Taylor Guitars converts to 100 percent employee ownership with unique finance partner
by Karen Kahn
On January 11, 2021, in a video for employees, Taylor Guitars announced that it had transitioned to 100 percent employee ownership. An agreement that could be called the NAFTA of employee ownership, it is majority funded by Canada’s Healthcare of Ontario Pension Plan, with additional capital from Social Capital Partners, and establishes the first US-based Employee Stock Ownership Plan (ESOP) for Mexican workers.
Founded in 1974 by Bob Taylor and Kurt Listug, Taylor Guitars today is a global leader in guitar manufacturing. A company with $122 million in revenue, with some 1,200 employees in Southern California and over the border in Mexico, the guitar manufacturer has been planning and preparing to transition to an ESOP since 2013. The original plan—to start preparing for the transition in early 2020—was put on hold because of COVID-19, but as it turns out people wanted guitars during the lockdown. After a good year of sales, the company’s owners decided it was time.
The deal is funded by Canada’s Healthcare of Ontario Pension Plan and Social Capital Partners and establishes the first US-based ESOP for Mexican workers.
Ted Margarit of Chartwell Financial Advisory shepherded the deal and worked with owners Taylor and Listug to ensure a strong management team was in place to support the transition. Says Margarit, “ESOPs aren’t for everybody, and leadership is key.” Leading up to the ESOP, in 2019 Taylor and Listug brought master guitar designer Andy Power on as a third partner, seeing his work as vital to the firm’s future, and expanded the leadership team to eight. Explains Listug, “Strengthening our leadership team has been essential to our succession planning.”
In their video announcement, Taylor and Listug explained to their employees why they chose to sell the firm to them:
Who will be the best people to guide it forward into the future? Who will keep our company true to our values and maintain the culture we love? While Bob and I still have many good years left to dedicate to the company, we wanted to make sure we put the company in the best possible position for future success, to give it the best chance to be around for the next 100 or maybe even 200 years.
Taylor Guitars could have sold to private equity, like its competitor Gibson, which is now owned by KKR, but that type of deal would have left the future of the company in outside hands. The ESOP deal, by contrast, required more forethought and creativity but ensured the culture and values Taylor and Listug had cultivated over nearly 50 years would continue into the future.
The Taylor Guitars conversion is the first time that a pension fund—US or Canadian—has ever invested in an ESOP transition.
According to Margarit, finding the right financing partner was crucial to the transition. Taylor and Listug didn’t want to hamstring future growth by carrying too much debt, nor did they want to lose the flexibility that has allowed the firm to prosper. After exploring traditional financing options, Margarit turned to Jon Shell at Social Capital Partners (SCP), a Canadian nonprofit that innovates solutions to wealth and income inequality. The two had met a couple of years ago at an ESOP forum in Salt Lake City. Shell was looking to demonstrate the viability of large institutional investments in ESOP transitions. He saw ESOPs as an opportunity for an investor to meet their financial needs while also having a significant social impact by generating wealth for workers.
Margarit was confident that the Taylor Guitar deal would be the perfect vehicle for SCP to demonstrate the viability of using institutional capital to spark more transitions to employee ownership. He reached out to Shell in 2019. SCP in turn had been discussing employee ownership financing with the Healthcare of Ontario Pension Plan (HOOPP), interesting its investment team in the value and efficacy of a direct investment in an ESOP conversion. HOOPP became a partner in a deal that also includes a long-term, junior loan from the current owners.
Says Margarit, HOOPP met with Taylor and Listug, and it was clear that there was a real values match. In turn, HOOPP, which is a $100 billion pension fund, could offer capital at the scale that was needed and with the kind of flexibility Taylor Guitars desired. Rather than a five-year horizon that would be typical for a loan of this type, HOOPP offered a 10-year horizon, with no principal payments during the life of the loan. Moreover, if Taylor Guitars needs cash for future expansion, it has the flexibility to skip interest payments altogether. As Margarit explained, “This deal will never put the company at risk.”
Simultaneously, for HOOPP, this is a low-risk investment, explains Shell. The multi-million dollar loan is secured against the value of the firm, and the leadership team which has built an influential and profitable firm will continue to lead. An added benefit is the tax advantages for the ESOP, which will free up more cash to invest in the firm’s future.
The Taylor Guitars conversion is the first time that a pension fund—US or Canadian—has ever invested in an ESOP transition. When asked why HOOPP was interested in the deal, Shell explained, “The money that an ESOP needs is a pretty perfect match for institutional capital, whether from a pension fund or a foundation. For HOOPP this deal is a good investment that is at the scale they need, over a relatively long time horizon, and offers a rate of return that meets the needs of their pensioners.” At the same time, says Shell, “HOOPP loved the added social benefit. The ESOP will generate considerable wealth for Taylor Guitar’s employees.”
So why did HOOPP choose to make its investment in the US, and why aren’t US pension funds doing the same? First off, Canada makes employee ownership really hard to do—something Social Capital Partners is working to rectify. As for US pension funds, there remain some barriers to this type of investment, but they are not insurmountable. According to Margarit, Canadian pension funds have been in the forefront of direct investing for about ten years. The US doesn’t have a lot of pension funds at the same scale, and these funds aren’t equipped in many cases to make direct investments. They make their investments through the private equity asset management world.”
Fortunately for US pension managers, new private-equity funds focused on employee ownership transitions are growing in number. These vehicles could provide a perfect opportunity to bring institutional capital into the arena and spark a new wave of employee ownership transitions.
These are low-risk, long-term investments that have real social impact and a commercial return,” explains Shell. “US foundations concerned with wealth inequality could be doing this, too.”
At the same time, says Shell, foundations should be making investments out of their core endowments similar to the investment HOOPP just made. “These are low-risk, long-term investments that have real social impact and a commercial return,” explains Shell. “US foundations concerned with wealth inequality have the opportunity now; they can and should ensure that the thousands of baby boomer business owners nearing retirement have access to the capital they need to transition to employee ownership rather than selling to private equity or competitors.”
Emphasizing the urgency of the moment, Shell continued, “If a pension fund, which is required to achieve commercial returns, can do this, there should be a flood of foundation endowment money going into ESOP lending. If they don’t take a serious look at this, you would have to wonder, why?”
It’s a win-win, says Shell, a concrete way to address wealth inequality while still getting a strong risk-adjusted return. Certainly, due to the foresight of the HOOPP, over 1,200 workers who make Taylor guitars now have a more secure financial future.
Karen Kahn is a communications consultant and the editor of Employee Ownership News.