Unlocking Contractor Wealth: Employee Ownership Trusts Explained

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ℹ ABOUT THIS EPISODE

After 30 years building your company, do you know how you'll exit? In this episode, Wade Carpenter and Stephen Brown break down Employee Ownership Trusts (EOTs) — a lesser-known but powerful exit strategy for contractors.

You'll learn how EOTs compare to ESOPs, what they mean for your cash flow, bonding capacity, and taxes, and why your employees might be your best buyers. If you haven't planned your exit yet, this episode will get you thinking.

⌚️ Key moments in this episode:

• 00:00 Succession Dilemma
• 00:31 EOT Explained
• 01:34 Why Owners Consider It
• 02:10 EOT vs ESOP Payouts
• 03:19 Size Fit and Complexity
• 03:40 Origins and Regulation
• 04:47 Owner Benefits and Legacy
• 06:29 Funding the Buyout
• 08:25 Bonding Company View
• 10:02 Tax and S Corp Issues
• 11:25 How the Money Flows
• 15:24 Advisors and Planning Team
• 19:18 Other Exit Options
• 20:36 Employees Are the Value
• 22:20 Wrap Up and Call to Action

The Contractor Profit Blueprint is a complete guide that breaks down exactly how to identify where your money's going and start keeping more of it. This isn't theory. It's the same framework I use with contractors I work with every single day.

Head to profitfirstconstruction.com/blueprint to download your free copy. 

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

Wade Carpenter: [00:00:00] A contractor can spend 30 years building a company, then realize the hardest project left is figuring out who gets the keys when he steps back. Today, we're talking about one alternative many contractors have never heard of: an Employee Ownership Trust. Come on in, let's talk about it.

This is the Contractor Success Forum. I'm Wade Carpenter with Carpenter & Company, CPAs, alongside Stephen Brown with McDaniel-Whitley Bonding & Insurance. And Stephen, let's start off with a definition. What in the world is an Employee-owned Trust?

Stephen Brown: Well, it's a perpetual purpose trust, okay? It performs a purpose that goes forward in, in perpetuity. Now I know that sounds confusing, but the first thing is, what is a trust? A trust is set up to keep something going in certain parameters after, for example, you've sold your business.

There's an ESOP, Employee Stock Ownership Plan, and then there's Employee Ownership Trust. Those are two types of [00:01:00] trusts. These trusts are set up with trustees that act on behalf of the beneficiaries, and the beneficiaries would be the employees, okay? In a ESOP or a EOT, Employee Ownership Trust, the purpose of it is to buy out the owner, or owners, and keep the company going in perpetuity, and also provide incentive for the people that wanna come work for that company to come and work and stay.

So you're keeping the brain trust of that company still active, still intact, still producing income after you're gone.

Wade Carpenter: Yeah, I think every contractor out there, they get to a point where, you know, as we were kicking around before this, you know, it's like, do you have something to sell? And if you do, do, you really wanna pass it off to some private equity or whatever? They're gonna ruin the company.

You don't wanna displace your employees. You want to keep your legacy going. There's a lot of things that go through your mind, and maybe you don't have a son or daughter or somebody that wants to carry it on [00:02:00] in your family. So they're struggling with what do we do? And we don't want this to go away.

So this is yet another tool we can think about. What else do we need to know about these things?

Stephen Brown: Well, ESOP generally, the income in an ESOP goes into your shares, which are purchased at your retirement. As an ESOP-owned company, it's building up your retirement. And if there's enough money and profits in the ESOP, then employees will sell their shares and the company has to produce the cash to buy out those shares at retirement.

Where an Employee Ownership Trust is designed to take the profits after what's needed to run the company, the profits are distributed as dividends to all the employees. So, the trust owns the business on behalf of all employees, and the employees can get a cash dividend each year as dictated by the terms of the trust and administered by the trustees, [00:03:00] or it can be put into a retained earnings account where that employee can access it later, which might have some benefits for retirement as well.

Generally an Employee Ownership Trust is considered easier to implement than an ESOP. But there's so many pros and cons and moving parts to the two of them that you have to consider.

For example, an Employee Ownership Trust generally may lend itself to a medium-sized to smaller company, where an ESOP might be easier to implement for a larger company.

And you could say, "Well, why is that?" And that's because there's more moving parts, and there's a lot of expense and planning involved in setting up both of these.

Wade Carpenter: Absolutely. And, I don't know if you wanna talk about the history of these things, but they're not as common here in the United States. I believe they originated in the United Kingdom, and I don't know if you know any of the history. I know there's one model in the UK that somebody's been doing it for quite a long time, but it's [00:04:00] really new over here.

The ESOP is well-established here in the United States. I'm not gonna go into the history and all that stuff, but there's one that's been working with these in the UK, a large company, for years and years, and it works very well there.

They have different laws than we do here in the United States, and one of the things that... again, as we get into this the pros and cons of an ESOP versus an Employee-owned Trust.

The trust law is done at the state level. You've got a lot more regulation for an ESOP because it's basically a plan for the employees, and it's regulated by the federal government and all this stuff.

Whereas you've got state law governing these things, you do have a lot less regulation on it, but there are some different challenges.

Why would an Employee-owned Trust appeal to a contractor owner versus a... I know you kicked around some of this, but you got any first thoughts on that?

Stephen Brown: First of all, it is [00:05:00] equitable in that every employee will get cash distributions. How that's handled for tax purposes within the company, outside the company, I don't know the answers to that. But from everything that I've read, it's easier to set up.

It seems to me like the less moving parts you have in setting something up, there's something to be said for that. It's a huge decision of what your state laws say of where your company is incorporated and what those state laws say about what you can or cannot do.

So you would wanna find an expert in Employee Ownership Trusts, someone that can give you a fair analysis of the pros and cons of both ideas.

Wade Carpenter: Just thinking about why they would want to do it. Maybe they don't want to go through all the hassle of the ESOP, and all the regulation and all the reporting that has to be done, and they can't find an outside buyer, or the one that they like. And they want their employees to benefit from them.

But with this structure, everybody [00:06:00] stays in place. And as you said, it's not like, okay, somebody owns more ownership than me in an ESOP. They're members of the trust, I guess I would say.

The owner basically, they don't physically have any ownership. The trust has the ownership. So their legacy as an owner stays intact. So they still get to run the company while they're transitioning out and getting bought out. Again, they're different funding structure, but the idea is the owner's still gonna get paid for his shares.

The challenge, number one, with an ESOP, you're basically funding stock. So a lot of times a bank will lend on something like that, and that's where they talk about the leveraged ESOP, where they borrow money and then the owner gets paid for it. Versus, typically the trust, no employees are putting money in and they're going to be paid out of profits.

The owner gets paid back out of his own profits. So part of the problem is, whether a bank would actually lend on this like they would an [00:07:00] ESOP.

Stephen Brown: I mean, I guess the question is do you need a bank to lend on it, or can you structure it within the program? You've got certain assets in the company and other things that the company can borrow against to fund the buyout.

First of all, you have to properly value the company where it's fair to all parties. And then you have to make sure there's enough money in there for surety bonding and for cash flow purposes.

So, you either do an ESOP or an Employee Ownership Trust if your cash flow's good and you're making money. You've regularly got a niche, you've got a team, everything's working, everything's clicking.

Why just close it down? Why sell it to someone that doesn't understand the dynamics of your company? Like I said, the brain trust, but also, what's that core group of folks' passion character, purpose? Then you've got the business model, and then you've got all the systems in place you've built up.

Now, that has tremendous worth to it for generating income [00:08:00] now and in the future. And it's the future income that keeps this going. You wanna avoid bank debt for the buyout as much as you possibly can, and fund it as much as possible through cash flow. That might not be good enough for the owner that wants a big buyout fast.

But if there's enough cash flow going in the company, something can be worked out for the owner and the employees that benefits both of them.

That's all I'm thinking.

Wade Carpenter: Well, so I guess I would ask you, for a bonding company, would they see this any differently with the ownership structure with a trust, from a bonding standpoint? An ESOP versus the owner owning it outright? 

Stephen Brown: Well, first of all, the most important thing in ESOP or an Employee-owned Trust is to communicate to your bonding company the number of key players are still gonna stay in place. That's number one.

Then the second thing is will there be adequate working capital to perform your work? And you [00:09:00] might disagree with the bonding company, but the bonding company has a general criteria that they look at that gives them a certain comfort level of bonding you.

You have to talk to different bonding companies to see what that comfort level is. But if you've got a track record with a good surety, and a good agent and surety relationship, you wanna keep that going. There's worth in that as well.

Working capital, key people staying, understanding the terms of the trust agreement for the terms of the ESOP and the Employee Ownership Trust. The more you've thought things out and organized it with your surety agent and your plan administrator, the better you can communicate that and bring your surety in as a part of the team.

Remember, they have a great deal of sweat equity involved in you, and they wanna keep it going. They don't wanna lose your business. When they know that you've got a good plan working, you've got good people running the company, you know what you're doing, and you've [00:10:00] got everything you need to continue to perform that work they wanna keep going.

Wade Carpenter: Absolutely. Also, I don't know if you really kicked around the tax implications.

Stephen Brown: That has to be you, Wade

Wade Carpenter: Well, ESOPs can have some tax-favored benefits to the owner. One concern for Employee-owned Trust that I had was the vast majority of contractors that are making any kind of money at all are set up as S Corporations.

While S Corporation ownership generally has to be an individual, you can have certain cases like a state-type trust, but a generic trust I would think would break an S Corporation election.

They may be forced to be a C Corporation, which would mean that they would have to change the dividend structure and all that stuff, and they would have to consider federal income tax.

So that was a concern I had. It may just be something where, if they're gonna do that, they may wanna convert to the C [00:11:00] beforehand.

And again, you're dealing with state law versus federal law, and there's some considerations here. Going back to the federal law, from the tax standpoint, that's where I was a little concerned that this might mess up.

And it just is another consideration. Because yes, you are a lot simpler, a lot less regulation on the Employee-owned Trust, though you do still have to have some legal parts in place.

And so, you know, have you thought through, how the money flow actually works on this?

Stephen Brown: Well, first of all, you have to come up with a fair evaluation of the business with the employees. Right? The current ownership is gonna step out and the former ownership can be a trustee to make sure they're familiar with the terms and conditions of the trust, and the employees say, "Yeah, we wanna still have you be one of the administrators," but they don't control it. That's an important criteria.

Then, the employee [00:12:00] ownership, the management, helps to decide how they're going forward in the future.

Are they gonna keep things the same, or are they gonna need to push their bonding program in certain areas, are they're gonna have to buy certain equipment or make other business decisions? Then that will come in the future, not right now.

Right now, you have a system in place and people in place that are generating income, and it's that income that funds the buyout.

So you definitely have to do some liquidation and get rid of some company cash and other things to buy out the old ownership.

But at the same time, you can structure things with your current customers as far as pay plan, retainage, other things that might help the situation, because they say, "Hey, we don't want your company to go out of business or be run by someone else. We like working with you guys."

So your key customers may wanna help support an Employee Ownership Trust, or an ESOP that's going on. They have a vested interest in [00:13:00] that as well. So that's a consideration. That's just something to think about.

Wade Carpenter: I'm just trying to think about the different considerations I would have.

We've already talked about the cash flow, and whether it's a lot of the sales in the country, unless you're selling to private equity, probably the seller is usually financing the note anyway, so it's coming out of their pocket.

I guess the question is, is it creating some cash flow challenges? Would I have to worry about making sure the cash is flowing and who's carrying the risk on this?

I wouldn't think a bank would love the deal, because, they, first of all, may not understand it. If it was federal law, then they would have to have some people that understand it from a state law. I would just have some concerns if you're trying to fund it through a conventional bank, or especially, a lender may be out there that may wanna do these things. I don't know.

Stephen Brown: Yeah I don't know the answer to that. All I'm saying is some of these successful ESOPs, Employee Ownership Trusts that I hear about are just funded by good cash flow and solid profit margins. [00:14:00] And those are unpredictable. So the owner might have to take some risk in the future planning there.

But that's all the reason why maybe the owner that's going out might wanna be one of the many trustees of this trust, and that they at least can help steer things the way they intended them to be steered for the benefit of all the employees.

Wade Carpenter: Okay. I didn't know if you had specific things that you wanted to talk about. 

Stephen Brown: No, just the pros and cons. You wanna get out of your company, and how do you do it most profitably? A lot of folks, you've got a lot of sweat equity. Your name's on the company. You wanna keep that going. You wanna do everything you can to support your current employees that have gotten you where you are now. Okay? You can't do it all by yourself.

So you want to reward those employees, and you wanna reward future employees. And someone coming to work for a big construction company that knows that they're owners of the company, either an employee ownership trust or an ESOP, have [00:15:00] certain pride in keeping that going.

You're working harder because you have a purpose. You're hiring people that have that drive to succeed and wanna join other people with that same common drive to succeed.

So to me, either one, it's all about momentum, right? You want a plan to retire, to get out of the company, and you gotta get started somewhere. So you have to look at all these options.

Now, the only thing that I was gonna ask you, Wade, is it just seems to me– and we had an attorney that specializes in ESOP come as our guest on one of our podcasts years ago.

It was very informative. How the structure's set up, what's involved, what kind of costs are involved, what kind of administration is involved. There are moving parts. You need an expert to guide you through this.

I'm not your expert, except maybe when it comes to keeping the bonds going and the relationship after this has taken place. You're the expert in guiding them of [00:16:00] what the laws say about the taxes and implications. You mentioned maybe the S Corporation converting to a C Corporation.

Any way you look at it, there's just certain headaches involved with getting it done. But people that do it all the time make it a little bit easier than people that don't do it all the time. That's a fact.

And finding someone you trust to help steer this ESOP or Employee Ownership Trust in the right direction without taking all the money out of your company to do it, takes a little bit of study and work on your part to make sure you found the right person or people.

The construction attorneys that we work with, of course, a construction-oriented CPA such as yourself, and bonding agents such as myself. Then you've also got the banking relationship as well.

So this will all go back to your board of directors. You sit down and saying, "Okay, here's the pros and the cons. This is what I want to accomplish, guys. What do you think?"

I had these conversations with customers. They ask what [00:17:00] I think about it, and I tell them the same thing: let's crunch it down as if you're gonna pull the trigger now and see what that looks like, and then bring the surety in. Give them the facts, the figures, the data. Let them chew on it, and let them see the key people that they have.

I can think of certain situations where the more surety is involved with the key players involved, the key project managers, the people running the different divisions the decisions they make, the authority that they have, their experience, their track record, we get that by going to see their job sites and looking at the numbers when it's done, and that builds so much trust, Wade, I can't even tell you.

You know, they say a picture's worth a thousand words. A visit to a job site and really understanding what that project manager's, what that division manager's doing, what they want to accomplish, is worth its weight in gold.

Having a regular annual meeting before the year-end is finished with your surety after you've already met with your CPA. If you're [00:18:00] projecting kind of what the year-end numbers are looking like, you're communicating what you want to do in the future. That's worth its weight in gold for a surety relationship. And I would venture to say that a surety relationship is also the same criteria that would make a good ESOP or Employee Ownership Trust work. Those elements are in place either way.

So yeah, there's gonna be less for bonding. There's gonna be less for cash and expansion and other things that you want to do right now, but that doesn't mean that couldn't come in the future.

Wade Carpenter: Yeah. And again I didn't mean to sound negative about this. I think just like in tax law, we talked pretty early on and you have to say it depends. You do your best, but. 

Stephen Brown: Right. Yeah that's my point. It depends on so many things. But to say out of hand, an Employee Ownership Trust is new and not something you consider just because it's new, I don't think is accurate. We need to study and know why it [00:19:00] works. Why did it work over in England? What's the difference there and here? You're right, the laws are different, and the state laws are different.

So, you might say, "Well, Wade, Stephen, why are you even having this talk without having that exact information at your fingertips?" Well, look, listeners, you can look that up yourself. You can study it yourself. You can make your own decision on these things. We're just presenting to you the idea of an Employee Ownership Trust.

We've talked about ESOPs, we've talked about selling your company to someone else, and leverage it based on your EBITDA.

We've talked about just fire sale, what means you're just selling everything and closing the doors. We've talked about perpetuity, when you have family members in a family. How do you do that going forward? You might wanna keep it a closely held family and let that family buy you out. And you dictate the terms to your family, and they decide whether they're willing to do that or not.

As family members, you might say, "Well, how fair is that to me? [00:20:00] Am I an indentured servant to this situation, working for my mom or my dad?" Who knows? But nevertheless, you got that to consider.

And then you've got ESOP, Employee Ownership Trust. What other ways could you get rid of your company and make money?

Just maybe outright just sell it to a competitor. Let them absorb it. That's always a good option as well. But that competitor's gonna wanna make sure that your key people and you are still around for a while to keep things smooth, to make it worth their buyout.

So that's the only con there to having a good competitor, is if those terms don't fit what you want.

Are we missing anything here, Wade?

Wade Carpenter: Well, I think we could probably kick this around for quite a while if we wanted to, but at the end of the day, anybody that's built a great company knows that they're built on the backs of their employees.

And if you got great employees, that's part of the value of your company. You don't just replace that overnight. You just can't take one person out and plug somebody else in, especially in construction.

So [00:21:00] that's why one of these employee ownership trust or ESOP either one of these things they could fit depending on what your particular situation is, what the state is. There's a lot of things that go into it.

I'm glad you brought this to us because most people have never ever heard of this. And, you know, if nothing else whether it's right for you or not, if it made you think about it in a different way. I think maybe that's where we're trying to provoke some thoughts because a lot of contractors get to retirement and they've never even put any thought to it. And this might be another avenue that they should possibly consider.

Stephen Brown: I think you hit the nail on the head. You can simply value your stock and sell that stock to others from day one when you start a company.

As a corporation, you can have shares and you can figure out a value of those shares and you can start saying, "Do you wanna buy now?"

But a lot of times the employees don't have the cash or the wherewithal to buy that stock. So you give stock options and other bonus benefits and things to make that [00:22:00] happen or you form a trust.

But either way to say, "I'm selling out to a competitor, but we're taking care of you." Well, as a key employee, you're just taking care of their current income.

That's how you're doing it, right? So, I think you made a good point here. The value of your company, a lot of it depends on the backbone of your employees that are helping you carry it. Key consideration.

I appreciate you letting us do this podcast Wade, just for throwing it out for our listeners.

We'd love to hear from you listeners if you have any ideas or experience with Employee Ownership Trust, and what your thoughts are. And also what you're doing for your employees that might be working that we can share with others.

Wade Carpenter: I don't think I could sum it up any better than that, Stephen. Again, appreciate you bringing this to us. If it just made you think about it, we appreciate it if you just like, share, subscribe, pass it on to another contractor you know. If you got comments, put them down below and we'd love to hear it.

Or if you got thoughts on other things you'd like us to talk about in the future, we'd love [00:23:00] to kick those around too. We do this every single week. We appreciate you being here, and we will see you next time.