ESOPs in the Grocery Industry: Why Grocers Are Pursuing an ESOP as an Exit Opportunity
March 9, 2023 | Christopher Silvetti, Vice President, Prairie Capital Advisors, Inc
When faced with the prospect of ownership transition, grocery store owners have a number of different options to weigh. Some may sell to a larger competitor or chain, while others will consider a purchase offer from a private equity firm. Meanwhile, a few may simply close up shop. However, none of these options preserves the store’s legacy and importance within the community or continues the store’s culture and emphasis on employee well-being. An Employee Stock Ownership Plan (“ESOP”) is a viable alternative option for grocers who wish to retain a community focus that may be lost when selling to an outside entity.
The Grocery Industry in 2023
The past several years have been action-packed for the grocery industry. The COVID-19 pandemic and resulting lockdowns caused people to stay home and avoid public spaces, including restaurants and other public food venues. As a result, grocery stores—which were considered essential businesses and were therefore allowed to remain open even throughout lockdown periods—saw a massive spike in sales in 2020. Since then, as vaccines became widely available and social distancing guidelines relaxed, many people returned to more normal grocery shopping habits and spending patterns.
Even with a return to normal spending, however, the grocery industry has continued to contend with supply chain issues that resulted from the economic fallout surrounding the COVID-19 pandemic. In addition, grocers have had to adapt to consumers’ interest in moving toward online grocery shopping and curbside pickup. Moreover, in 2022, high inflation began to affect consumers’ shopping patterns as food prices skyrocketed across numerous categories. While some consumers are shopping at grocery stores instead of dining out in order to avoid high prices at restaurants, they are often focused on deals and are also patronizing discount grocers more frequently. Meanwhile, increasing consolidation in the grocery industry has challenged independent grocers who often struggle to compete with larger chains.
Consolidation in the Grocery Industry
A large number of companies in the grocery industry are considered independent and operate a single location or small chain of stores within a specific region. However, over the past several years, market concentration in the grocery industry has increased due to large companies—such as Kroger and Albertsons—acquiring a number of smaller companies through mergers and acquisitions (“M&A”).
Additionally, in October 2022, Kroger announced plans to purchase Albertsons for $24.6 billion, with the anticipation that the deal would close by early 2024. If the merger proceeds, the resulting company would control 15.6% of the U.S. grocery market, second in scale only to Walmart (21.0% market share). However, elected officials, independent grocers, union groups, food producers and the National Grocers Association (“NGA”) have all expressed concerns about the transaction moving forward. Greg Ferrara, president and CEO of the NGA, succinctly stated the overall argument against the deal by saying, “A merger would not only put smaller competitors at an unfair disadvantage, but also increase anticompetitive buyer power over grocery suppliers, which ultimately would harm consumers.”
In early December 2022, the Federal Trade Commission requested more details about the proposed merger from both Kroger and Albertsons, which Grocery Dive says is “an indication that the agency is taking a closer look at how the deal would impact competition.” Overall, antitrust attorneys expect the deal to face a lengthy regulatory review.
Regardless of the fate of the Kroger-Albertsons merger, industry experts anticipate that M&A activity will continue in the grocery industry in the near term. Experts note that independent grocers often do not have the scale to compete with large grocery chains, especially with regard to e-commerce, which is becoming increasingly important to the industry. As a result, independent grocers may choose to sell to these larger firms.
However, selling to a larger company is not the only option. Selling to an ESOP is a great way to maintain a grocery store owner’s legacy within the community and retain the culture they and their employees have worked so hard to establish. It is also a way to stand out in comparison to large chains when trying to attract both customers and employees.
What Is an ESOP?
An ESOP is an employee benefit plan that governs a trust, which is established to own some or all of the stock of a corporation for the benefit of the sponsor company’s employees. To be eligible for participation in a company’s ESOP, workers must meet certain requirements, such as being over 18 years old and working over 1,000 hours per year. ESOP participants receive an allocation of stock—at no cost to them—which accumulates in their accounts over time. As the company’s stock value grows and additional stock is allocated, ESOP participants accrue more wealth until the vested account value is paid to them upon retirement or departure from the company. For more information on ESOPs, watch Prairie’s video “What Is An ESOP?”
ESOPs are found throughout the U.S. in a wide variety of industries. The National Center for Employee Ownership (“NCEO”), a nonprofit organization that supports the employee ownership community, reports that there are approximately 6,500 ESOPs in the U.S. with nearly 14.0 million participants and total plan assets of over $1.6 trillion. Each year, about 250 new ESOPs are created.
ESOPs and the Grocery Industry
According to statistics provided by Certified EO, an organization that is building a network to bring national recognition to employee ownership through the use of a marketing and certification program for employee-owned companies, 71 companies in the grocery industry have ESOPs.
Further, the NCEO reports that 12 of the top 100 largest majority employee-owned companies in the U.S. are in the grocery industry. Publix is the largest majority employee-owned firm in the U.S., with 230,000 employees. Other large majority
employee-owned companies are also grocers—WinCo Foods has about 21,000 employees, while Houchens employs approximately 18,000.
While these grocers’ ESOPs may have started over 35 years ago, there are new grocers joining the ranks each year. For instance, in 2020, PAQ Inc., an independent franchisee of Food 4 Less, chose the ESOP route for its 20 stores in California. Then, in 2021, both C&K Market (Oregon and California) and Hi Nabor Supermarket (Louisiana) became 100% ESOP-owned. In 2022, JND Holdings—which operates supermarkets, liquor stores and convenience stores/gas stations across Minnesota, North Dakota and Wisconsin—implemented an ESOP. Most recently, in December 2022, Neighborhood Fresh—a grocery store with four locations based in Northeastern Indiana—sold to an ESOP.
So, why are ESOPs so popular in the grocery industry? Of course, there are a number of reasons, but some of the top cited by grocers include company culture and employee well-being. John Alston, president and CEO of 100% employee-owned Brookshire Brothers in Lufkin, TX, says, “When the Brookshire family started making plans to retire and exit the business, several alternatives were considered. After careful consideration, the decision was made to create an ESOP so that, ultimately, the employees of the company would stand to benefit.” Indeed, employees at companies with an ESOP usually see their wealth grow over the time they remain with the company. Wealth creation is especially important in the current environment where income inequality is a prevalent trend. While numerous research studies have found that a large number of U.S. adults are living paycheck to paycheck and/or have no retirement savings, according to the employee ownership advocacy group Employee-Owned S Corporations of America, the average ESOP participant in employee-owned S Corporations has more than double the amount in his or her retirement account than the average American employee.
Alston continues, “Looking back over the now twenty-plus years that we’ve operated as an ESOP, it’s clear that our employee-owned culture has continued to strengthen over time and is now deeply embedded throughout our organization. This culture is expressed by our team daily in their commitment to one another and the common goal of making Brookshire Brothers a great place to work and shop.” ESOPs are one way to enable the continuation of a company’s culture as well as the owner’s legacy. If a business is sold to a third party, the likelihood of preserving both culture and legacy fades. However, putting an ESOP in place means that the company will remain in the hands of the workers that helped to build it. Therefore, the culture of the company will likely remain consistent, and the values of the original owner or owners will be carried out over the long term. The company will also remain independent and retain the brand appeal that the original owner worked so hard to build. As a result, the positive impact that the grocery store has had in its community will continue.
In addition to maintaining company culture and providing for employees, the company itself can benefit when selling to an ESOP. According to Corey Rosen, founder of the NCEO, companies tend to perform better after implementing an ESOP, which means that the surrounding communities benefit as a result.
Further, ESOP-owned firms tend to have a highly-engaged and loyal workforce, which strengthens the company further. According to representatives from Kirby Foods, a 100% employee-owned independent grocer headquartered in Champaign, IL, “We believe that the ESOP has had a positive effect on the retention of long-term employees as the value of the ESOP has grown over time.” The NCEO reports that workers at a company with an ESOP have a median job tenure of 5.1 years, which is 46.0% higher than the median job tenure for workers at companies without an ESOP. Notably, when studying the broader food industry—which includes not only grocers but also food producers and distributors—the NCEO found that food companies with ESOPs had a 14.0% lower median quit rate than food companies without ESOPs. The NCEO notes that, while ESOP companies are not immune to challenges and disruptions, having an ESOP helped both businesses and their workers to “thrive even under extraordinary economic circumstances.”
Finally, there are a variety of financial benefits for those that choose an ESOP as part of their ownership transition strategy. If a loan is used to finance an ESOP transaction, the contributions that are used to repay the loan are tax-deductible, so the company can repay the loan with pre-tax dollars. Additionally, for S corporations, the ESOP’s share of recognized earnings is not subject to income tax at the federal level and, oftentimes, the state level. At the same time, owners of C corporations who sell their stock to an ESOP can defer capital gains on the sale under IRC §1042. Employees also receive a tax benefit in light of the fact that an ESOP retirement account is non-contributory and tax deferred.
Moreover, an ESOP can be structured to meet a variety of liquidity events. Depending on the owner’s goals and timeline, it may not be practical or desirable to sell 100% of the company’s stock to an ESOP. Regardless, an ESOP can be structured to provide partial liquidity to one or more shareholders. In fact, an ESOP is an excellent solution for a situation with multiple shareholders where one may be seeking liquidity and others wish to retain control. Notably, an ESOP can be structured to give the plan a minority share in the business at first, providing some liquidity. The remainder of the company’s stock can be sold to the ESOP or a strategic buyer at a later date. In general, an ESOP provides grocers with a variety of options for transitioning their shares.
Overall, grocers who sell to an ESOP have found that this type of ownership transition benefits not only the seller but also the company’s employees and the local community at large. If an owner sells to a large corporation or private equity, decisions will likely be left in the hands of someone outside of the community. However, by selling to an ESOP, a company can remain locally controlled, which helps the community retain its unique qualities and the local economy to remain vibrant.
Christopher Silvetti is a Vice President at Prairie Capital Advisors, Inc. He can be contacted at 312.445.9209 or by email: csilvetti@prairiecap.com.