The Ultimate Retention-Reward System

Employee ownership usually generates two extreme reactions: EO is the greatest thing since sliced bread, or EO is hopelessly idealistic. Queen's IRC Director Dr. Carol Beatty spent seven years studying 10 companies with employee ownership and published what she learned in the highly entertaining book, Employee Ownership: The New Source of Competitive Advantage . In the following excerpt, she speaks about “exit strategies” for employees.

Companies embracing employee ownership need to think of an exit strategy for internal shareholders. Otherwise the employees may find their wealth inaccessible until they retire or quit. The company may also find itself hamstrung by such repurchase liabilities.

How did our companies handle this issue? Some went public and created an external market for the shares. Others sought a share swap with or an outright sale to a larger publicly traded company. How did these companies and their employees fare?

At Creo, the decision was to take the company public. The July 1999 initial public offering of shares put the company's valuation at $1 billion, giving the founders and early employees 160 times the hypothetical value of their first shares.

Others decided on various sale scenarios. Employee owners at Spruce Falls, who initially owned 52 percent of the company's shares, came to trust Tembec's leadership over a period of six years. It must have seemed natural to sell their shares to Tembec when it was allowed to increase its stake from 41 percent to full ownership in 1997, with an average employee investment of $10,000 at the end of 1991 turning into about $145,000. Frank Dottori observed that many employees were uncomfortable with share ownership: "They want job security so they don't have to wake up tomorrow and find themselves unemployed. But they don't like to be shareholders. Many will say, ‘I can't sleep at night if I have $10,000 invested in Tembec and see it drop from $10 to $9, with me losing $1,000."

At Integra, the company took what Klingbeil called "the elevator ride of value." At Integra's worst moment it was virtually nothing. Two and a half years later, it was probably worth 10 to 20 times earnings, a significant value per share. However, economic cycles made the share value extremely volatile. Employee capital should theoretically be patient capital, but many employees find it difficult to be patient. So Integra employees chose to be bought out by the Scott Pickford Group rather than continuing as an independent company, swapping their shares for shares in Scott Pickford's parent and reaping 10 times their original investment. Most kept their shares in the publicly traded company, rather than cashing them in after the lock-up period expired.

At Revolve, the employee owners, who split their holdings across their two business lines, had a long and complicated journey to safety. In November 1997, SKF bought a 40 percent stake in the company. But SKF wasn't interested in the gas seal business, so Revolve had to sever that operation off. The seal business was owned 100 percent by family, friends, and business associates. The magnetic bearings business—which quickly grew to become the large operation—was 60 percent owned by those same family, friends, and business associates, with SKF holding the other 40 percent. Employee owners had to wait six months more to sell their remaining interest to SKF and to another partner firm.

SFG also found a strategic buyer—after employees there also experienced the elevator ride of value—and became an operating division of Cayenta. Some long-term senior employees found the value of their shares worth as much as $400,000, while relatively new junior employees got a few thousand dollars.

Some of these exits weren't as much strategy as luck. And some employee owners are still waiting for their opportunity as at Great Western Brewery.

Sidebar: Three Key Lessons

Kim Sturgess [President and CEO, Revolve Technologies] has learned three key lessons about employee ownership from her experience at Revolve.

1.      Make sure at the outset that you get top-flight input on structuring the deal—and similarly with any future deals to bring in outside investors. In particular, think about your exit from the very beginning. "People told me to do that and I said, ‘Yeah, yeah.' But you have to think about the exit from the start," she stresses.

2.      Tied to that is the necessity to maintain control. Revolve's team lost it twice: once to the venture capitalists and then again, on the magnetic bearings side, when it joined too closely with a major partner, SKF, giving it the right to buy up more of the company. That dramatically reduced any future negotiating power for selling the rest of the company. As a key customers and sales channel, Revolve was too dependent on SKF; when the buyout offer came, the employees effectively had no choice.

From the start, an employee-owned company must assess how fast it wants to grow versus how much control the original team wants to retain. Taking on venture capital can speed growth. But it comes at a cost. "The minute you lose ownership and voting control of the company, you have your money invested in something that you don't control anymore. That situation should be avoided at all costs. If you want to put everything in, you need to control," Sturgess stresses.

3.      Finally, she warns against ever getting into a situation in which you are trying to manage by consensus in a group. "Never—ever. It sounded great and it fit with my views: I like to be inclusive and empower people. But somebody has to be in charge. Period, end of story," she says.

That means settling the tension between being employees and owners. "Employees are employees and owners are owners. When employees try to be owners and be involved in all the decision-making—well, certainly in our case it didn't work. Things got better when everybody agreed they were employees first and owners second," she says.

Copyright © Industrial Relations Centre, Queen’s University, Canada.

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