AEC Unscripted: M&A Edition
Welcome to AEC Unscripted: M&A Edition, the podcast that delivers unfiltered, authentic insights from leaders in the Architecture, Engineering, and Construction (AEC) industry who are on the front lines of mergers and acquisitions.
Hosted by Jeff Adams, CPA, CM&AA, each episode features candid one-on-one interviews with CEOs and influencers, sharing their real stories, successes, and obstacles in the world of AEC M&A.
If you're an AEC firm leader ready to shape your future through strategic growth, join us for inspiration and practical advice to take your firm to new heights.
AEC Unscripted: M&A Edition
Ep. 16 | M&A Alternatives: Evaluating the ESOP Transition Path
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When AEC firm leaders begin exploring succession, external M&A is often the first path on the table. But what happens during due diligence when a firm realizes a traditional sale doesn't align with its culture, brand, or long-term growth goals?
In Episode 16 of AEC Unscripted, host Jeff Adams, CM&AA, is joined by Christopher Hostettler, former CFO and current advisor at MKSK. Chris shares how their firm thoroughly evaluated strategic M&A suitors before ultimately choosing an internal transition path—and how analyzing both external M&A and alternative models allowed them to preserve their firm's brand and scale to 140 team members across 12 states.
Key Takeaways:
- Exploring External M&A: Real-world lessons MKSK learned while entertaining third-party suitors and conducting M&A due diligence.
- Evaluating Transition Models: How to compare traditional external sales against alternative ownership structures to protect firm culture and brand value.
- Capital & Governance Structure: What firm owners must consider regarding valuation, debt service, and board governance when weighing transaction paths.
- Post-Transaction Momentum: How selecting the right succession strategy laid the foundation for MKSK to double in size.
Whether you're a founder wondering how your firm's legacy will be preserved or a leader evaluating the right transition path for your business, this conversation provides a practical roadmap for weighing M&A options and setting up long-term success.
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Intro & Welcome
Opening CreditsWelcome to AEC Unscripted: M &A Edition, your go-to podcast for unfiltered conversations and expert analysis, brought to you by Stambaugh Ness.
Jeff Adams, CM&AAWelcome to AEC Unscripted. I'm your host Jeff Adams, the Director of Mergers and Acquisitions at Stambaugh Ness. Most of our conversations focus on external transactions, or selling to a strategic buyer, merging with another firm, or exploring broader M&A opportunities. But today, we're taking a different perspective and examining a transition path that more AEC firms are considering employee ownership through an employee stock ownership plan. Joining me today is Chris Hostettler, longtime leader and former CFO of MKSK, a nationally recognized landscape architecture and planning firm headquartered in Columbus, Ohio. Chris spent nearly three decades helping guide the growth of the firm and played a leading role in evaluating, structuring, and implementing MKSK's transition to a 100% employee ownership. What makes Chris's story particularly compelling is that MKSK carefully evaluated traditional sell options before ultimately deciding that an ESOP was the best way to preserve the firm's culture, protect its brand, create liquidity for its owners, and provide long-term opportunity for its employees. Since making that transition, the firm has doubled in size and continued to evolve in its leadership and its governance structure. Chris is here to share what drove that decision, what the ESOP process actually looked like, and what lessons AEC firm owners should consider as they think about their own succession and transition plans. Chris, thank you so much for joining me today.
MKSK's Origins & People-First Culture
Chris Hostettler, CPAThank you, Jeff. My pleasure to be here.
Jeff Adams, CM&AAWell, Chris, how about telling listeners a little bit about MKSK and your journey from CFO to advisor?
Chris Hostettler, CPAThanks, Jeff. Be happy to do that. We are delighted to tell our story. And pretty much you already summarized our story that encapsulate encapsulates what we have to share, but there's a lot to it. And MKSK, just for those of you who are not familiar with us, we are a national regional landscape architecture firm, an urban planning firm. Originally founded in 1990, we are 100% employee-owned through an S-Corp. And we are very proud of the people that have been part of this team over the years. I could tell you all about the projects, which are exciting, but I think the thing that is at the heart of what I have to share is about our people. I haven't designed as a CFO with the firm, I've never designed anything all these years, but I have had the great blessing of being part of the team that has formed the nucleus of where we are today. I can tell you the people that I have shared the office with over all these years are some of the most passionate and talented people in the industry. And that's one of the things that we've always aspired to do is to make sure that the people that we hire are highly talented and they're passionate about their work, and that's the thing that we've seen in the work that we've done. We love our people, we love the clients that we serve, we love the communities that we work with. We're all about designing projects and working with communities where we can make those communities more attractive and make spaces where people want to come back and enjoy and flourish. I think we've done that quite successfully over the years. So that's where we're at today, about 140 people in 12 offices across five states, originally founded in 1990. My journey at MKSK started about 29 years ago. I celebrated 29 years this summer. And when I started, we had about 17 people in two offices in Ohio, our founding offices in Columbus. And prior to that, just to give you a quick synopsis of my career, I started my career in the early 80s after I got my MBA from a high state university, and I worked in corporate banking for about 10 years. So I was a corporate lender, saw a lot of lending transactions, worked with a lot of businesses of varying sizes. And what I really enjoyed in that aspect of the work was seeing the entrepreneurial heart of folks that were working hard to grow businesses, cause them to flourish. And that was the thing that really intrigued me as I went on to pursue other avenues in my career. I spent another five years in public accounting and learned all about taxes and financial reporting and audits and reviews. But ultimately, my heart was to find a place as a CFO in a small, medium-sized business where there was that entrepreneurial spirit and where I could assume a role where I could be responsible for helping to direct the strategic and financial growth pattern of the firm. And so I have been blessed to be part of that team for the last 29 years and see some amazing people come across our doors. A lot of terrific clients, some amazing project work that we've done. We've changed the shape and the front door to the city of Columbus in the last 30 years, along with a lot of other communities across the Midwest. So that's a little bit of my story.
Jeff Adams, CM&AAChris, I spent two and a half years of my life in Columbus, Ohio. I formerly was vice president of finance for Wendy's Restaurant. Okay. Columbus, I say it's one of America's best kept secrets. A guy living in Atlanta here, where there's, you know, a few more million people. I thought Columbus had everything to offer that Atlanta did except all the traffic. And I absolutely loved it. Our family loved our time there. Well, we're we're told that the traffic is coming in Columbus. That's what I'm hearing. In fact, it's arrived capitally.
Chris Hostettler, CPAIt's arrived, but maybe not quite as congested as Atlanta.
Jeff Adams, CM&AAIt sounds like it's no longer a secret.
Chris Hostettler, CPANo, it's not. We're expecting great growth in the next 15, 20 years.
Jeff Adams, CM&AAThat's what I hear.
Exploring Growth & External M&A Suitors
Jeff Adams, CM&AASo at what point did ownership transition become a real concern for the founders?
Chris Hostettler, CPAWell, the founders, in fact, I guess part of the story is that about 20 years after our firm originated was also the same time that a landscape architecture firm across the street from us was founded in 1990 as well. And we began to collaborate with that talent when we started working in some bigger projects around central Ohio. After a year or two, we realized that they had a team that was very talented, we had a team that was very talented, and we decided to join forces. And so we brought the two founding partners from both firms together, and that's what created MKSK in our current structure as we stand today. But after those folks had reached probably 25 years of practicing hard and doing great work, naturally they were starting to think about where do we go with our ownership transition, where do we go with leadership transition, and how do we accomplish that? So somewhere in the mid-teens in 2014 to 2018, we started evaluating other options for us. And in fact, we had some talented, for lack of a better word, younger partners. We were an LLC at the time. We were confident could take the show and run with it. But as we crunched the numbers and looked at the figures to get our selling shareholders a fair value, it would have encumbered the firm too heavily. Financially, it just didn't make sense. And we tried to evaluate that for a period of time. And after we looked at those numbers, we said, well, there's got to be some other options for us. At that point in time, we began to entertain suitors, for lack of a better word. We had a number of years where we spoke with other larger A & E firms that were interested in bringing on a specialty landscape architecture and planning firm. Very attractive. I mean, we would have been a strategic purchase for a lot of firms, and we did due diligence with quite a number of them. I shouldn't say quite a number, but at least a handful. And in each case, we found a reason that it just didn't work. So finally, we sort of had an epiphany. Towards the end of 2017 or 2018, we had gone through a due diligence phase with a wonderful AE firm that was out of state. They were looking at us seriously, we were looking at them seriously, and their leadership team had come to Columbus to meet with us, our leadership team had gone to their state to meet with them, had some very serious conversations, gone through all the due diligence process, and we were very close to trying to decide whether this was the right thing. Once we looked at everything, we realized that we just didn't want to get lost in the shuffle of a bigger firm. And we wanted to maintain the brand that so many people at our firm had worked so hard to build. We were proud of the communities that we serve, we were proud of the clients we serve, we're proud of the projects that had been award-winning, and we were most proud of the leadership team and the culture that we built in our firm, and we just didn't feel that that was sustainable if we were to actually move forward with an M&A. So at that point, then that epiphany, we finally realized this is not the right decision. We need to go look at ESOPs.
Jeff Adams, CM&AASo Chris, so you were there when the merger of the two firms happened to form the current MKSK structure.
Chris Hostettler, CPAYep.
Jeff Adams, CM&AAWhat did that merger teach you about growth and culture?
Chris Hostettler, CPAWell, we had tested the waters across the street because we were both within a block of each other and we had collaborated on some projects with each other and realized that they were great people. They felt the same way about us. And what was interesting was that when we pulled the switch to go forward with a merger with both firms, naturally you would think, well, one plus one equals two. I guess we like to say one plus one equals three, because in effect we realized that the clients that they had worked with, the skills that they had achieved and fine-tuned were different from the clients and the markets that we were working with and the skills that we achieved. And so when we brought the two together, we were able to leverage the skills, abilities, and passions of both teams and actually create a firm that was much stronger and much more capable of serving a wider diversity of client bases. So that was the interesting thing. The cultures, of course, had to merge, but we'd already spent some time working on that, and we had great respect for each other. So I think the most important thing there was this great respect between the leadership teams of both firms, and our staff grew to respect that as well over time as they began to work together.
Jeff Adams, CM&AAWell,
Evaluating Options: The Pivot to an Internal Transition
Jeff Adams, CM&AAyou know, most of our episodes focus on external transactions, uh, you know, a sell to a third party, but your story is definitely different in that your owners ultimately sold the company to the employees.
Chris Hostettler, CPAThat's right.
Jeff Adams, CM&AASo let's kind of start with why, and you kind of touched on that here. But what were the founders hoping to accomplish through a transition?
Chris Hostettler, CPAWell, you know, they were looking at their future and their retirement. They weren't exactly within a year or two of it, but in fact, many of those founding partners are still working very hard for us, and we've been at this ESOP thing for seven years now. I think we were looking for a fair value for them. We were looking for an opportunity for our employees and our leadership team to continue to grow and provide opportunities for them to grow. We have been a firm that has not aspired to grow aggressively. We have been content to grow primarily with organic growth at a relatively steady pace, but we do that by virtue of doing great work for great clients who keep coming back to us. And some of our clients have been with us since the 1990s, and we've done a lot of work for some of those clients. Of course, over the years we've built more clients, new regions and new states with that. But if we wanted to maintain the brand, we wanted to maintain opportunities for growth. And one of the things that we've done over the years is that we have 12 offices. Quite a few of those offices were actually folks that originated here in Ohio. They had family reasons to go to other states, commitments with family or marriages, and we gave them the freedom to go out there and start an office. A couple of our principals did that, and we've been quite successful using that model. And so here we are with 12 offices in five states.
Jeff Adams, CM&AAWell, when the founders were evaluating all these different priorities that they had and things that were important to them, goals for the transition, was there anything that stood out as most important, you know? Liquidity, legacy, employee opportunity, continued to be independence.
Chris Hostettler, CPAWell, you know, well, you know, of course, all those things. Actually, I would say the answer to that is hard to say because once we learn what an ESOP offered us, I think we discovered that we could do all of that. Okay. And that's the beauty of it. If you're willing to do the hard work and study what an ESOP offers you, you can get the liquidity. The founding partners, the owners can get the cash, they can get the fair value that they've earned hard to earn because they put their wet equity into this firm, you know, 30 years ago. They're the ones that mortgage their houses and sign personally on bank debts and leases and all those kind of things. They're certainly entitled to that fair value. But going forward, I think the intent was to provide opportunities for employees to grow for the continued legacy of the firm. And we discovered that we can do that with the ESOP model.
Jeff Adams, CM&AANow, Chris, you initially dismissed the ESOP concept, right? We did, yeah. Why was that?
Chris Hostettler, CPAI think it was overlooked. We were speaking with a lot of people in an industry, and for years, M&A has been a hot topic. Everybody understands what M&As are, or at least they will eventually, and of course we entertained a number of them in those years in the twenties to 2018. And so it was basically something that we were aware of on the side, but we got caught up in the in the process of studying M&As. You feel attractive when somebody comes knocking on your door and said they want to look at your numbers and maybe consider making you a strategic purchase. We were appreciative of all those overtures, but at the end of the day, that wasn't the right result for us.
Jeff Adams, CM&AAWhat assumptions did you have about ESOPs that later changed?
Chris Hostettler, CPAWell, the assumptions were that they were probably too cumbersome. We just really didn't understand ESOPs, to be honest with you. I think the leverage nature of it, because for an ESOP in our world, at least the way we did it, is going to be a leveraged transaction. Similar to what you would do if you were trying to sell your firm to your own leadership team. But the benefit here is that if you create an S-Corp that's 100% owned and it's 100% owned by the ESOP trust, you don't have to pay federal or state taxes. And so there's a real dividend in terms of providing extra cash flow to the firm to begin to pay those seller notes, which we financed once we structured
Understanding the S-Corp Advantage & Tax Structure
Chris Hostettler, CPAthe deal. But the biggest thing was just not understanding how an ESOP works because it is a complicated transaction to get your head around.
Jeff Adams, CM&AAWell, you were the CFO, so I know you were probably either doing or responsible for reviewing pretty much all the financial analysis and modeling that took place on this ESOP. So what what what analysis did you undertake to determine whether an ESOP would work?
Chris Hostettler, CPAWell, we've got a great model of leadership at the office, and they charged me with being the captain of coming to understand what an ESOP is. Let's study it, let's determine whether it's something that's valuable for us. And so part of that just involved me getting involved. There is a National ESOP Association, which is the one that we've gotten involved with. And they've got annual conventions and quarterly meetings across the country. In the first six months, I decided let's go to a couple of those conferences and make sure we understand what the ESOP's all about. I began to wrap my head around the whole concept of ESOP, how it works, and what the various parts were that you had to pull together. And of course, you have to go through the due diligence phase on yourself, right? You have to go through the process of understanding what is the fair value that we think our firm is worth in terms of selling it to ourselves. Um, how do we do that if we structured ESOP? So there were many iterations of financial projections, budget projections, cash flow projections, debt service analysis, um, talking to various banks about financing options. Because there are certain banks in every community, most likely there certainly were in Ohio, that are interested in helping to finance ESOPs. And so we studied that. We worked with a couple of banks to talk about that option for us as well. So there was a fair amount of financial analysis going on for sure.
Jeff Adams, CM&AAWell, what do you think from an owner's perspective? What would surprise firm owners about the economics of an ESOP?
Chris Hostettler, CPAWell, one of them I think I've already s suggested is that we are a tax-free entity, right? So we don't pay federal or state taxes, and that's a huge bonus in terms of providing extra cash flow to the firm.
Jeff Adams, CM&AAExplain that just a little bit, Chris. What what what is the mechanism that creates this tax-free environment?
Chris Hostettler, CPAWell, the ESOP essentially is a retirement plan. Okay, so that's where there's a lot of nuts and bolts in this. The ESOP was approved by ERISA back in 1974. So it is a retirement plan similar to a 401k. And if the ESOP purchases 100% of the shares of the company and you're an S-corp-owned firm, then the ESOP owns 100%. That the ESOP becomes the sole shareholder of the firm. And because it's a retirement plan, there are no taxes due at the ESOP trust level. So now there are firms that will decide to become an ESOP and they'll be an S-corp, but they may not sell all of it to the trust. That's the flexibility that you have with an ESOP and a trust. Maybe certain founders decide they want to continue to hold on to a portion of the interest in the firm in their personal holdings and just sell the rest of the firm to the ESOP. We elected to sell 100% of the firm to the ESOP. We had three major shareholders that owned a little over 50% of the firm, and then there were a number of other minority shareholders that constituted the other portion of the firm that made up the 100%. But all of those shareholders agreed to sell their shares to the ESOP trust so that we could be fully tax-free at the federal and state level. I guess the other surprise that I would suggest that maybe some people don't recognize is that if those shareholders continue to stay involved, the former shareholders now become employee owners, right? If they're continuing to work with the firm, then at some point they're going to get another buyout. Um because they're continuing to have shares allocated to their accounts, which we call a little extra happiness to those founding partners and those folks that had an ownership interest in the firm. They get a buyout from selling their shares to the ESOP trust, but if they continue to work and they're eligible employees because they're putting in the hours and they're working for the next couple years, then they'll get additional shares allocated to them. So I think that is a little bit of a surprise to everybody.
Jeff Adams, CM&AASo what question would you say every founder should ask before deciding whether an ESOP is or isn't
Transition Roadmap: What It Takes to Execute
Jeff Adams, CM&AAthe right path for them?
Chris Hostettler, CPAWell, I think one of them is what's the time frame for your retirement and what's the time frame for your need? I guess some folks have a need for their cash that comes from the selling of their interest in their firm. I think the buyout timing has to be an important consideration. For us, that made a big difference in terms of making it a manageable decision because our selling shareholders were agreeable that it could be structured over a longer period of time. We we're not looking at trying to get our selling shareholders bought out over three or five or six, seven years. They agreed to something a little longer, 10, 12 years. And so if you've got a longer time frame, that helps facilitate the repayment schedule and makes it more affordable for the firm. But the other thing that I think is important, if you're looking at considering it as an alternative, is just confidence in the next generation of leadership. Do you have people that are just as passionate and just as entrepreneurial about running the ship as they were? Because I think passion and commitment to the firm and its legacy are important because you're relying on that next generation to be the ones that are going to step in and pay you for the next five or ten years, however long the deal is structured. And so I think you have to be confident that the people behind you are really excited about having that opportunity to take those seats in the C-suite and venture to a place nobody else has gone because every year's different, right? We don't know what the economy is going to bring, but we do know that we've had success over the course of the last 30 years. But, you know, we have new challenges every year. So I think confidence in the team. And then the other thing is the willingness to mentor the people that will be sitting in those C-suite positions. We had a very strong leadership transition program where CEO sat with the incoming CEO for two years prior to, and then he's still here willing to serve as an advisor to the CEO. Um, I did the same thing with the great guy that I hired, actually, Tom Porto is who I hired 20 years ago, and he became the CFO about three years ago now. And he has been in my footsteps for the last few years. I've been there to advise him, and that's sort of the role that we created. One of the benefits of an Aesop is that when you get to be an older guy like me, I I sort of jokingly referred myself as the CFOG, the old goat. I can still be of all, I can still be around, I can still advise to a certain extent and help Tom with the great job that he's doing, and he's doing a fantastic job for us. But you have to have confidence, those people our C B D O, our COO, our CEO, our CFO. They're all folks that have been. Waiting in the wings for quite a few years and they have run with it and done a fantastic job.
Jeff Adams, CM&AAYou mentioned you went down the path with an external firm and realized, hey, this is not the way we want to go, and you turned toward ESOPs. So from that moment when you started thinking ESOP to actually closing the ESOP, how long of a time frame was that?
Chris Hostettler, CPAWell, it was probably close to a year and a half. It was early in 2018 when we made the hard stop on all other decisions, and we began to get serious about evaluating the ESOP concept. I started doing my due diligence and we actually pulled the trigger on it, I think, on September 1st of 2019. So it was about 18 months for sure. There's just a lot of moving parts involved in pulling all that together.
Jeff Adams, CM&AAWhat are some of those? Our listeners are thinking, well, why 18 months?
Chris Hostettler, CPAAnd so because an ESOP is structured under the rules of ERISA, under the rules of the Department of Labor, and subject to internal revenue service rules, there's a lot of things that you have to comply with. Beginning with understanding the fiduciary responsibilities of bringing a trust into the equation. There's the legal structure. We were an LLC, so we had to convert from an LLC to an S-corp because you have to be a corporation to be an ESOP. And we could have gone C Corp. We elected to go S-Corp because we wanted the tax-free benefits. And then we had to make the decision do we want to sell all of the stock or only a portion of the stock? So all those are some of the preliminary decisions that you need to make. And then you've got to find the right consultants to bring into the equation. The first thing we did after we'd gone to some of those ESOP conferences was we'd met with some of the folks that we viewed as good consultants. We made the decision to go with one of the national known ESOP consultants, and they did a great job holding our hand through the process. But throughout that process, you have to bring in tax consultants because you're establishing a new benefit plan. You have to bring in legal consultants, you have to evaluate the quality of your financial statements. We had to upgrade from a compilation financial statement to a reviewed financial statement in those early years. So some of those transition things took some time. The other thing was we just have to figure out who those consultants will be. We had to decide on whether we wanted to be our own trust, have our own trustee, or whether we wanted to bring an outside trustee into serve as the trustee for the ESOP. And because of our unfamiliarity with ESOPs and everything, we decided because of the fiduciary responsibility, we'd be well advised to bring in an outside trustee who was experienced in that matter. And so we had to go to the process of interviewing and vetting a number of different candidates for that position. And when it all came down, we chose a great trustee. He wasn't the typical bank trustee. In fact, he wasn't a bank trustee. He was an individual who was a CPA and an attorney, had worked in the ESOP world for 25 years. He was a former Big Eight CPA. He was well skilled in understanding valuations and understanding what it takes to run a good business. And so we've had him participate in our board. Now he's not on our board. He can't be on our board because he's the trustee. But he sits in on our board meetings to overview and hear what we're doing and offer us some words of wisdom every now and then. He's a Texas guy, and we love his Texas cowboy dry humor when he comes to our board meetings. So we have a lot of fun with that. But you know, bringing those folks in, all those kind of things. And then you've got to decide what's the structure of the ESOP itself. I mean, we haven't even talked about that. But we had to decide when the plan was going to go live, what are the criteria for for our employees? When do they become eligible? What are the vesting criteria? Because it's like a 401k. You invest in a 401k over five or six years. You have to determine what the vesting criteria are in the ESOP. Then the critical part is how do we allocate shares to employees? Because what effectively you're doing is we had to we had to authorize uh a new number of shares to the new S-Corp because we wanted the shares that were going to be allocated to be done so um in a in a manner that would have meaning in terms of people getting shares every year. We didn't want to get them a fraction of one share. We had to get them shares that sounded like, you know, okay, you got a hundred shares this year, next year you might get 150 shares. So we had to authorize more shares to make that uh an important consideration.
Jeff Adams, CM&AAYou didn't want to be like Bitcoin where you like a point two.
Chris Hostettler, CPANo, we're not not
Governance, Board Restructuring, and Advisory Support
Chris Hostettler, CPAnot happening there. No. And then we had to decide what happens with distribution rules, because when somebody retires, then how quickly can they get paid out? And how do we structure those distribution payments, those kind of things? So all of those conversations, all of those decisions are in the planned document. You have to make those decisions before you go live, which we had to do during that 18-month period. So the other thing we had to do was revisit the whole idea of our board of directors. You know, we were an LLC, and at that time we had 10 principals, partner owners in the firm, and our board was all 10 people. Um once we started listening to the advice of some of our new consultants, our trustee, ESOP consultant, and our tax and legal advisors, we were advised that it would make sense just to maybe consolidate the board and make it a little more light in terms of effectiveness. And so we consolidated our board and brought it down from 10 to 5 folks. And the biggest thing we did was we added one of those five people as an outside board member, somebody who is not a principal in the firm, doesn't have an ownership interest in the firm, never did have an ownership interest in the firm. But we chose a woman who is a very experienced advisor in the AEC space. She became a very valuable voice on our board as an outside board member. And we also uh uh asked her to serve as the chair of a compensation committee because part of the fiduciary responsibilities of a trust is to make sure that you're doing things above board and that nobody's being enriched in any way that wouldn't be ethical or with integrity. So we had to reconstitute the board and the way that it operates. We added an advisory board as well, which we'd never had.
Jeff Adams, CM&AASo that's different from the board of five.
Chris Hostettler, CPACorrect. We added an advisory board of outside advisors, people from university, from communities, from cities, from other areas, other engineers. One of the folks that joined our board was actually the CEO of an engineering firm that had been in ESOP for more than 20 years. And so his experience in terms of helping guide us through some of the ESOP decisions we're going to make in the future years was extremely valuable. They didn't have any legal authority, there was strictly an advisory board. But I think the reason that it made so much sense was because we've got a new leadership team that has just taken over the firm. And prior, our board of directors was primarily composed of the leadership team that had already been there for 25 years. Now we've got a leadership team that is going to probably want to hear and they need to hear the voices of other people who have some experiences that they may not be familiar with. And so the wisdom and the voices of our advisory board, once we brought it on board, which we did right away, we reconfigured the board of directors and we created a new advisory board in the same year. And they have worked hand in hand with each other just wonderfully well.
Jeff Adams, CM&AASo how did governance change once the founders were no longer the sole owners?
Chris Hostettler, CPAThe governance situation, because we understood that we had a trustee looking at us because we had fiduciary responsibilities, I would say that our governance structure probably became a little bit more disciplined and a little more rigorous in terms of understanding what we had to do from a governance perspective. The board is, of course, their new folks, and they wanted to be sure that the way they governed the firm was above above board. The thing that I like to say is I've been here 29 years is that we've got great people with high integrity, great ethics, and they're just passionate about the work. You hear me say that many times, I'm sure. But that's truth, is the way our and our outside board and inside board is operated. And so from a governance perspective, we have been much more, I guess I should say, open book. Um, you know, when your founder led, we made great decisions, but maybe not quite as open book with the way the firm was being operated. Um not to say that the decisions there was any reason to hide them. We tried to share some of the decision making that the leadership made over the years, but not clearly as well and as effectively as the new leadership team is doing now. And I think partly that's a reflection of the generations that are taking over. We have quarterly business update meetings with the entire firm. In the quarterly meetings we share financials, but we also talk about the project wins, successes, and what some of the different officers are doing because we're in 12 different offices. We've got a lot of work going on and not everybody knows what some of those key projects are, so we share that valuable information and we celebrate the employees that are working hard to do that. That's probably a little bit broader than governance, but it's a way that we're operating the firm now, and I think it's been quite successful.
Jeff Adams, CM&AASo I guess here you are seven years later now, right, since the ESOP was put into place. Did it accomplish what you hoped it would?
Chris Hostettler, CPAMore than we accomplished, I think, honestly. Well, I think we're surprised ourselves. We've honestly hit our targets the last six or seven years, which when you put a projection together, you think, well, are we going to be able to do this? You know, we've all done that, and sometimes you do and sometimes you don't. Well, I mean, we tried to be reasonable and responsible because we knew that the valuation firm that comes and looks at our numbers every year bases our valuation somewhat on a discounted cash flow perspective. So they're looking at future projections. We have to be reasonable about those projections. And by and large, we've hit our numbers a little bit up, a little bit down each year, but close enough that we're very pleased with the results of the performance of the ESOP. We have accelerated the payment on the retirement debt to our seller shareholders. We've accelerated the release
Measuring 7-Year Results & Business Growth
Chris Hostettler, CPAof shares to our employee owners. That was, in the original document, it was structured over a 30-year release schedule. So when you set up an ESOP, you have to figure out how many shares you've got and then how many over however many years you want to release those shares. And the experts would tell you that you want to don't release them too fast because otherwise you end up with some financial problems if some of those people need to leave early and you've got this big balloon payment that you have to make up. That's called a repurchase obligation. So you're better off trying to do it over a 15 to 20 year term. One fact, we structured as a 30-year release of shares, but now we're aiming to get that down to 20 years. And we're doing that through a feature that was unique to us. I don't know that a lot of firms do this, but we have a 401k, of course everybody has a 401k, but we also have a safe harbor feature. And we elected to take the safe harbor and use the 401k safe harbor dollars and pay that into the ESOP each year. If the firm is performing financially well and we approve the safe harbor, then instead of putting the safe harbor dollars into the 401k, those same dollars are going into the ESOP. And what that accomplishes is it's releasing more shares. It's bringing us down from the 30-year allocation schedule down to a 20-year allocation schedule, which was our goal all along. But if you look at the performance of our share value over the last seven years, if those same dollars had gone into the S P 500 or the Dow or the NASDAQ, our stock value, of course, is just one company. But our stock value has outgrown all those multiples, all those performance indexes
Recruitment, Culture, and Employee Entrepreneurship
Chris Hostettler, CPAby quite a bit. So our employees, as they look at their stock value each year and it gets updated annually, I think they're all very pleased.
Jeff Adams, CM&AAAnd I know I am. Well, you said before the firm had doubled in size since becoming an ESOP. To what extent do you think employee ownership has contributed to that growth?
Chris Hostettler, CPAIf we got underneath all the numbers, we'd have to suggest that was a very big part of it. Um partly because if we didn't have an ESOP structure, I think uh some of our leadership team might not have stayed. I mean, they're just so committed to the brand and the culture that we built that if we'd done something else, I don't know that we'd have the same joy to share with everybody and be able to tell the story. But that's not the real story. I think the real story is that it's created a cohesiveness within our firm. There is a cohesiveness within everybody that walks in the door, I believe. Now we've got younger people that are still understanding the Aesop concept. But those of us that have been here five or six or seven years now have seen what it has done. Everybody understands that a rising tide raises all boats, right? Well, um, the same is true in an ESOP. To the extent that the firm does well, all of our employees do well. To the extent that all of our employees do well, the firm does even better in some respects. And so that cohesiveness of people understanding that when they walk in the door, they're an employee owner. They're not just an employee. They have some skin in the game. And now the interesting thing about an ESOP is that it doesn't cost them anything. That's the beauty of the ESOP model. There is no cost direct to our employees to receive the benefit of being an employee owner at MKSK. They begin to understand the culture of trying to perform best on the projects that we work on. And we do best when our clients give us challenging work. That's the kind of work that we love to do. We love to find those clients that bring challenging work that's going to take creative minds and real heartfelt skills to make and build better communities and exciting projects. That's what inspires our folks. That's what inspires our team. We like to say that we're uniquely MKSK. We are local, but we stay locally invested. So we stay locally invested in the communities in which we serve while we aspire to do national work and lift the whole profession up. And so that motto, those values are what leads the firm. Employee ownership is what runs through the blood of the whole organization. And it's an amazing thing that we've experienced over the last six or seven years.
Jeff Adams, CM&AAWell, I get the sense that recruiting and retention had to be positively impacted by the employee ownership. Any real numbers or metrics that you can share related to what you guys saw?
Chris Hostettler, CPAI don't know that we have any real metrics that we can share. I know that our turnover rate has been very low if we compare it to industry numbers. We just have people that like to stay. Now, do we lose people? Of course we do. But oftentimes that's because there's family reasons or something that needs to take them away from one of our offices. But then we've also got folks that need to move, but they say, hey, I don't want to leave the firm because this is an employee-owned firm and I understand the benefit. We've got a gal who's a terrific graphic designer for us here in Columbus, Ohio. She's moving to Chicago in the next week or two, and guess what? She's going to land in our Chicago office. She didn't want to leave, she didn't leave KSK, but she's going to be able to move to one of our other offices and continue to enjoy the benefit of staying within this MKSK family. And I know that we've also attracted some strategic hires, some of the folks that we really want to bring into the firm. When they know that we're employee-owned, that can be the deciding factor for some folks. Let me remind your audience that in the AEC space, um probably less than 15% of firms in the AE world are employee-owned. And probably even a smaller percentage of those firms are 100% employee owned. And so we're probably one of the few 100% employee-owned architecture engineering firms across the country. And that is a huge benefit because we're all competing with each other for talented people. And we pride ourselves on the talented people that we have at MKSK. When we compare ourselves with others, we're all trying to pay compensation levels that are competitive. We all offer 401ks, we all offer health plans and medical and dental and short-term and long-term disability and life insurance, all those benefits. Um, what distinguishes us from anybody else is that we offer them a benefit that nobody else can, or not very many other firms do. And that is an additional plus to their retirement, which they don't even have to pay for. Those studies done by Rutger suggest that when an employee retires in a firm that's been around for a while, their ESOP distribution many times will be two to three times larger than whatever they've been able to accumulate in their 401k. That's a huge number for some people. It's in some respects mind-boggling. But they didn't have to pay anything for that either. That's what's so amazing about the employee ownership model. It doesn't cost our employees anything to get that benefit other than the hard work and the talent that we bring to the door every day.
Jeff Adams, CM&AAThat might be the best return on investment an employee can get, right?
Chris Hostettler, CPAIt's it's amazing. It is, y eah.
Jeff Adams, CM&AAWow.
Drawbacks, Repurchase Obligations, and Final Advice
Jeff Adams, CM&AAEvery transition type has its own drawbacks. Well, what are some of the things that ESOP owners need to understand? What are some of these drawbacks that they have?
Chris Hostettler, CPAWell, you know, of course, this is a retirement plan. So you have to recognize that there's going to be some new rules and regulations and laws under ERISA, Department of Labor, Internal Revenue Service rulings. You have to be prepared that someday DOL might walk in and want to audit the valuation that's done annually to determine the value of the shares of the company. Um that hasn't happened to us yet. Hopefully it won't. But someday it might. So we have to be prepared for that. That's why governance is such an important part of it, too. You have to make sure that you're dotting your I's and crossing your T's on governance matters. Bringing an ESOP into fruition is it's costly. There's no question about it. I think, you know, we were probably only around 70 folks when we made the decision to go ESOP, and we thought maybe we were too small. I've heard of firms that are even 30 or 40 that have done ESOPs and done it successfully. So that's maybe a misconception that needs to be revisited by every firm that's looking at that option. There are challenges for sure. You have to bring in a whole new consulting team, you have to be prepared for the cost of instituting the ESOP, which is substantial that first year. And then there are annual costs, of course. You have to maintain your annual valuation, probably update your financial statement reporting. You have to work with the trustee, a new board, maybe, or board members. And so all those things are probably, in some respects, new challenges, but good challenges because they help as iron sharpens iron, one man sharpens another, and that's what we've experienced in this situation over the last seven years. I think we fine-tune our model and it's gotten better every year. But the repurchase obligation is one of the commitments that needs to be obviously understood because as the value of the stock appreciates, hopefully that's what's happening in your firm, so does the repurchase obligation to those future retirees. And so in the initial years, largely what we've been doing is paying down the debt to the seller shareholders. But in future years, once that debt is paid off, we have to be prepared to pay off the retirement plan balances that are owed to those employees that are retiring. So you have to do a good job of modeling what that repurchase obligation is and being prepared to reserve cash to fund those obligations in future years. In truth, those obligations don't show up on the balance sheet of the company. They show up on the commitments of the ESOP trust. So it's not necessarily a clear number on the balance sheet that you're looking for, but you still have to understand what that commitment is. So yeah, those are some of the drawbacks.
Jeff Adams, CM&AASo I guess for the seal, you're probably waving the banner of steady controlled growth. Is that kind of what I'm hearing to
Chris Hostettler, CPAThat's exactly right. That's exactly right. Yeah, and that's the beauty of it. If there's a way to do that, and you're fortunate enough to experience that, that's why the model for us has worked so nicely over the last six or seven years.
Jeff Adams, CM&AAWhich aligns with the way a lot of AE firms like to operate, right? So steady controlled growth. So no, I think that's great. Chris, for any AEC founder that's listening today that's maybe say five or ten years away from transition and is weighing an external sale against an ESOP, what's the one piece of advice that you would give him or her before they decide which path to pursue?
Chris Hostettler, CPAPersonally, I wish we had done it sooner. Okay. So I wish we had done it sooner. But that being said, part of the journey going through any of these kinds of big decisions is understanding what your options are. We went through the MA evaluation, looked at a number of different firms, spent a couple years doing that. Ultimately, we had that epiphany moment where we decided that we wanted to be in charge of our own future. We wanted to have the independence and the opportunity to allow our leadership and our employee owners to grow the firm on their own. Had we done it sooner, that'd have been great, but it wouldn't have been right yet. We had to be clear that this was the right decision. So you want to clarity, you want clarity of mind. But I think again, you just have to understand that employee ownership is a differentiator. It really is. It really adds that cohesiveness that I don't think we would have experienced if we hadn't made that decision. You know, I've been involved in the financial world for well over 40 years in banking and public accounting and CFO seats. I would say that this opportunity to be involved in initiating the ESOP employee ownership model at MKSK, that's probably the defining moment in my career in terms of the work that I've done. It's just been really exciting to see how this has all evolved, the decisions that were made to bring it about, and the results that have happened. Now you have to be able to work at it. It's a challenge in its own right. But as long as you're confident of the people that are behind you and you want to assume that, allow them to assume those seats in the C-suite, then I would encourage you to consider that as a good option for you. And the other thing to remember is that the long-term benefit can be life-changing for the employees who will be with your firms for 10, 15, 20 years. When they retire, they could be receiving no guarantees, obviously, not even in our shop. We can't guarantee anything. But I know that there are engineering firms and architecture firms that have reported that some of these former employees, they hit retirement age, they've walked out with some really remarkable retirement checks. And that changes their retirement and it probably even changes their some of their children's retirement, some of their children's futures. Employee ownership is a wonderful thing. It comes back to that whole aspect of everybody has their opportunity to become their own entrepreneur inside of an employee-owned firm. That was the aspect of working in my corporate banking world that I appreciate so much, is just seeing the hard work that entrepreneurs bring to the table every day and what inspires them to come back and keep working hard and growing their business. And when you move to the employee ownership model, basically you're giving them the opportunity to become their own entrepreneur, to bring this desire to do great work for great clients and great projects and do it in a way that changes not only the firm, but changes their own future. That's my heartfelt emphasis about the value of employee ownership.
Jeff Adams, CM&AAWell, Chris, congratulations to you on being part of building a legacy to last for decades to come here with MKSK. You mentioned that being a key big major part of your career, and I big major part of a lot of people's careers.
Chris Hostettler, CPAJeff, there's something let me add one more thing. We have a lot of fun. We've created a number of different committees over the years, and one of the things that we were encouraged to do is to create an employee ownership communications committee, which I shared helps to promote a lot more visibility and transparency about a lot of things that are happening across the firm. But October is National Employee Ownership Month, and so we do some fun things in October to celebrate employee ownership. Last year, for the first time ever, we challenged a few people in the firm to create some poems about what employee ownership means to them. And I just want to read one of them to you because it's only about three or four sentences long, but I think it shares the gist of what we're trying to communicate. And it's called New Beginnings. Here it is. It says A new beginning, a new start, with open mind and a hopeful heart, to work at a place where work is more than a role, where people care, share visions, and a common goal. Welcome. You're an owner here. Simple words, yet strong and clear. Where voices are heard and ideas matter, designing together for a future that's better, an owner among a dedicated team, together we'll create and dream. And that was an anonymous poem submitted by one of our employee owners describing the value of employee ownership, which I think really and sums up the model that employee ownership offers your listeners if they consider that option.
Jeff Adams, CM&AASo an incredible testament to what you guys have done there at MKSK. Chris, thank you so much for participating today.
Chris Hostettler, CPAThank you, Jeff.
Jeff Adams, CM&AABeen my pleasure. And thanks everyone for tuning in to AEC Unscripted. I'm Jeff Adams, and it's been a pleasure guiding you through M&A through the lens of employee ownership. Please remember to subscribe and leave us a review wherever you get your podcast. And until next time, keep pushing forward.
People on this episode
Jeff Adams, CPA, CM&AA
Host
Christopher E. Hostettler, CPA | Former CFO & Principal Advisor at MKSK
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