We Have A Secret

Apr 26, 2007 Michael Wurzer

We were named a finalist for Business of the Year (that’s not the secret) by our local Chamber of Commerce and so they invited me to speak to the Chamber over breakfast last week. I used the opportunity to talk about how FBS is employee owned and how I think that really helps us a lot (this is part of the secret). Some of the advantages of employee ownership I listed were:

  • As owners, we’re committed to the success of our clients.
  • Employee ownership is a great incentive compensation program.
  • We’re focused on the long-term.
  • Unlike many small businesses, our exit strategy is already established.
  • FBS doesn’t pay federal or state income taxes. (The secret.)

What’s that? No corporate income taxes? That’s right, and we’re not going to jail, either. How can this be? There are two keys. First, FBS is an S corp, which means that only the shareholders are taxed on the profits of the corporation. Second, in our case, 100% of the shares of FBS are held by the FBS ESOP (employee stock ownership plan), which, like a 401(k) plan, generally doesn’t pay income taxes. So, the S corp profits pass through to a tax exempt entity. Pretty cool, huh?

This is one case where the government has done the right thing by not only getting out of the way of a great business idea but actually encouraging it. Unless executed poorly or for the wrong reasons, putting ownership in the hands of employees is brilliant. I think this is especially true in software development companies, where dealing with incentive compensation is difficult, if not impossible. With the ESOP, we’re investing in ourselves every day, making the incentive compensation recurring and reinforcing.

A few days after I spoke to the Chamber, I received an e-mail from one of the attendees, asking if they could meet with me to learn more about the ESOP concept. That whole tax thing kind of got their attention. We met just the other day and one of the big questions for them was whether they were big enough to justify an ESOP, because they have less than twenty permanent employees. Twenty is a general rule of thumb for when an ESOP makes sense or doesn’t, because the expenses of running an ESOP are not insignificant. Though not nearly as involved as taking a company public, forming and managing an ESOP requires great legal, valuation, and administrative advisors. The expenses of these advisors can make an ESOP not advisable for a real small company. Unfortuantely, the smallest companies are often those who could benefit most from employee ownership. Business succession is one of the most challenging parts of owning your own business and employee ownership is a great answer to that challenge.

Real estate brokers and agents face this issue all the time. They build a business for years around their personal brand and then they have to figure out an exit strategy. Hopefully the broker finds a larger company interested in buying them, but that’s not always the case. Wouldn’t it be cool if an ESOP worked for real estate, too? ESOPs might seem weird for real estate, given the commission models of compensation and the independent contractor status of so many agents. On the other hand, Ebby Halliday has created an ESOP (though I don’t know if or how agents are included as it isn’t mentioned on their web site) and Keller Williams and RE/Max have some interesting models that touch on shared ownership. Also, agents certainly are entrepreneurial; they have an ownership mentality. Perhaps an ESOP real estate firm is possible? Maybe broad-based ownership focused on the long-term is just what the industry needs?