It’s remarkable how fully optimized some industries are – computer chips and potato chips come to mind, as in Intel and Pepsico’s Frito-Lay – and how others continue to offer enormous pieces of low-hanging fruit to the enterprising business leader.
By the American Trucking Associations’ count, annual driver turnover runs nearly 100% at so-called large truckload carriers, also known as long-haul truckers. And if it costs $3,000-to-$5,000 to recruit and hire one driver (I’m told that estimate is conservative), keeping the million or so long-haul driver jobs (1) filled every year represents a $3 billion-to-$5 billion toll on an industry that already suffers from narrow profit margins and an enormous need for capital.
The turnover is disastrous for drivers, too. Many are never at a single employer long enough to accumulate any retirement savings. They typically live paycheck-to-paycheck while employed, and then suffer a big step down in income when they retire with only social security.
Despite this being the business problem that has plagued – and, indeed, defined – the trucking industry for years, there has been little or no overall improvement. Drivers job hop. Trucking firms devote enormous resources to recruiting. And everyone’s the worse for it.
What could possibly fix this mess? Without a doubt, in many cases, an Employee Stock Ownership Plan, or ESOP.
This article will examine the decade-old ESOP at Paladin Capital Inc. (formerly Quickway Distribution Services Inc.), a 1,000-truck operation based in Nashville. The company’s driver turnover – 20% voluntary, 15% or so initiated by Paladin as it enforces lofty quality standards – sets it apart from the industry. Drivers who’re owners also help Paladin achieve near perfection in on-time performance for its demanding retail chain store clients. They also have drastically reduced fuel-wasting idle time, at an annual savings of between $500,000 and $1 million, depending on fuel prices. The safety record is admirable.
“We have a company where everybody has the same last name: shareholder,” says Bill Prevost, Paladin CEO. In return for working like owners, in just ten years some Paladin drivers have amassed ESOP retirement accounts of nearly $200,000.
Rarely in my experience has an ownership format so thoroughly and persuasively helped address a difficult problem in operating a business. To be sure, employee stock ownership plans have strengthened 7,000 or more U.S. companies, notably in the grocery, engineering and construction, manufacturing and distribution industries. And those companies, based on a wide survey of research, tend to outperform their competitors.
But an ESOP’s potential to a trucking company, seldom applied to date, may very well be proportionately larger because of the unique turnover challenge. ESOPs have a demonstrated record of improving employee retention, as well as boosting productivity and reducing friction between managers and workers.
Paladin isn’t alone, but ESOPs are few in trucking. Big G Express, a Shelbyville, Tenn., carrier with about 500 trucks, reduced its annual driver turnover to 75% from 120% in just a year’s time, as it learned to communicate the benefits of its 2009 ESOP transaction to drivers. ESOP stock valued at $5.88 in 2009 rose to a value of $27.75 at the end of 2014, and some long-time drivers (years of service prior to the ESOP is a factor in compensation) have already seen their ESOP accounts approach $70,000. Randy Vernon, Big G’s president, says the company is just getting started on reducing turnover. Paschall Truck Lines in Murray, Ky., is also a well-regarded ESOP-owned carrier. Executives from both Big G and Paschall, by the way, visited with Prevost and Paladin, before launching their ESOPs.
Before getting back to the Paladin story, and the turnover challenge, a couple of surprising financial facts, and one comforting governance finding, for owners of trucking companies:
--After-tax proceeds from selling to an ESOP can be higher than a private equity sale or management buyout. That’s because under the ESOP law, owners selling a C-corporation, if they reinvest the sale proceeds in qualifying securities (stocks and some bonds), can defer capital gains taxes, potentially forever. That’s a 25% to 33% tax bite avoided when federal and state taxes are calculated.
--Going forward, ESOP companies that operate as S-corporations, which are pass-through vehicles, are exempt from federal and most state income taxes. That provides a lot more cash flow to service acquisition debt, make new acquisitions and invest in the business. Taxes are paid by ESOP members when they retire or withdraw their funds, just like a 401(k) or IRA account.
--An ESOP doesn’t mean the CEO all of a sudden answers to his or her workers. Just like at other corporations, there is a board of directors and traditional governance systems. Many founders sell all or a part of their company to an ESOP, finance a portion of the transaction and receive warrants, and stick around to lead a company that becomes more productive and more fun to work at.
Paladin was founded in 1960, acquired by a larger company, and later resold and owned by its original owner, Steve George, and a partner, Roger Blume. As 2003 approached, the owners were looking to sell, and asked Bill Prevost, who they’d recruited to eventually become CEO, to look into putting together a management buyout.
Prevost did so, but a lawyer brought in to look at the potential transaction pointed out how tax-inefficient it was going to be: the sellers would pay federal capital gains, then at 15%, plus any state levy; the business itself would go on with its 38% effective tax rate; and managers participating in the purchase would be taxed at 25% of so of their compensation, which would ultimately be used to pay down acquisition debt. “It didn’t make sense,” Blume says.
The lawyer recommended looking instead at an ESOP, with the above-described tax provisions in mind, and Prevost began educating himself on the format. Financially it made great sense, but would it work in an industry with such high employee turnover?
“People said I was nuts, that truck drivers would never get it,” recalls Prevost. “But I knew as soon as their ESOP account balance got to be worth a bass boat or a new pickup truck, we’d have their attention.” To preserve Paladin’s liquidity and to make sure drivers were building retirement nest eggs -- not indulging in recreational vehicles and the like – Prevost structured the ESOP as a retirement trust. Funds are distributed upon retirement. Paladin has paid out $8.5 million to date in ESOP retirement benefits.
Paladin operates in the so-called direct-store-delivery sector of trucking, each truck loading up at a large retailer’s warehouse and then making, say, six-to-twelve stops at stores in a shift. The mostly local nature of the work means 90% of drivers are in their own beds every night, a big plus in recruiting. But the multiple stops and loading/unloading tasks complicate recruiting; many experienced truckers are in poor physical condition and aren’t suited to the work. And safety standards are non-negotiable. So while turnover is relatively low, Paladin hires just 2.1 drivers for every 100 it interviews. That’s a costly process.
The ESOP, however, has turned many Paladin drivers into evangelists for the company. They refer nearly 40% of new drivers and are paid a $2,500 bonus for every hire they bring in. Kendall Ray, a Louisville driver for Paladin, has brought in three successful recruits. Once, while shopping in a Dollar General store, Ray was talking up Paladin to a fellow truck driver he ran into. That guy didn’t come aboard, but another driver who was two aisles away and overheard the conversation introduced himself and did join Paladin. “I approach ‘em where I see ‘em,” Ray says. “A lot of the time they’re not satisfied” at their current job.
With the ESOP account balances rising, says David Wilburn, vice president of recruiting and retention at Paladin, “If a guy’s been here three or four years, he ain’t going nowhere.”
Blume, the former owner, agrees. The ESOP “doesn’t help you hire the new guy. But it helps you keep a 3-year guy from quitting over something.”
Paladin has a 401(k) plan, and matches $1, up to 3% of pay, for every $2 an employee contributes. About 40% of employees are participants, but they contribute too little. So, when Chris Tate, Paladin’s CFO, is at a retirement ceremony – the company hands over giant checks, like the retiree had won a golf tournament – he’ll go around the room and ask, “who has $170,000 in non-ESOP savings?” He’ll gradually cut the amount, plumbing for an outlier with a big 401(k) account. But usually, Tate says, “you get all the way down to $500 before someone raises a hand. The ESOP is it.”
“They walk in with nothing,” Wilburn says.
Drivers comfirm this. Kendall Ray, 52, says the ESOP is his only retirement savings. Barry Priddy, 60, a Louisville driver, agrees, an old 401(k) account having come and gone: “I had $15,000 saved up at one time.” Tom Kennedy, 64, a driver in Livonia, Mich., joined Paladin before the ESOP and thus has a nice account balance. He plans to work until he’s 70 ½.
An important point: the ESOP alone would never have made Paladin a top-performing company. Rather, top-performing companies that place a high value on employee participation tend to become ESOPs. Five drivers I spoke to all brought up a company environment that supports their families and hears driver complaints. “They treat you like you’re somebody,” says Mike Horsley, 48, a Shelbyville, Ind., driver. Truck driving, Horsley says “is not an easy life. But the ESOP came along. Man, I’m staying.”
Over its decade, the Paladin ESOP has returned 32% compounded annually, the shares rising from 87 cents to $13.80. To date, an amount roughly equal to 25% of a worker’s pay has been deposited annually. Yearly deposits and the stock’s rise account for the swift accumulation of savings. (Yes, all you armchair financial planners, there is risk in concentrating one’s retirement savings in ownership of a single company, especially one’s employer. But ESOP shares are awarded to workers, not paid for, and most drivers would have nothing without the plan. And by the way, ESOPs allow for diversification as workers gain seniority.)
Driver performance at Paladin is graded – and rankings published to all employees – on such things as being on time, idle time, safety and mileage. As owners, the drivers have reduced idle time from a former high of about 25% to about 10%; Tate, in presentations on the ESOP, shows drivers how the improvement has added thousands of dollars to a typical retirement account.
Drivers aren’t the only group easier to recruit under the Paladin ESOP. The company makes regular acquisitions of smaller carriers. And its approach has a special appeal to some owners. Robert Bearden, who founded a Cairo, Georgia trucking company bearing his name, was looking for an exit strategy in 2012 and talked to potential buyers. He’d seen firms his size folded into bigger carriers before. Of his nearly 300 employees, he says: “I just couldn’t force myself to go tell them, ‘I sold the company. If you want to work for the new owners, here’s an application you can fill out.’ I couldn’t sell them out.”
Bearden stuck around after selling to Paladin in 2012 and has enjoyed the unexpected upside of employees who’re owners: “They’re trying to make it a better place to work and more profitable.”
(1. The Labor Department says, as of 2014, there were 1.8 million heavy and tractor-trailer truck drivers in the U.S. A large minority of those work for companies like UPS that have low turnover. But the majority are at independent trucking firms where turnover runs very high.)
Mary Josephs, founder and CEO of Verit Advisors, led ESOP advisory at Bank of America. You can reach her at CEO@verit.com.
