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ESOP and the metal fabricator

When employees own a fabricator

Company owners at work at Lou-Rich. The company has had an employee stock ownership plan (ESOP) since 1992.

Settling into his new job two years ago, Greg Thomas sat in on a capex planning meeting and heard a second-shift machine operator speAk his mind. Thomas is national sales manager at Lou-Rich, a large custom metal fabricator in Albert Lea, Minn., that’s part of Innovance, a holding company that owns several other manufacturers in the area.

At that Lou-Rich meeting nearly two years ago, Thomas recalled the machine operator shaking his head when people talked about buying a certain machine. He liked the technology, but he wasn’t sure how good the return on investment would be.

Here was a second-shift operator, and he was talking about ROI.”

That impressed Thomas, along with the fact that the front-line employee was invited to the meeting in the first place. But it wasn’t surprising, considering that, with their ownership interest, some shop floor employees will be retiring quite comfortably, with retirement accounts in the high six-digit range.

To be clear, they’re not driving fancy cars or living in big houses. Most of their retirement money is invested in an employee stock ownership plan (ESOP). Those retirement accounts (along with the traditional 401(k) plan that the company also offers) had a lot of time to grow. Still, the fact remains that employees who have the largest ESOP retirement accounts don’t sit behind desks poring over budgets, PowerPoints, and other planning documents. They instead move material, operate machines, and fabricate metal. It’s probably safe to say that, given the choice, the people at Innovance wouldn’t have it any other way.

ESOPs in the Industry

Along with giving employees an ownership interest, ESOPs come with advantages and disadvantages. On the positive side, S corporations that are 100 percent ESOP-owned pay no federal taxes on earnings. On the other hand, if someone unexpectedly quits, the employer is obligated to pay that person the vested value of his or her ESOP account, either in a lump sum or in periodic distributions.

ESOPs aren’t unheard of in metal fabrication. MEC, the $300 million custom fabricator in Mayville, Wis., is one of the country’s largest ESOP-owned enterprises. Family businesses dominate this industry. As first- or second-generation owners retire, some are passing businesses on within the family, others are selling to strategic or financial buyers, while still others choose to pass the business on to their employees through an ESOP trust. Lou-Rich (and Innovance) falls into this last category.

Having an ESOP retirement account isn’t like owning a company’s common stock directly. Legally speaking, the ESOP trust “owns” the company, so while employees have an ownership interest, they don’t have a controlling stake. Depending on the plan specifics, companies do put some issues up for a vote. For instance, at Innovance employees vote directly on decisions like company acquisitions that require investment beyond a certain portion of Innovance’s total assets. But for the most part, votes occur via an independent ESOP trustee.

What makes Innovance’s ESOP unusual is the way it distributes shares among employees. In most ESOPs, the greater an employee’s salary, the greater number of shares he or she has in the ESOP. At Innovance, as part of the ESOP’s annual allocation of shares, all full-time employees receive the same number of shares regardless of wage.

The decision to do so came not long after the ESOP trust was formed in 1992. At the time shares were being released to employees the conventional way, based on a worker’s salary. “But then our president at the time, Jim Anderson, asked if that was the right thing to do, or should everybody participate equally,” said Mike Larson, Innovance president and CEO. “So, we had an employee vote, and that’s how the decision came down.”

Larson spoke in an easy cadence, but it quickened when he wanted to emphasize a point, including the importance of decisions the company founders—his father Louis Larson and his business partner Richard Ackland (the Lou and Rich of Lou-Rich)—made in the early 1990s.

The company’s two founders, along with Jim Anderson, were crucial in developing the ESOP. “They could have sold the business to somebody else, probably for more money, but they felt it really was the employees who helped them become successful.”

Farm Boys Make Good

In 1972 two 30-somethings launched a tool and die shop in 1972—not in Albert Lea but in Hayward, a farming community a few miles to the east.

“They were really just a couple of farm boys here in southern Minnesota,” Larson said.

Louis Larson and Rich Ackland built tools for John Deere and others and performed some farm equipment repair. They soon expanded their operation out of repair work and into stamping, machining, and sheet metal fabrication. What began as a two-man operation in 1972 grew to a 40-person shop in the 1980s.

In 1989 came a significant move. A customer was moving to South Carolina, and Lou-Rich bought that customer’s Albert Lea manufacturing facility. “This was a big leap of faith,” Larson said. “It increased the available manufacturing space from 30,000 square feet to 200,00 sq. ft., so it gave them a lot of opportunity to expand.”

And grow it did, to the point where in 1992, when Ackland and Larson were only 52, they had become successful enough to retire. “That was their goal going way back,” Larson said. “They wanted to build a business, run it for 20 years, then retire. So they stepped away from day-to-day operations.”

For a few months after their retirement in 1992 the two founders still were the primary shareholders; their CFO, now president, Jim Anderson, also had a small percentage of shares. “Anderson was an integral part of the company becoming an ESOP,” Larson said.

To begin the process, Lou-Rich took out a bank loan to buy 30 percent of the founders’ shares. As a participant of the ESOP, each employee would receive a certain number of unallocated shares each year. Around this time the company also offered common stock (outside of the ESOP) to those employees who wanted to buy it, either with a personal check or a regular payroll deduction.

Over the next 20 years the ESOP eventually acquired all of the company shares, both from the original shareholders and from the employees who purchased common stock. By 2012 the company became a 100 percent ESOP-owned S corp.

Road to Innovance

Lou-Rich didn’t stay still for those 20 years. In 2004 it acquired Almco, a nearby manufacturer of vibratory finishing equipment. In fact, Lou-Rich had been one of Almco’s customers.

“The owners [of Almco] approached us,” Larson said. “They liked us, and they liked the idea of employee ownership. They felt they could sell it to someone else outside the community, a big organization. But that big corporation probably wouldn’t care as much about the people in the company and the community. They really wanted to sell it to a local company.”

Instead of absorbing the Almco product line as it had done with several smaller acquisitions in the past, leaders at Lou-Rich decided to keep it a separate business. The manufacturing models were just too different; Lou-Rich is essentially a large high-product-mix job shop, while Almco is an equipment manufacturer.

To that end, leaders formed a holding company called Innovance. Lou-Rich’s ESOP was transferred to Innovance, which now owned both Lou-Rich and Almco as subsidiaries. They also formed Panels Plus, a company based on a product line, acquired in 2000, used to produce wall panels for the construction business.

In 2016 Innovance acquired Howard Lake, Minn.-based Mass Finishing Inc. (MFI), which makes deburring and polishing equipment complementary to Almco’s product line. Later that same year it purchased Rogers, Minn.-based Midland Technologies, a maker of vacuum and vent technology for the high-pressure die casting industry.

“[Midland] has significant machining capability, which complemented our existing machining capability [at Lou-Rich], so we could help each other with some projects,” Larson said.

Today Innovance is an $80 million company with more than 400 employees. It’s far different from the 40-employee shop of the 1980s and a world away from the small farm equipment repair shop of the 1970s.

Diversification and Risk Reduction

Why expand in this way? As Larson explained, the moves made sense in Innovance’s quest for diversification and risk reduction, which is all the more important considering the ESOP. The last thing an employee wants is for the company share value to drop off a cliff. If Lou-Rich had highly concentrated revenue coming from just a handful of large customers (a common situation among custom fabricators), what if one large customer pulled its business?

To take advantage of scale, subsidiaries share back-office operations like accounting, human resources, and information systems. Each company has a different demand cycle, and when one is buried with work, resources at another company can lend a hand, depending on the nature of the project.

At the same time, each Innovance subsidiary has its core expertise. At Lou-Rich, it’s fabrication and machining. In fact, with the company’s major investments in fiber laser automation, including a 6-kW Bystronic machine it purchased last year, Lou-Rich has enough capacity to supply the entire organization with laser-cut parts. The automated material handling system is designed so that it can accept additional machines in the future.

Innovance’s organization overcomes a common challenge in today’s fabrication world awash in laser cutting capacity: Shops are overwhelming their press brake department and other downstream operations. This hasn’t been a problem at Lou-Rich, simply because its lasers feed so many downstream operations, both at Lou-Rich and at its sister companies.

Good strategic planning reduces risk even more. When Thomas joined the company two years ago, he set out to create marketing strategies for all Innovance subsidiaries.

When it comes to strategic planning, companies with established product lines like MFI, Panels Plus, and Almco are somewhat straightforward. Lou-Rich is different. Like any custom fabricator, it’s selling hours and capacity, not products. Designing an operation around a handful of customers may introduce all sorts of efficiencies, but if that handful is a fabricator’s only source of revenue, watch out.

“For us, we need to focus on a cross section of industries, from medical equipment, ag, industrial equipment, and food packaging and processing,” Thomas said. “But we’re also looking to target companies of a certain size.”

Call it the Goldilocks strategy. The fabricator focuses on customers large enough to provide consistent work with the potential for a long-term business relationship, but not so large that its work takes over the fabricator’s entire business.

Importance of Place

Larson didn’t grow up thinking he’d lead the family business. He has a mechanical engineering degree and MBA from the University of Minnesota, and he worked for Honeywell in the Twin Cities as an engineer before joining the family business as director of engineering in 1992, becoming president and CEO in 2001.

When he returned to Albert Lea in 1992, he went to work at Lou-Rich’s plant on Front Street. Walk a few blocks to the west, and you reach leafy residential neighborhoods and, this being Minnesota, a lake, one among several around town.

It’s a quintessential rural Minnesota town near the southeast corner of the state, a place where most people know most everyone else. Kids ride their bikes, parents chat, while a few hundred yards away, a 6-kW fiber laser slices through 0.25-in. carbon steel. It’s little wonder business leaders in this town strive to keep things local.

“In my time I’ve seen businesses become milked by outside investors, and it can hurt a company tremendously,” Larson said. “I’m not saying that it always happens, but it seems to happen more often than not. When financial buyers acquire a company solely for its profits, they’ll squeeze it any way it can.”

Larson’s father and business partner founded a company for financial security, but they weren’t looking to amass a fortune or create a dynasty. Mike Larson hasn’t inherited any ownership stake, but he leads an organization in which a second-shift operator sits in on capex meetings and asks about ROI. All in all, that’s not a bad trade-off.

Photos courtesy of Innovance, www.innovance.com.

Almco, www.almco.com

Bystronic Inc., www.bystronicusa.com

Lou-Rich, www.lou-rich.com

Midland Technologies Inc., www.midlandtechnologies.com

Mass Finishing Inc., www.massfin.com

Panels Plus, www.panelsplus.com

About the Author
The Fabricator

Tim Heston

Senior Editor

2135 Point Blvd

Elgin, IL 60123

815-381-1314

Tim Heston, The Fabricator's senior editor, has covered the metal fabrication industry since 1998, starting his career at the American Welding Society's Welding Journal. Since then he has covered the full range of metal fabrication processes, from stamping, bending, and cutting to grinding and polishing. He joined The Fabricator's staff in October 2007.