ECCI Partners Sidestep Pitfalls of Transition

by Gwen Moritz  on Monday, Dec. 4, 2017 12:00 am   5 min read

Almost since they went into the environmental engineering business, Stan Jorgensen, Bob Harrison and Rod Breuer have been thinking about an exit strategy.

Now that ECCI Inc. of Little Rock is in its 25th year, Jorgensen, president and majority shareholder, has figured out a transition plan that is notable for what it isn’t:

  • It isn’t closing the doors and dividing up the retained earnings and assets;
  • It isn’t selling the business to another firm, risking a cultural misfit; and
  • It isn’t an ESOP, an employee stock ownership plan, which are strictly structured and frequently indebted.

Instead, Jorgensen, 67, sold his partners, both also in their 60s, on a multistep plan that will allow 12 senior employees to buy stock at a discounted multiple of earnings. And they will buy the stock using after-tax cash bonuses funded by what would have been part of Jorgensen’s salary. Even more urgent than transferring ownership, Jorgensen said, is installing younger management that still has the stomach for risk-taking.

“It’s not just ownership. It’s leadership,” Jorgensen said in a recent interview. “Even if you own stock and the old farts are still in charge, it’s not going to change.”

Last week the C-corporation’s board of directors — that is, the three founders — named two new vice presidents: Julie C. McCallister, a senior environmental scientist who has been at ECCI for 13 years, and Michael G. Geurin, a senior project manager who joined the company nine years ago.

It’s the first of several steps that ECCI is taking in hopes that the 23-employee firm will survive and thrive even as the founders are able to take out value they’ve created to see them through retirement. By the end of this month, new corporate bylaws will have been adopted, the board expanded, new officers elected and the bonus checks issued to the employees who have been on staff for at least five years.

Alese Stroud, a Little Rock mergers and acquisitions consultant, said Jorgensen’s plan for ECCI seemed to anticipate and address the most common problems that trip up companies that transition to new ownership.

“That’s just an incredibly brilliant approach,” said Stroud, who has not worked with ECCI. “He could be the local poster child for how to do it right.”

ECCI, like other environmental consulting firms, owes its existence to the environmental movement that began with Earth Day in 1970. Major legislation that followed — the Clean Water Act, the Clean Air Act — created a new regulatory framework, and helping client companies comply with the new regs created a new industry.

When Jorgensen, Harrison and Breuer created their business — officially Engineering Compliance & Construction Inc. and originally two separate companies that merged in 1997 — “we didn’t know what we were doing, of course. We thought we would build it up and sell it,” Jorgensen said.

But as the business grew, the idea of selling it to another company lost its appeal.

Maintaining the jobs and corporate culture they had created became more important, even as the partners realized that the best, most entrepreneurial employees would want ownership.

Having previously worked at public companies, the partners first started to offer stock options. But that didn’t work, Jorgensen said.

“People don’t understand those. Especially spouses, because they don’t seem real,” he said.

The next idea was a new class of stock, B shares that would eventually replace the A shares that key man life insurance would acquire from the original partners’ estates. But that program, which began in 2006, “was too slow,” Jorgensen said. “It depended on people dying.”

And while an ESOP can have significant tax advantages, Jorgensen was uncomfortable with the debt typically associated with that strategy. “I’ve never seen one work well for all the parties,” he said. “They usually work well for the owners.”

In Jorgensen’s mind, the key to a successful insider sale is “avoiding debt.”

Think, Think, Think
In mid-2016, Jorgensen began exploring ownership transition options “in earnest.” At the start of 2017, he took the first concrete action: He began taking Fridays off and reduced his salary by 20 percent (even as he increased his time on the golf course).

That savings, which the company banked, will fund the bonuses that the senior employees will use to begin buying stock from Jorgensen, Harrison and Breuer — replacing their non-voting B shares with A shares. (Harrison and Breuer have not reduced their work schedules.)

The employees cannot be required to use the taxable income to buy the stock, but Jorgensen expects they all will — in part because the price is right. While M&A companies might suggest a valuation on a debt-free engineering firm like ECCI of 4 times annual EBITDA (earnings before interest, taxes, depreciation and amortization), ECCI’s three shareholders long ago adopted a deeply discounted multiple of 2.5.

“If you are going to sell to your employees, you can’t stick it to them,” Jorgensen said.

Stroud, the consultant, praised that approach. Citing research by Project Equity, a California nonprofit that promotes ESOPs, she said owners’ natural tendency to overvalue their businesses hurts them in two ways: They rely too much on an optimistic valuation to fund their retirement and fail to save enough otherwise, and then they have trouble finding a buyer that values the business as much as they need.

“Mr. Jorgensen has skirted that whole issue by putting a reasonable price on his company and allowing his employees to buy it so that he never has to go on the open market. So stroke of genius for him,” she said.

Not having to find a third-party buyer is a distinct advantage of an ESOP, but the employees may end up paying the seller’s inflated asking price and going into debt to do it. That’s what Jorgensen said he wanted to avoid, and Stroud praised that as well.

“I’ve talked to more people who say they want to reverse their ESOP than are happy with it,” she said.

Jorgensen plans to continue his four-day workweeks in 2018, and he eventually hopes to serve primarily as chairman of the board as his new, younger partners take over more and more of the management duties. (The key man insurance remains in place, just in case one of the founders dies before the ownership transfer is complete.)

Jorgensen had already cut back on his work and salary and settled on the general plan for selling stock to employees when his regular trip to the Arkansas Environmental Federation’s annual trade show in October lit a new fire under him.

At the Hot Springs Convention Center, he was surrounded by the usual players in the environmental industry, entrepreneurs like him and his partners who got into the burgeoning industry decades ago and are now “retirement age, healthy and in charge — and don’t want to quit.”

And he noticed something. The old farts were congratulating themselves on the businesses they had built, but the few companies that had actually gone through ownership changes were the ones that “had excitement in their booths.”

He came back to the office and immediately started planning to hand over the management to younger employees while he’s still able to help guide the transition.

“They are looking at the most productive parts of their careers. They’re hungry to make their own way,” he said.

Stroud said gradual retirement, like Jorgensen’s, has a much better chance of succeeding than when an owner/manager simply walks out one day.

“That’s the problem: They don’t know how to get out,” she said. “Or they think they do, and it’s not effective. They frequently don’t cross-train for themselves. We’ve seen that several times, people trying to step out and they don’t realize how vital their role was to the company.”

By stepping away gradually, Jorgensen is “forcing someone else to fill his role and allowing him to mentor them. ... I’m rapidly deciding that’s a best practice.”

And since Jorgensen, Harrison and Breuer will continue to own some stock, there’s another advantage to new, younger management: new ideas for growing revenue and company value.

“We were all risk-takers, baby boomers,” Jorgensen said. “We jumped off the deep end several times and didn’t think anything of it.

“But I wouldn’t do that now.”

 

 

Please read our comments policy before commenting.