They have a phrase in Texas to describe those who don’t quite fit the image they create for themselves. All hat, no ranch. On the other hand, if a fellow Texan were asked to size up someone like Rod Sanders, founder with his sister of Plano-based Highland Homes, you might get something more like doesn’t need the hat.
Sanders is 70; his sister, Jean Ann Brock, is 60. Their company survived the housing crash. The business has improved markedly. Highland got bigger. It would seem, then, it might be a good time to sell.
To be sure, others have. LionsGate Homes, of Dallas-Ft. Worth, to the Ryland Group (now part of CalAtlantic Homes) in 2013; Streetman Homes, of Austin, to Standard Pacific (also now part of CalAtlantic) in June, 2014; Grand Haven Homes, also of Austin, to Brookfield Residential Properties in March, 2015. There have been many more, too many to list here.
With 2,289 closings and $1 billion in revenue in 2015, Highland might have fetched a price that dwarfed what the publics paid for those three Texas home builders.
“We’ve been approached regularly,” Sanders says. “We are the largest private builder in the state of Texas with a billion in revenue and 600 employees, so it would be something that other builders are interested in.”
But Sanders and Brock are not.
“It’s easier to take the money and run, but we didn’t feel it would be the right thing to do. We couldn’t do that to the company we spent 30 years building,” Sanders says.
Sanders and Brock did, however, want to do something other than continue business as usual. Though it would net them less return than an outright sale, they turned to an employee stock ownership plan (ESOP), which is a qualified retirement plan established for employees to purchase shares of the company from the owner. The ESOP can purchase shares of the company from the owner, either for cash or for a note to be paid over time or through some combination, alleviating the need to obtain external financing to fund the transaction.
“For builders with a larger number of employees and the leadership necessary to take the business forward, a sale to an ESOP is worth careful consideration,” says Jeannine Pendergast, senior ESOP client advisor at Portland, Maine-based Spinnaker Trust.
In 1985, Sanders and Brock started Highland—building homes in the Dallas suburb of Rowlett, Texas. During the next 30 years, through economic ebbs and flows, the duo steered Highland into Houston, Austin, and San Antonio and grew it into the 24th biggest builder on the BUILDER 100 in 2015.
But that financial growth is only part of what makes Sanders proud of the company he built. In fact, before he even mentions the numbers, as impressive as they are, he points to the culture and the people of Highland.
“We have built a culture that we believe is ingrained in our company, which is dedicated to our customers, our home owners, and our employees,” he says.
After studying options, Sanders and Brock decided the best way to ensure that these groups would continue to be taken care of, they needed to sell Highland to its employees.
“We found it to be an ideal solution,” Sanders says. “We can maintain the culture and honor those who built the company and we can hopefully continue to run the company into the future, without us here, and we can work as much or little as we want.”
Pendergast says culture is a common reason owners elect to sell to ESOPs. “The ESOP allows for the culture of the company to continue,” she says. “If they sell out to a third party for a big premium, there are no guarantees.”
But owners will have to sacrifice money to an ESOP. “An ESOP is highly regulated and is not allowed to be sold above full market value,” Pendergast says. “A lot of third parties can buy at above full-market value because they’re cutting out overhead.”
On the other hand, ESOP transfers can often occur faster than sales. “The sales transaction is often much faster and less complicated than a sale to a third party,” Pendergast says.
The advantages for employees in an ESOP are obvious—they get a financial interest in their employer. “It’s a retirement plan that is 100% funded by the company and it allows every employee to secure their future,” Pendergast says.
In fact, Pendergast claims studies have shown that employees working an ESOP are generally more satisfied. “They are usually happier, more satisfied employees,” she says.
When Sanders and Brock decided an ESOP was their best option, they hired an attorney and an investment banker to guide them through the year-long process, which is common according to Pendergast. They also had to set up a board of directors, which governs the management of the company. Since it’s a retirement plan, ESOPs also need to be approved by the Department of Labor.
“Deciding the ownership transfer this way was the big decision,” Sanders says. “The rest of it was largely just administrative, although we had to establish a Board of Directors, which we never had in any formal sense.”
While the trustee and an annual valuation are required ongoing expenses, Pendergast says the tax benefits that come with ESOPs make these manageable.
An independent trustee administers the trust on behalf of the employees. Could the trustee and someone representing the employees and the founders have issues? It’s possible, says Michael Kahn, principal of Michael P. Kahn & Associates. The most notable example is probably Florida-based Mercedes Homes, an ESOP that declared bankruptcy after the crash in 2009 and ceased operations in 2012.
That’s an extreme example, though.
“In the beginning, they can be great,” says Kahn, who makes his living facilitating home builder sales. “But over time, people’s needs and wants change. Ten years from now, someone may want to take their money and get out. They have to create cash for that and there are tax ramifications.”
But Sanders downplays the likelihood of problems at Highland. “We don’t anticipate a conflict,” Sanders says. “That’s why we’re doing the ESOP.”
The Succession Plan
The ESOP didn’t just work from a financial perspective for Sanders and Brock. Right now, they have no desire to step back. But as they get older, they wanted to ensure Highland was in good hands.
“One of the advantages of the process for my sister and myself is that we will be able to stay, which we want to do, for as long as we’re physically able,” Sanders says. “We could stay while having that [the ESOP] completed and still work fulltime. It’s a win win. I don’t see the downside other than not getting an immediate or full cash out.”
Unless there’s a team in place ready to instantly assume control of the company, Pendergast says owners really need to be planning a half decade or more in advance. “When an owner sets up an ESOP, they should be ready to possibly stay on board five or 10 more years,” she says.
That’s not to say Highland doesn’t have an established succession plan in place. Under Sanders and Brock, Highland has a seasoned management team.
“They remain in place and continue to run their respective divisions,” Sanders says. “There’s not any change in that. We’ve had a fairly long run in place for all of those individuals.”
This is very important, according to Pendergast. “In order for an ESOP to work, there needs to be a strong management team in place,” she says. “They’re [company that are good candidates for ESOPs] are continually trying to grow management to lead the next generation. They have a vested interest in growing the people coming up from behind them.”
The only real change, for the time being, is at the top. “We are no longer the owners,” Sanders says. “We are employees now, but we still have a responsibility to see that it [Highland] succeeds.”
It is, after all, the ranch.