Update on Sept 10, 2020: This bill was not included in the Senate Republicans' most recent coronavirus relief bill.
The Temporary Federal ESOP Grant Program Act (S 4236) was introduced by Sen. Ron Johnson (R-WI) on July 21, 2020, and is cosponsored by Sen. Tammy Baldwin (D-WI). The bill has the potential to create new ESOP companies, to expand the amount of employee ownership in current ESOP companies, and to inject working capital into ESOP companies to make them stronger.
The U.S. economy will recover from the COVID-19 outbreak, but the distribution of the benefits of that recovery remains an open question. A recovery that accelerates the concentration of wealth will increase the fragility of our economy, and this bill recognizes that employee ownership can both strengthen the recovery and ensure that working Americans receive a just share of future economic growth. If American workers have a larger ownership stake in the post-COVID economy, the recovery will be both broader and deeper.
The bill is a bold and bipartisan departure from prior legislation, and in this post we aim to explain its potential, what is different about its approach, and some issues that need clarification. (We covered the announcement in a blog post, and the text of the bill is here.)
Prior legislation has provided tax incentives for the creation or expansion of employee ownership. By contrast, this bill would directly support employee ownership with cash grants from the federal government. The grants would support both the actual purchase of shares (up to $20,000 per ESOP participant) and some of the transaction costs (up to $50,000). The bill defines the purpose of the grants as supporting either establishing an ESOP or “increasing the percentage of the eligible business concern owned by” an ESOP (section 2(a)).
The bill could provide a powerful incentive for companies to adopt or expand ESOPs—a company with 100 employees could receive a grant of $2 million (or, more precisely, $2,050,000). Under this bill, an average ESOP participant would receive $20,000 in contributions into her ESOP account as a result of this program, an amount that represents the equivalent of just over five years of ESOP contributions in the median privately held company with an ESOP (excluding companies with 401(k)-ESOP hybrid plans) in 2018 and just shy of four years of contributions in the median privately held company with a leveraged ESOP in 2018. Assuming the bill is implemented in a way to accommodate existing limits on contributions, it could accelerate the transfer of stock to working people.
The bill would allocate unused money from the business stimulus bill. The program would end on September 30, 2022.
The original intent of the designer of ESOPs, Louis Kelso, was that ESOPs would be used to finance business growth with capital investment. However, there has been no such requirement in federal law, and the great majority of ESOP financing has been used to acquire shares from existing shareholders, not to increase capital investment.
This bill appears to imagine an approach closer to Kelso’s original intent. Under the bill, a company would use the grant to make a contribution to an ESOP trust, which would use the funds to purchase newly issued or treasury shares from the company. The company, in turn, would use the money for capital expenditure. The bill says that the capital investment must be for “replacement and maintenance of fixed assets, including manufacturing equipment and tools, computers, land, buildings, facilities, health and safety equipment, and other similar investments” (section 2(b)(3)).
As we understand the bill's intent, non-ESOP owners would not sell any shares to the ESOP trust as part of this transaction. The ESOP participants would receive the shares in their accounts. The capital investment would then go to work to increase the value of all of the company’s shares. Assuming the company purchases productive assets, it would be able to invest in itself without using debt, while also preserving its cash on hand, and the capital investment itself would stimulate employment economic activity, assuming that the assets the company purchases as long as the assets are stimulative. The share ownership of non-ESOP owners would be diluted as a percentage of the total outstanding shares. That dilution would be offset, at least in part, to the extent the grant leads to an increase the equity value of the company.
As it is currently worded, the bill might allow the grants to be used in a transaction in which the company or the ESOP buys shares from existing owners instead of buying newly issued shares. If Congress wishes to prevent such transactions under this bill, as appears to be the bill's intent, it will require minor amendments: the bill might simply incorporate a provision stating that grant funds must be used toward the purchase of employer securities issued by the company for this purpose and not currently held by any other owner
We have been asked whether we believe that these federal grants could encourage owners to sell shares in distressed companies to employees at inflated prices. The NCEO does not believe this is a realistic possibility as long as the bill maintains the existing requirements for ESOP valuations. ESOPs created under this bill would be bound by the same requirements for independent valuations as are all ESOPs. A company that is struggling or greatly in need of the grant money would have a correspondingly low stock price, giving the ESOP a greater ownership percentage in the company. The ESOP’s investment would thereby be “risk adjusted” in the price per share.
As currently written (Section 2(b)), the bill contains its own valuation requirements: (1) valuation “by an independent valuation expert utilizing generally accepted valuation approaches” or (2) valuation “by the trustee of the employee stock ownership trust if such valuation is certified by such an independent valuation expert.” We believe these provisions are unnecessary because existing regulations already require that the purchase of new stock by the ESOP would be for no more than adequate consideration, just as the law requires for any ESOP transaction. The safeguards of fairness and prudence required under existing law would apply to the purchase of the new shares by the ESOP trustee. Replacing the bill's valuation requirements with references to existing valuation standards would reduce potential confusion and eliminate the chance that the new standards could be seen as changing existing valuation standards.
This bill advances an approach to employee ownership that is both a bold innovation and a return to the founding ideas of ESOPs as expressed by Louis Kelso. It is a statement of a policy principle that employee ownership should be an integral part of any economic recovery legislation.
Like any policy innovation, the drafting process will need to include some amendments, such as the ones suggested in points 2 and 3 above. In addition, the bill might benefit from expanding its scope to forms of employee ownership other than ESOPs, especially worker cooperatives, and from more precise standards for the timing and form of company contributions to the ESOP. The bill might also consider how best to define the company's investment resulting from the grants in order to maximize their stimulative effect and to ensure that service companies, which have less potential capital investment per employee, are able to fully participate. Congress may wish to consider what may be an unintended consequence of one provision: the bill currently requires that the grant recipient increase the percentage of its shares owned by an ESOP, a provision that would make 100% ESOP-owned companies ineligible for grants.
The NCEO was not involved in discussions about the version of the bill introduced on July 21, but we look forward to continued productive conversations about finding the optimal language for this bill, which has the potential to dramatically increase the amount of employee ownership in the United States, preparing our country for a post-COVID-19 economy that is both stronger and fairer.
Want to share your reactions to this bill? Use the NCEO's input form for this bill to provide anonymous or identified feedback, or contact Loren Rodgers.
Updated on July 30 with clarifying edits and ideas on possible improvements to the bill's wording.
Updated on July 28 to emphasize in point 2 that requiring purchases of new shares appears to be the intent of this bill, but since I was not involved in drafting that language, I cannot say so definitively.
Thank you to the many people who talked with me and contributed their experience and wisdom to these thoughts. This is a fast-moving issue, and no productive analysis would have been possible without a team of contributors. More even than typical, however, people have diverse understandings of this policy, so although I warmly thank all advisors, I claim all mistakes as my own.
In addition to the anonymous advisors, I thank Ted Becker, Chris Buch, Ron Gilbert, Tim Jochim, Judy Kornfeld, Kevin Long, Scott Miller, and Corey Rosen.