Not Sold on ESOPs? There's A New Alternative

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Loren Feldman:
Welcome, Ari and Brad. It’s great to have you both here. Who wants to take a crack at explaining what a perpetual purpose trust is?

Brad Herrmann:
Go for it, Ari.

Ari Weinzweig:
Okay, Brad, I’m gonna do my best. As I’ve been explaining this within our own organization, I referenced a line from the Basque co-op Mondragon where they say, “We’re building the road as we walk.” So we are also building the road as we walk. Best I can understand, there’s only about 40 of these in the country. Maybe it’s up to 42 now with the two of us, so we’re all kind of figuring this out. But I guess maybe easier than explaining it would be to tell you how I found out about it, and through that, to explain it.

Loren Feldman:
Well, give us a hint of what it is so we have some sense where you’re going.

Ari Weinzweig:
It basically allows you to gift the company to itself, which sounds simple and obvious, but legal constructs don’t allow the company to own itself. It has to be owned by someone else. So this allows the company to own itself. And essentially, as Natalie Reitman White, who helped us do this from Alternative Ownership Advisors out West, says, “Purpose becomes more important than profit, because the purpose guides it.” So in essence, the core of it can be owned by a purpose, instead of a person.

Loren Feldman:
So to the extent anybody is familiar with this, I suspect they’re familiar with it, because of Patagonia and Yvon Chouinard, who did this, I think, last August. If I remember correctly, and understood it correctly, 2 percent of the stock went to a trust controlled by his family and by advisors, and the rest went to a nonprofit organization, which is going to receive all of the profits. That’s what people know about this, if they know anything about it. It sounds like yours is different, Ari. Is that correct?

Ari Weinzweig:
Well, I think they’re all probably different because there aren’t that many, and because maybe it will change, but nobody started a company with this in mind. It’s always been grafted onto a company, an organization, that already exists. And so, in a good way, Brad and his organization and Zingerman’s Community of Businesses share a lot of values, but we’re different organizations. So in order to make this work, we’re going to each adapt it as we do. Here in our world, the trust is only applicable on the intellectual property, because each of our businesses in the Zingerman’s Community is actually a separate legal entity with different managing partners, etc., etc.

So this is about the intellectual property, which Paul [Saginaw], my co-founding partner, and I own. And this will allow us to transfer more and more of the ownership and the intellectual property over the next 10 to 20 years, to what we call community shareowners, which are staff who own a share. And the trust itself is essentially a small piece of it, but what it does is, it protects the business from being sold. And it also protects the use of the intellectual property. And so it’s the entity that would approve any use of the intellectual property.

So that could be opening a new Zingerman’s business, which would be pretty straightforward. But it could be 30 years from now somebody comes and goes, “Hey, man”—pick your negative organization—”the Nazi Party wants to give us $20 million to co-brand a Zingerman’s T-shirt.” And then the trust would say, “Sorry, that’s not aligned with our values. No go.” Similarly, if a big company came and said, “We’re gonna give $50 million to you all to buy out the Zingerman’s name,” it would say no.

Brad Herrmann:
That’s one of the things—well, two points here: The best thing to happen for perpetual purpose trusts is Patagonia. Because now, when I mention what we’re trying to do, people go, “Oh, I saw that.” And they market it really well with, “Our only shareholder is the planet,” or something like that. So that’s wonderful.

And our model is going to look a little different. We’re a more traditional business. You know, Ari’s got some complexities in there that are unique. Ours is 100 percent of the company is going to fall under the trust, and all of the employees will be the beneficiaries in the long run, not to mention community, and potentially charities, etc. But the primary beneficiaries are the employees. And we love the same thing Ari loved about it. And that is, it can never be sold. So I love the expression, “Run it or ruin it.”

Loren Feldman:
Ari, what Brad just described sounds complicated enough to me: I believe, just one organization. You’re talking about putting a whole bunch of Zingerman’s Community of Businesses under this umbrella, and you’re doing it through the intellectual property, as opposed to stock. Could you explain that a little bit? What happens to the actual ownership if it’s just the intellectual property that’s going to the trust?

Ari Weinzweig:
There’s actual ownership in the intellectual property. I’m gonna try to explain all this in a relatively manageable format. So, tell me if I’m going too off course, but we have Zingerman’s Community of Businesses. Paul and I started the deli, the first business, in 1982. In 1993 and ‘94, Paul and I wrote our first formal vision, the process that Brad is well familiar with, and so are you Loren, where we write the story of our organizational future at a particular point in time. And we picked, at that point, 2009. So we went 15 years into the future, and that’s where we created this community of Zingerman’s businesses, all located here in the Ann Arbor area, each with its own unique specialty.

So instead of replicating the deli, as most people would do, we created new Zingerman’s businesses, and each business with a managing partner or partners in it, so that there were owners on-site, all operating as one organization. So each of those businesses—whether it’s Zingtrain where I’m sitting right now, our training business; Zingerman’s Bakehouse; Zingerman’s mail order; Zingerman’s Coffee Company; etc.—each of those are separate legal entities, and they have a managing partner who owns very real shares.

Paul and I retained the ownership of the intellectual property, and we own shares in each business. We’ve operated as one organization. I just wrote a piece in my E News that I do every week, last week on governance. And I referenced in there that, although the story is not told a lot, we have been governing our organization by consensus of all the managing partners, our partners group, for 29 years. Next year, it’ll be 30 years. And I think that group is roughly 20 people right now.

So in our model, the governance of the organization, the running of the companies, stays within that partners group. The trust is only for the intellectual property. So it would deal, like I described earlier briefly, with brand issues. You know, Loren, if 21 Hats started to put Zingerman’s on its T-shirts or on its website without permission, somebody from the trust—

Loren Feldman:
I thought I had permission, Ari.

Ari Weinzweig:
Somebody from that entity would call you up or drop you an email and say, “Hey, dude, what’s up? You can’t do that.” And then it would approve the use. So if we were going to co-brand with 21 Hats or Patagonia or whatever, the trust would have to sign off on that. Beyond that, in our world, the trust doesn’t do much. It really has no governance say in the organization. But it creates an ownership for the intellectual property that, as I’ve been metaphorically saying, can allow Zingermans to become this old-growth forest, rather than clear-cutting.

Loren Feldman:
So if the ownership stays separate from the trust, could the businesses still be sold to another entity at some point?

Ari Weinzweig:
Well, in theory they can, but not with the Zingerman’s name.

Loren Feldman:
I see.

Brad Herrmann:
And that’s more about, I think, the Zingerman’s model itself, and that you’ve got that one company that ties all the others together. That’s unique, not so much of the trust model.

Ari Weinzweig:
Yeah, and it’s unique that we’ve been governing in the way that we have, by consensus of a pretty large group for all this time. So, yes, in theory they could depart, but they would have to stop being Zingerman’s Bakehouse or Zingerman’s Roadhouse or whatever, which clearly would not be great.

Loren Feldman:
So Ari, let’s go back to where you wanted to go initially, which is how you wound up here. I’m sure you considered every option. How did you land on this one?

Ari Weinzweig:
Well, like many people of my age group, when we started businesses—well, now for us, 41 years ago—we weren’t really worried about succession planning. We were happy if we stayed in business for a few years. So in a good way, not by accident, we have arrived at this point. And about 15 years ago, Paul, as he is good at doing, started asking these provocative questions about succession. So again, I’m going to attempt to explain this relatively coherently.

But we had early on arranged a buyout agreement between the two of us so that if one of us would pass away, we had life insurance that would fund the buyout of the heirs of the person who had passed. So if I had died, the life insurance would pay out to Paul. He would use that money to buy out my heirs so that they wouldn’t become owners in the business. And that was all good. And about 15 years ago, he started saying, “Well, what happens after the second one dies?” And I said, “Well, we have insurance. It’s no big deal.” And he goes, “Yeah, but where do the shares go?” I’m like, “I don’t know.”

Anyway, so that started a long, long series of conversations, and the obvious answers for what you do are the typical things: You sell the business to somebody else. I have a lot of friends who’ve done that. It’s a very good way to hit that post-cash event that people like. You can do an ESOP, which is an employee stock ownership plan, which our friends at Great Game of Business, Springfield Remanufacturing, are big fans of. I’m not a big fan of it, for a number of reasons. But one issue that we have is that because we have all these separate businesses, you can’t do it as one ESOP, even if we wanted to.

Loren Feldman:
You literally can’t do one holding company?

Ari Weinzweig:
Well, our employees work for each business. So the Zingtrain employees work for Zingtrain. The employees at Cornman Farms work for Cornman Farms. You could do an ESOP within Zingtrain, but you can’t do an ESOP for all of Zingerman’s. There are other issues with ESOPs, in my unprofessional opinion, also.

Loren Feldman:
I think Brad’s gonna raise a few of those, too, when we get to his story.

Ari Weinzweig:
Okay. So you can leave it to your heirs, which we weren’t going to do. Or you could go public, which is another version of selling it. I didn’t really like any of those. You could also sell it to your partners, and they could inherit it. But the problem with that—and I’m not saying this would have happened—is it doesn’t eliminate the thing that you sell it to them, and then five years later, they sell it. So us giving them a deal to get it in the interest of keeping it local and in the community isn’t really that helpful if it just gets flipped to something multinational five or 10 years or 20 years later.

So, around the time we were struggling with this, I was reading E.F. Schumacher’s book, which is celebrating its anniversary. This was 1973, so whatever that adds up to: 50 years, this year. And in there, it’s not the main point of the book—which by the way, the book is fantastic—but he wrote about the Scott Bader Commonwealth in England.

Scott Bader was born in Switzerland, moved to the U.K., I think in 1923, and started his own business in the chemical business. And in 1951, having attained a fair bit of success, made the same sort of decision Brad has made and we’ve made now, which is essentially, rather than selling the company or leaving it to his kids, he wanted to preserve it to benefit the people who work there and keep it self-owned.

And so he created what he called the Commonwealth, and they are now celebrating their 100th anniversary. So it worked. I love this because it allowed the business to stay local. Because part of what happens when companies get sold is all of this great stuff—not like we’re the greatest thing in the world, but we’ve contributed a lot to the community, in terms of jobs, quality of life, contributions, etc., etc.

And all of a sudden, when headquarters shifts from Ann Arbor to Abu Dhabi or New York or San Francisco or wherever, over time, and no matter what the good intentions of the people who made the purchase were, they move on. And more and more decisions are made further afield. The power shifts away, the money shifts away, and you really lose that connection with the community. And this model I love because it allowed us to prevent all those things from happening.

Brad Herrmann:
Yeah, Ari, I think you hit on something there. Well, you said a lot of things that are really meaningful to us, but one is: How many people truly depend on a healthy company? I mean, it’s your employees, it’s their families, in some cases their relatives, their friends. But then you also have your vendors, all the different suppliers, and that kind of stuff. And I think that’s meaningful when you look at the total impact of an organization. And how frequently, and sadly, how accepted it is, that, “Well, it’s time. We’re going to sell to the big guys. And hey, a lot of you are probably going to be redundant.” And no matter what they say, look at what it looks like two years later, and it’s almost always drastically different.

Ari Weinzweig:
Yep, every time. And I have a lot of friends who are in that, who have worked for companies like that that were sold, and all end up leaving. And especially, Brad, in our context, because we literally, because of the restaurants, the cafes, etc., we have people who come in two, three four, five times a week. And so, in a good way, we’re so integrated into people’s family traditions now, after all these years. People come back to town. In a really wonderful way that I’m very humbled to be able to talk about, it’s a big part of the town.

And in a good way, people who work here, they learn visioning. They learn servant leadership. They learn self-management. And then they’re on the school board. They’re on a committee at their church or their synagogue or their mosque. They’re contributing to community effort. So there are all of these things that are happening that are kind of secondary to the actual work of the business. But the reality of the ecosystem is it’s spread far beyond what it means to have a “job.”

Loren Feldman:
So Ari, if I heard you correctly, you read a book, you heard about a company that did this 100 years ago in the UK. What made you think you could do it? How’d you take the next step?

Ari Weinzweig:
What made me think I could do it? I guess when I have a good feeling about something, I’m not always right, but often there’s something to it. And I just do what I have typically done with so many things: start talking to other people who I respect about it. And with this one, I actually got a lot of naysaying, because it really hadn’t been done much in the U.S., and there was a lot of: “That’ll never work.” “Why would you do that?” “You’re giving away the company.” “It doesn’t make sense.” “Why wouldn’t you sell it to the existing partners?”

Loren Feldman:
Who is this coming from, Ari, who’s the skepticism coming from?

Ari Weinzweig:
Many people.

Loren Feldman:
Business owners? Partners? Employees?

Ari Weinzweig:
Yeah. All of the above. Not from everybody. And I understand it. I mean, it was a different model. It goes against commonly-held values about maximizing your value and getting your money out after decades of hard work. And in a way, it goes against the entrepreneurial mindset that we’re gonna sell it to our existing partners, and in 30 years, they’re gonna flip it for a lot of money. And it goes against the common value of extraction that, to Brad’s point, we wouldn’t just turn around after 40 years of hard work and sell it and move to Florida or whatever, with all the new money that we got. So we’re basically gifting the organization to itself, but we feel good about it. And we’re able to get paid out and make a living over time. And everybody, hopefully, can come out ahead.

But anyway, over time, I just kept asking—like, that’s what I do. I don’t force it, but I don’t give up on it, either. And Maggie from ZingTrain—Mag Bayless, one of the partners at ZingTrain—was one of the people who thought it was a good idea. And one day, I don’t know, three years ago, she called me, and she said, “Hey, I found this guy, and I think he knows something about this program who you could talk to.” So he was a guy who had worked for Organic Valley, and I called him, and he said, “Well, I’m not really the expert, but there’s this place in Oregon. Organically Grown is a large organic produce wholesaler. And they have done this, and they know about it.”

And so I called the woman who was the CEO at the time, who has since moved on, and we had a good talk, partly about why ESOPs don’t work, and then about why this can work. And then they had basically spun out a small subset of a couple of folks who were very passionate about this type of program who, essentially, I describe it as: They were like ZingTrain, but for perpetual purpose trusts. And so we worked with them, Alternative Ownership Advisors, over about two years. So they guided us on doing this work.

Loren Feldman:
Before I ask Brad to explain how he landed on this as well, Ari, I understand there are a lot of concepts involved here and a lot of a lot of goals. But any owner thinking about this is also naturally going to think, “What do I get from my many years of work?” And I just want to make sure we’re clear. It sounds like you’re not getting a payday at all. This is a gift. Am I understanding this?

Ari Weinzweig:
Well, it can be done in any way you design it within the legal construct of it. Paul, and I will get paid our salaries for a while. I don’t know what we agreed on, 20 years or whatever, so that we can keep living. I mean, I think that the idea of this is that it can be done in a way that allows the founders or owners to exit with grace and do perfectly fine. Yes, it is giving up the chance to turn around and sell 40 years of Zingerman’s for a lot more money than we’re going to get the way that we’re going to get it.

Brad Herrmann:
And that’s where ours is gonna look different. It is going to use the profits, so I mean, essentially it is giving away, at the end of the day, but they are going to use future profits to pay off a loan to founders. So there is an evaluation, there is a loan, and it is going to get paid off. But we do get a lot of flexibility as to how that happens as well. And I suppose you could involve a bank, if you want, as well. There certainly is a lot of flexibility in how this is executed. You also could just write it in your will that when you die, it goes into a trust as well. And you get paid nothing, and here it is. So lots of different ways that it can be done.

Loren Feldman:
All right, Brad. How did you wind up discovering perpetual purpose trusts and deciding that that was the right option for you guys?

Brad Herrmann:
Well, I think that the genesis of it is that my business partner—Ari and I, both, by the way, are incredibly fortunate to have business partners who have become a part of our person. And I think that’s a key part, too. This whole conversation has to happen with aligned business partners. Otherwise, it’s going to be really difficult for anybody. But it started when my business partner Hai [Nguyen] and I were at a company that was acquired, and we stayed four years after it was acquired. And we didn’t like it four years later. It’s really that simple.

At the time, we mistakenly thought that we can’t work for big companies. What we’ve learned since then is that we actually just don’t do, I’ll just say, “shitty culture.” And so when we started the company, we didn’t know a whole lot. And we were certainly aligned at that level. Like, we want to build the kind of place that we want to work [at]. And right or wrong, that was one experience, but it shaped us and it solidified us on what we wanted to do. So we continue with that today. Like, when we get done with this thing, I don’t want other people to have the experience that I had. I mean, it wasn’t terrible. I mean, come on. I just didn’t like it. I wanted to do something else.

And we feel like we’ve built something that people really enjoy coming to, a place that people really enjoy working [at]. And it has a positive impact on them and their families and everybody else who we work with. And we think that’s worth preserving. So we have the big, hairy, audacious goal of being a 100-year-old software company. Now, most software-as-a-service companies, the goal is to have the giant payday. I don’t know, like Ari, we are more than comfortable on the path less traveled. And we want to see if this thing can outlive us and last 100 years. So that inevitably starts you on the, “All right, well, how do we do this?”

Employees owning it, to us, feels like capitalism at its best, right? People getting to think, act, and feel like entrepreneurs and keeping that entrepreneurial spirit because they get to participate more than they might normally in the fruits of their labor. And I think that’s awesome. And I think it’s maybe a remedy or an alternative to capitalism as the bad guy that I had probably programmed in my brain as a young lad in business school.

Loren Feldman:
They taught you that in business school?

Brad Herrmann:
Well, you know, “Maximize shareholder return.” I think that was programmed into our brains. And I think that there’s something to be said for, “You know what? Maybe that’s off. And maybe a business does have responsibilities beyond just maximizing return for their shareholders.” But as I alluded to, I’m not getting paid nothing. We have a profitable company. I live a wonderful, spoiled-rotten life already. And we’re not going to get nothing as we transition to this trust. We’ve put a value on it and set a formula and roll.

But the way we got the trust, though, is we looked at ESOPs. You know, it feels like it’s been 10 years; it’s probably been four. We’ve gotten to know a ton of ESOPs and asked a lot of questions about those very good friends and values-driven companies. We also explored what I call do-it-yourself employee ownership.

Loren Feldman:
Explain that.

Brad Herrmann:
There are a few folks—one who’s been super helpful is Carl Erickson at Atomic Objects in Grand Rapids, Michigan. We went up there to sit down with him and his team and say, “Tell us about this.” And essentially, he’s slowly selling the company to his employees and bringing them into the fold as partners in the S-Corp.

Okay, great. But there are a couple of things that didn’t didn’t quite work for us on that. Number one, it’s gonna cap you at 200 participants. We had some H1B non-citizens who wouldn’t have been able to participate. And it really lends itself to a more sophisticated employee. It’s going to complicate your taxes. You’re gonna be getting K-1s. You know, there’s no more 1040EZ once you go down this road.

So those are the reasons that we didn’t go for do-it-yourself employee ownership, despite it being our preferred option at the time. We ended up going down the ESOP route in the absence of better options, believe it or not. But we ended up pulling the ripcord on it about a week before we signed all the papers. It wasn’t going to work the way we wanted, and I probably, honestly, should have pulled the ripcord a lot sooner, but that’s my fault. And we spent a lot of time and money.

Loren Feldman:
Explain what happened. It must have been pretty intense to make a decision like that at the last minute.

Brad Herrmann:
Well, it starts with incompetent advisers. Being honest, they probably could have nipped this in the bud sooner for us, or said, “It doesn’t work the way you think it does.” But that kind of opens it up, and I’m sure there’s plenty written about what folks don’t care for with ESOPs.

For starters, they are complicated as all get out. I mean, I was laughing earlier. “Learner” is on my top five on StrengthsFinder, so I’m not afraid to dig into complicated things. I think I’m a pretty sharp guy, and five months into an ESOP, I was perpetually overwhelmed with complexities and having to have things explained to me over and over again. Not because I couldn’t get it, but because there’s 57 million different ways to do it.

And I think there certainly is a contingent of folks who think ESOPs are almost intentionally complicated. You’re not going to put an ESOP in without an army of advisers on the financial side, the trustee side, etc. I mean, it’s certainly an industry, in and of itself. The other thing we didn’t like is they’re inflexible. Like, if you make a mistake when you do it, it is incredibly difficult to unwind. Because the Department of Labor is your boss. And they’re going to think you’re trying to take advantage of employees. Or the trustee’s going to fight for the employees. So anyways, I feel like I’m rambling on a little bit over there.

Loren Feldman:
No, no, no, not at all. I would hasten to add, I’m sure all three of us know lots of owners who chose the ESOP route and are glad they did. I know a lot of people who are… They promote it with religious fervor.

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