The pros and cons of employee ownership in hotels
 
The pros and cons of employee ownership in hotels
19 JULY 2016 8:15 AM

Converting to employee stock ownership plans can provide family-owned hotel companies an exit strategy, but the structure also comes with some regulatory hurdles.

REPORT FROM THE U.S.—Employee stock ownership plans, commonly referred to as ESOPs, aren’t a particularly common ownership structure in the hotel industry, but some believe they offer a novel way to transition out of ownership. However, ESOPs also present significant regulatory hurdles and ongoing reporting and accounting requirements that might seem challenging.

Willmar, Minnesota-based TPI Hospitality is perhaps the most prominent example of the ESOP structure in the hotel industry.

COO Mitch Peterson said the company made the change at the beginning of 2015, as long-time owner and CEO Tom Torgerson sought to gradually move out of day-to-day ownership and operation but had no family successor in place.

“So, we evaluated all the options and landed at an ESOP as the best one,” Peterson said. “It realized more market value than selling outright. This worked really well for him.”

The structure
There are various structures and purposes for ESOPs, but on a basic level, an ESOP is a trust created to purchase a company’s stock and contribute it to its employees based on years of service.

The employee’s ownership stake is handled similar to retirement benefits, vesting after a certain number of years. Employees are only taxed on payouts, and they can opt to roll those over into other retirement plans like IRAs to avoid that tax, as well.

Peterson said TPI treats its ESOP as a retirement benefit but still offers a 401(k).

In most structures, employees are not given actual control over the company. In the case of TPI, a third-party trustee was appointed to represent the interests of the employees but decisions are still made by a board appointed by Torgerson.

The ownership structure also allows companies to borrow at a lower overall cost because, if structured in the right way, debt payments can be made tax deductible.

Why TPI made the move
One of the biggest benefits of ESOPs from the perspective of current ownership is that it provides a ready-made buyer of shares in a company while simultaneously avoiding things like capital gains and state and federal income taxes.

Peterson said the tax implications were a major factor in TPI’s decision to adopt the ESOP structure.

Torgerson, who remains TPI’s CEO, personally financed the transaction, Peterson said, which gives him a continued financial interest in the company’s success even as he transitions away.

“Tom doesn’t get paid out unless the company succeeds,” Peterson said. “We just have a tremendous sense of alignment.”

But more than just the monetary benefit, Peterson said an ESOP was a good way to reward the company’s employees and “help pay back the associates who helped build the company.”

The impact on recruitment and retention
Peterson said ultimately he sees the ESOP providing TPI’s employees with “much greater levels of accountability” because the better the company performs, the better their ultimate benefit. He said it can be motivating to have a retirement benefit they can exert influence over in a positive way, unlike some other options like 401(k)s.

“For most people, (predicting the stock market) is not their strength,” Peterson said. “This way, they’re doing what they do, and they’re making a difference.”

Ultimately, he said he hopes employee ownership will be a selling point for both potential employees and currently employees who might otherwise look at other jobs.

But Keith Kefgen, managing director and CEO at Aethos Consulting Group, said employee ownership might not move the needle in this regard as much as some might think. Ultimately, he said line-level employees are more likely to be moved by the possibility of having more cash in their pocket than a fractional ownership stake in the company they work for.

“To someone who is cleaning toilets, we’ve historically found that these folks aren’t looking to own 1/100,000 of something and get a little extra money at the end of the year or have to hold it for five, six or seven years,” Kefgen said. “They need cash and need things on a much more immediate basis.”

Kefgen said employee ownership is much more effective for recruitment and retention efforts when focused on senior management. He said the effect can be hard to gauge when it comes to midlevel management.

“It’s a gray area,” he said. “Some who are more long-term-minded like these sorts of things because it’s another way to make more money and earn extra dollars.”

The costs and administration
Jim Butler, founding partner with Jeffer Mangels Butler & Mitchell and chairman of the law firm’s global hospitality group, said ESOPs can bring a level of complexity, regulation and accounting costs to an organization that many would be unable or unwilling to deal with.

“They bring a fair amount of administration and overhead,” Butler said. “If you’ve got a fairly simple operation, the cost might not be justified. But if you’re a pretty sizeable company, it’s a pretty useful technique (for providing employee incentives) if you want the best (people).”

Because ESOPs draw a greater level of government scrutiny, Butler said they have a way of making even simple things complicated.

“It’s highly complex, highly regulated and very technical,” Butler said. “Anything you do, you have to call the experts and have them tell you if you’re able to do it. It’s not like sitting down once a year with your compensation committee to talk about giving out Christmas bonuses. You need to make sure everything you do is an approved transaction.”

Butler reiterated that size plays a big factor in how feasible the structure is for a company.

“If you’re a small company, the red tape will just drive you crazy,” Butler said. “If you’re big enough then maybe you don’t mind a few hundred thousand dollars in associated costs, but it’s still not trivial.”

Peterson said he believes TPI is the largest ESOP in the hospitality space.

Peterson admitted the transition to an ESOP represented “a huge learning curve” for both management and employees, but ultimately the greater level of accountability can be a good thing. The company is now providing financial information to its employees in much the same way that a publicly traded company is required to report.

“It’s just a good healthy practice,” he said. “The more aware people are of the dynamics and position of the company, the better able they are to respond to different things that occur. It helps to explain the seasonality of the business and how we have high points and low points. And when things are low, it’s easier for people to understand why you have to make adjustments.”

Peterson said if the company had this structure in place in 2008, the recession at that point “would have been difficult but not as difficult.”

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