Can ESOPs Do Roll-Ups?
When private equity firms roll up acquisitions, bad things tend to happen. What if an ESOP were doing the rolling up?
Here are today’s highlights:
Another business learns the hard way that making a profit matters.
Hiring slowed in October, but productivity continued to surge.
The FTC reveals evidence suggesting Amazon punishes sellers.
For a Phoenix ebike startup, influencer marketing was make-or-break.
Bill Fotsch thinks ESOPs should roll up businesses the way PE firms do: “Over a decade ago, I became a stakeholder in the West Coast remodeling company One Week Bath. Business has been good, and our employees are engaged. But my co-owner, Matt Plaskoff, and I have run into a problem. As we're both in our 60s, succession planning is on the horizon. An ESOP would seem like the natural next step -- we already see our employees as trusted partners. But the expense of an ESOP makes the idea unattractive. Selling the company to a private equity firm is even less attractive. Why forfeit a life's work to a stranger, bypassing the employees who've helped build the company's value?”
“Twenty years ago, I helped one client develop a customized employee equity program. It was ESOP-like but low cost—no big tax advantage but plenty of flexibility. The owner recently called to tell me they were acquired by a PE firm. He walked away with millions, and thanks to the simple equity program, so did his employees.”
“I got off the call thinking: Why don't company owners just do this themselves? If several businesses came together to create their own roll-up, the cost of the ESOP per company would plummet. Individual companies could continue to operate autonomously. Meanwhile, the ESOP turns the employees into owners, who could directly improve the value of their stock by sharing and implementing best practices within the roll-up.” READ MORE
Another venture-backed business comes to the belated conclusion that profits actually do matter: “Austin-based Sana Benefits, which provides small group health insurance, is among the many startups pumping the brakes ahead of an uncertain future. On November 1, the company announced it has laid off about half its team, 73 employees total. That followed a 19-percent staff reduction in February. Its reasoning might serve as a cautionary story for many startups. Sana is coming off of a $60 million series B round announced in June 2022 that brought its total funding since its 2017 founding to $107 million. In 2022, the company was touting 200-percent year-over-year growth in its customer base. In the startup world, that would be considered a success story by most.”
“The company wasn't profitable yet, but founder and CEO Will Young said that wasn't a concern at the time because they could raise new venture funding, plow money into research and development, and help its product stand out in a crowded field.”
“‘The world has changed, however, and venture funding is harder to come by now,’ Young wrote in a November 1 blog post. ‘Particularly for companies in the health care and insurance worlds (we check both boxes). The hard fact is this new environment rewards profitability today over future investments. We have to reposition ourselves accordingly.’” READ MORE
Alexis Grant talked to a founder recently who wants to sell a business that has $2 million in revenue and $400,000 in EBITDA. There’s just one problem: “She raised $2.5 million. The biz would sell for around that, so all $ would go to her investors. Nothing into her bank account. Which means she's STUCK. Raising $ can be smart. But it's not always the best answer. If you raise, you have to sell for so much more to end up with meaningful take-home. Sometimes bootstrapping is a more direct path to a lucrative exit.” READ MORE
Google says it’s making it easier for consumers to buy from small businesses: “Google is introducing new Shopping features that allow merchants to quickly update product imagery using generative AI and make it easier to display important shop information to attract new customers. Starting today, Google merchants in the US can label themselves with a new ‘small business’ attribute that makes it easier for shoppers to identify mom-and-pop-style stores. Stores that carry this new attribute will be clearly labeled as a small business in Google Maps, and products sold by these merchants will feature a ‘small business’ tag in Google Search.”
“Matt Madrigal, VP / GM of merchant shopping at Google, told The Verge that the ‘largest businesses’ will not have the option to display the small business attribute and that the company is relying on businesses to self-identify.”
“The knowledge panel in Search that displays details like where a retailer’s headquarters are located and how many people it employs is also being expanded to show additional shopping details.” READ MORE
Hiring slowed in October: “U.S. employers added 150,000 jobs in October, down from the previous month’s revised gain of 297,000, the Labor Department said Friday. Automakers had around 33,000 fewer workers on payroll because of the United Auto Workers strike, the department said. The unemployment rate rose to 3.9 percent from 3.8 percent the prior month. Wage growth cooled as employers hired less. Average hourly earnings rose 4.1 percent from a year ago, the department said, down from 4.3 percent in September.” READ MORE
But productivity growth surged in the third quarter: “There are hopeful signs that the U.S. is adjusting to the high-wage, high-interest-rate economy that's become a post-pandemic reality. Fresh data Thursday showed U.S. labor productivity growth jumped by a 4.7 percent annualized rate in the third quarter. That's the fastest — outside a recession when productivity typically spikes — since 2003. It was the second-straight hefty increase in productivity growth, following a 3.6 percent rise in the second quarter. Increasing productivity is the key to establishing a virtuous cycle of growth in the face of tight labor markets, inflation, and high interest rates.”
“Productivity is measured in output — that is, GDP — per hour worked. So, this big productivity number is kind of another way of saying the third quarter GDP surge we just saw came without a parallel surge in hours worked.”
“Productivity growth is the secret sauce that keeps an economy from becoming a never-ending tug of war between workers, business owners, and consumers over who benefits from growth. That's because when productivity goes up, the economic pie gets larger, so workers and owners both get bigger slices at the same time.” READ MORE
In its lawsuit against Amazon, the FTC has released evidence that the company sought to punish businesses that sold goods at lower prices on other platforms: “Internal documents cited in the unredacted parts of the complaint made public on Thursday show that Amazon executives acknowledged that requiring Amazon sellers to have the lowest price on Amazon or risk being buried in search results and other negative consequences had a ‘punitive aspect.’ One executive acknowledged that many sellers ‘live in constant fear’ of being penalized on Amazon for running afoul of its pricing policy.”
“While Amazon abandoned the contractual agreement for sellers to have the lowest prices on Amazon in the U.S. in 2019, the FTC complaint says that Amazon began using an internal algorithm to track sellers discounting off of Amazon.”
“‘An internal Amazon document written weeks after Amazon dropped its contractual price-parity requirement acknowledged that Amazon intended to use [the algorithm] to enforce its ‘expectations and policies,’ which ‘ha[d] not changed.’”
“Newly unredacted internal documents from Amazon in the complaint show that Amazon’s ‘take rate’ from sellers who use its Fulfillment By Amazon logistics program rose to 39.5 percent in 2018 from 27.6 percent in 2014.”
“A key argument the FTC case makes in its lawsuit is that sellers feel forced to use Amazon services—such as FBA and advertising—on Amazon’s website to be successful. The FTC describes both services as pay-to-play and alleges that sellers must raise prices for their products to offset the rising fees.” READ MORE
A Phoenix startup has become a leader in ebikes: “The idea for Lectric eBikes was prompted by [Levi] Conlow’s father, Brent, who wanted to buy an electric bike at a more affordable price than existing models on the market. He approached [Levi] and [Robby] Deziel to build a high-quality electric bike and provided the duo with an initial investment from his retirement fund to produce the company’s first model: the Lectric LX. Conlow and Deziel created a website and Shopify store for the bike, but it wasn’t an immediate hit. That led the co-founders to go back to the drawing board and they designed the company’s flagship foldable electric bike, the Lectric XP.”
“‘We doubled down and created about a dozen versions of the new design and then we sent those (bikes) out to YouTube influencers,’ Conlow said. ‘Those influencers were our whole marketing tactic. If that didn't work, then it was over, essentially.’ The Lectric XP became an instant hit with customers for its affordability and portability.”
“Lectric eBikes claims it's now one of the fastest-growing companies of its kind in the country, having sold more than 350,000 electric bikes since its inception. The company is on-track to sell 170,000 bikes this year and also recently launched pre-orders of a new all-terrain electric bike, the Lectric XPeak, Conlow said.” READ MORE
THE INSURANCE CRISIS
Lawmakers are investigating insurance companies that pull out of risky markets: “Faced with growing losses from hurricanes, floods, and wildfires, major insurance companies are pulling out of California, Florida, and Louisiana — a shift that threatens to undermine the economies of those states. Now Senate Democrats are demanding that insurers tell them which places could be next. On Wednesday, the Senate Budget Committee sent letters to 40 insurance companies, seeking documents that show where in the country those insurers have begun dropping customers, or are considering it. The committee, which has subpoena power, has given the companies until Nov. 17 to respond.”
“‘Climate-caused uninsurability has the potential to trigger cascading failures that undermine our entire economy,’ Senator Sheldon Whitehouse, Democrat of Rhode Island and the committee chairman, said in a statement. ‘With this investigation, we are seeking information about where the dominoes may fall next.’”
“Mr. Whitehouse compared the accelerating withdrawal of insurance companies with the 2008 housing crash, saying a broad insurer pullback ‘will have similarly grave economic effects.’” READ MORE
THE 21 HATS PODCAST
Sometimes, Dreams Do Come True: If you’ve been listening to this podcast, you know we spend a lot of time talking about all of the things that can go wrong for a business owner. And yes, in part because we started recording these conversations just a couple of months before the pandemic hit, we’ve had plenty to talk about. Even this year, with the worst of the pandemic behind us, we’ve been talking about everything from excess inventory to lost clients to layoffs to ineffective marketing to surviving the valley of death. So, with that in mind, this week, I’ve chosen to replay an episode both because it offers an inspirational message and because, well, we here at the home office need a little break. It’s the episode we recorded two years ago when Karen Clark Cole sold her business.
“Especially given that Karen had only recently been through a tough period that prompted her to take time away from the business, the conversation is a nice reminder that sometimes things do come together. It’s also full of great advice for anyone who thinks they may want to sell their business one day.
You can subscribe to the 21 Hats Podcast wherever you get podcasts.
Thanks for reading, everyone. — Loren