Bret Keisling discusses the National Defense Authorization Act, a new law as of December 2021 that could suspend competitive bidding when a 100% S Corp ESOP's existing Department of Defense contract is up for a renewal.
Mini-cast 170 Transcript
[00:00:00] Bret Keisling: Welcome to the ESOP Mini-cast. Thank you so much for listening. My name is Bret Keisling, and as it says on my business cards, I'm a passionate advocate for employee ownership. There is exciting news for ESOPs coming out of Washington, DC. In December 2021, President Biden signed into law the National Defense Authorization Act. Section 874 provides that if a 100% S Corp ESOP has an existing contract with the Department of Defense, the DoD can use quote, " noncompetitive procedures for certain [follow-on] contracts to qualified businesses wholly-owned through an ESOP," unquote.
[00:00:44] In layman's terms, if you have an existing contract that's up for renewal and you're 100% S Corp ESOP, the government doesn't have to resubmit the contract out for bid. You can be awarded a renewal one time simply because you're 100% ESOP.
[00:01:01] This is a pilot program and I think it's wonderful.
[00:01:05] There are a couple of caveats. The ESOP performing on the original contract must be rated as satisfactory or better in its previous performance of the contract. It's also limited to S Corps. I thought the S Corp differentiation was interesting and perhaps the result of lobbying from certain folks in the employee ownership space.
[00:01:22] I suppose it's ultimately a meaningless distinction. If you understand ESOPs, you know that S Corp ESOPs are exempted from federal tax for whatever portion of the shares are held by the ESOP. Although it's theoretically possible that a company would maintain C Corp status or some other form and also be 100% ESOP, I can't think of any that are. In my 13 years in employee ownership, with seven of those spin as a trustee, I can't think of any reason why they wouldn't convert to an S Corp if they're 100%.
[00:01:52] And as is often the case with government contracting, what seems to be a straightforward proposition has a lot of wiggle room. So, for example, the law's language indicates that if you perform satisfactorily or better on the original contract, you'll get a renewal. Unless, according to the law, a DoD official decides to waive it. That's a lot of wiggle room.
[00:02:12] Now, when I was a trustee, we had a number of clients who did government contracting. This new law would certainly be a boon to those companies and make a difference in the company's valuation.
[00:02:21] When setting the value based on government contracts, the appraiser has to consider when the contracts will expire. The more you rely on government contracts, the more there can be uncertainty in the valuation when considering what happens after they expire. The law undoubtedly will give comfort to trustees and appraisers as they work to develop a company's value.
[00:02:40] I'm going to share several things I like about the bill. And a couple of things that I don't care for too much.
[00:02:46] First, the fact that the law provides a path for ESOPs to gain more business is good for all of us. It will encourage other contractors to consider employee ownership. Particularly since the 100% ESOP distinction is geared towards when the contract is being renewed. Not the ESOP status at the start of the original contract.
[00:03:04] So, if a company has a $50 million DoD contract that expires in three years, if the company knew that sometime in that three years it transferred to a 100%. S Corp ESOP it would likely get an automatic extension of the contract, then obviously that provides a lot of encouragement to transfer to employee ownership.
[00:03:23] Another reason I love the bill is along the same lines of what I shared on the Mini-cast weeks ago about Lighthouse Foods adding the Certified EO logo to their packaging. The more EO and ESOPs are seen by the more people anywhere, the more likely we are to see ESOPs and employee ownership take stronger hold in our economy.
[00:03:41] Here are two things that bring me a little bit of discomfort, one general to government contracting and one specific to employee ownership.
[00:03:47] I've historically been hesitant to love government set asides and contracts, and this is another form of it. I understand all of the reasons for set asides and I accept them. But part of me wishes that we could just have a truly level playing field and let businesses compete and win or lose a contract based purely on the competitive process. Believe me, this general philosophical discomfort is very much outweighed by how happy I am to see ESOPs get this designation. It's huge.
[00:04:15] My second sense of foreboding, is that the only reason I see to limit this program to 100% S Corp ESOPs as opposed to 100% employee-owned companies is because the ESOP community is doing the lobbying.
[00:04:28] This is my fifth season doing the podcast, the first two of which I did as an ESOP trustee. Since 2019, my mission has been to amplify and celebrate all forms of employee ownership, not just ESOPs. In 2022, 3 companies reached out to me about considering an ESOP. In two of those three companies, an ESOP wasn't the right fit. End of discussion. My recommendation was that they look seriously at an Employee Ownership Trust as possibly an entryway to becoming an ESOP down the road, but maybe just to be a trust. I don't see any reason why a company that had 100% of its shares in an EOT shouldn't be eligible for benefits of the new law.
[00:05:03] Similarly, and I'm not sure how many worker cooperatives are involved in DoD contracting, but if a company is 100% employee-owned worker co-op they should be able to benefit under this law.
[00:05:13] I'm not a lobbyist and I'm grateful for the work the organizations do to bring benefits to ESOPs. But I believe with all my heart, and it shows through my work on this podcast and with the EO Podcast Network, that our country and our world will benefit from more employee ownership, regardless of the form. I wish those who did the lobbying shared the same view or more actively preached it to the government.
[00:05:35] With that I'll wrap up today's episode. I hope you'll join us Tuesday for a new episode of our primary EO/ESOP Podcast. And I hope you'll check out the Owner to Owner podcast with Jesse Tyler, which we launched in September as part of the EO Podcast Network.
[00:05:48] Until next week, thank you so much for listening. This is Bret Keisling. Be well.
[00:05:53] Bitsy McCann: We'd love to hear from you. You can find us on Facebook at EO Podcast Network and on Twitter @ESOPPodcast. This podcast has been produced by Bret Keisling for the EO Podcast Network, production assistance by Victoria Huerta, original music composed by Max Keisling, branding and marketing by BitsyPlus Design, and I'm Bitsy McCann.
Standard Disclaimer: The views expressed herein are my own and don't represent those of my own firms or the organizations to which I belong. Nothing in the podcast should be construed as guidance or advice of any kind in any field and the fact that I mentioned an organizational website or an advocate or a company on a podcast does not reflect an endorsement, but if you've heard your name or your group's name mentioned on this podcast, I'd love to have you come on and talk about it yourself.
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