in our experience typically the people who are
doing valuations do it very accurately. We would typically not recommend getting
a different valuation from a different provider because it's very rare that two
valuation companies will determine the same valuation. What we will
recommend is having a peer review of the valuation every so often wherein the
valuation company looks at the methods as well as the inputs that are used in
determining the output, but not comment on the output itself.
Question: Do you ever have situations where the employee owners of
an ESOP have a problem with the way the former owner and current
manager are running the business in terms of their fiduciary
responsibilities and so forth?
BEF Preferred Advisor Steve Greenapple: Situations where the value of the
stock drops sharply after the ESOP can happen as a result of macro or micro
economics. If your whole management team is killed in a plane crash, something
bad happens to the value of your stock. There are stock drop cases, but if the
company management has acted appropriately, courts generally find in favor of
the company, saying this is a risk of capitalism.
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Joe Mattos: From a practical point of view, this is why I have a majority of
outside directors on my board. If we are screwing up running the company, I
have directors who will stand up and make changes.
BEF Preferred Advisor Steve Greenapple: It is also important to understand that
employees do not own the stock directly. The trust does. It's a retirement plan.
People cannot vote on the stock or transfer the stock or walk away with the
stock. All they get to do is receive the financial benefit of the retirement plan
when they retire, die or become disabled. The only exception is, if you want to
sell the business, you have to ask the participants. Generally speaking, the
trustee has the right to overrule irrational decisions on the part of the plan
participants. ➧
Panelist Companies
Steiker, Fischer,
Edwards, & Greenapple
www.sfeglaw.com
BB&T
www.bbt.com
Stein Sperling
www.steinsperling.com
Skeen Leadership Group
www.skeengroup.net/
Capitol Bay Group at
Morgan Stanley
www.morganstanleyfa.com/
capitolbay
Smith Growth Partners
www.smithgrowthpartners.com
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