SENATE COMMITTEE ON GOVERNMENTAL ORGANIZATION

Senator Bill Dodd

Chair

2019 - 2020 Regular

Bill No: SB 553 Hearing Date: 4/9/2019

SUBJECT: Public contracts: bid preference: ESOPs

DIGEST: This bill would provide a 3% bid preference to a qualified Employee Stock Ownership Plan (ESOP) company, as defined.

ANALYSIS:

Existing law:

1. Governs, through the State Contract Act, state contracts for public works projects and generally requires that a contract be rewarded to the lowest responsible bidder.
2. Defines a “project” for purposes of the State Contract Act as, the erection, construction, alteration, repair, or improvement of any State-owned structure, building, road, or other State improvement of any kind with a total cost exceeding an amount periodically adjusted by the Director of Finance. The current amount is $291,000.
3. Defines “Department” for purposes of the State Contract Act to mean any of the following:
   1. The Department of Water Resources.
   2. The Department of Transportation.
   3. The Department of Parks and Recreation.
   4. The Department of Corrections and Rehabilitation.
   5. The Military Department.
   6. The High-Speed Rail Authority.
   7. The Department of General Services.
4. Grants, through the Small Business Procurement and Contract Act (Act), a preference for small businesses and microbusinesses in the award of a contract for goods, services, or information technology to the state and in the construction of state facilities.
5. Provides in solicitations where an award is to be made to the lowest responsible bidder, the preference to small businesses and microbusinesses shall be 5% of the lowest responsible bidder meeting specifications.
6. Permits a state agency and the California State University to award specified types of contracts with a value of between $5,000 and $250,000 to a certified small business, including a microbusiness and a disabled veteran business enterprise (DVBE), without complying with certain competitive bidding requirements, provided the agency obtains price quotations from at least two small businesses, including microbusinesses, or two DVBEs, as defined.
7. Establishes the Office of Small Business and Disabled Veteran Business Enterprise Services and prescribes duties for the office, which include maintaining a bidders list of small businesses and disabled veteran businesses and identifying which small businesses also qualify as microbusinesses.
8. Defines a “small business” to mean an independently owned and operated business that is not dominant in its field of operation, the principal office of which is located in California, the officers of which are domiciled in California, and which, together with affiliates, has 100 or fewer employees, and average annual gross receipts of $10 million or less over the previous three years, or is a manufacturer, as defined, and has 100 or fewer employees. It should be noted that the Director of the Department of General Services (DGS) is currently allowed to adjust the average gross receipts to reflect changes in the Consumer Price Index (CPI). As such, the average annual gross receipts average is currently at $15 million or less over the previous three years.
9. Defines “microbusiness” as a small business which, together with affiliates, has average annual gross receipts of $2.5 million or less over the previous three years, or is a manufacturer, as defined, with 25 or fewer employees.
10. Defines a “disabled veteran business enterprise” to mean an enterprise that is at least 51% owned by one or more disabled veterans and the daily business operations are managed and controlled by one or more disabled veterans. For certification purposes, a “disabled veteran” is a veteran of the U.S. military, naval, or air service who resides in California and has a service-connected disability of at least 10% or more.
11. Requires a contractor requesting a small business or microbusiness preference to do so under penalty of perjury.

This bill:

1. Requires an entity awarding a contract pursuant to the State Contracts Act to provide a 3% bid preference to a qualified ESOP bidder. This preference shall be calculated by reducing the bid by 3% of the amount of the lowest responsible bid for purposes of comparing the bid with competing bids.
2. Defines a “qualified ESOP bidder” to mean an ESOP or an S corporation ESOP that is 100% owned and operated by employee owners and demonstrates current compliance with applicable Internal Revenue Service (IRS) regulation for ESOPs.

Background

Purpose of the bill. According to the author’s office, “anywhere between 57-63% of California’s private sector employees work for an employer that does not offer a retirement plan. The employee owners of ESOP companies work diligently toward the success of their companies to achieve a more secure retirement that many California workers currently have access to. To increase secure retirement opportunities to more California private sector workers, SB 553 would require a state agency awarding public works contract to provide 3% bid preference to ESOP bidders if they are 100% owned and operated by employee owners.”

The author’s office further states that, “this legislation would incentivize more companies to become 100% employee owned, providing more Californians with corporate ownership opportunity and a greatly enhanced pathway to retirement security.”

Employee stock ownership plan. Put simply, an ESOP is a retirement plan, in some ways similar to and governed by the same laws and regulations as a 401k plan, which provides a company’s workforce with an ownership interest in the company. To establish an ESOP, a firm forms a trust that purchases the shares of a company from the owner and allocates the shares to employees as part of their compensation. ESOP shares are part of an employee’s remuneration for work performed. Shares are allocated to employees and may be held in an ESOP trust until the employee retires or leaves the company. Once the employee retires or leaves the company, the shares are then either bought back by the company for redistribution or voided.

Most private US companies operating as an ESOP are structured as S Corporations. S Corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. According to the IRS, to qualify for S corporation status, the corporation must meet a number of requirements, including being a domestic corporation and have no more than 100 shareholders.

Supporters of ESOP companies, argue that these types of companies increase production and profitability and improve employees’ dedication and sense of ownership. Critics of ESOP argue that ESOPs concentrate a worker’s retirement savings in the stock of a single company, which is contrary to the central principle of modern investment theory which is that investors should diversify their investments across many companies, industries, etc.

According to the author, there are more than 3,000 S Corp ESOPs that employ 470,000 workers in the United States and nearly 800 are California companies. It is unclear how many of these 3,000 companies are 100% owned by employee owners and thus qualify for the 3% bid preference under this bill. It should be noted that this bill does not require the principal office of the ESOP to be located in California; a requirement that is required for companies that are eligible for the 5% small business bid preference. Furthermore, it’s unclear how many of the ESOPs would currently qualify for the 5% small business bid preference.

Small Business Procurement and Contract Act. The Small Business Procurement and Contract Act (Act) was enacted in 1973 to establish a small business preference within the state’s procurement process and help small businesses be more competitive in the bid process. The definition of a small business in California includes any business that has 100 or fewer employees and average annual gross receipts of $15 million or less over the previous three years. The goal is to increase the number of contracts between the state and small businesses. The Act states that it is the policy of the State of California to aid the interests of small businesses in order to preserve free competitive enterprise and to ensure that a fair portion of the total purchases and contracts of the state are awarded to these types of businesses.

Upon meeting eligibility requirements, which includes the requirement that the principal office be located in California, certified small businesses and micro- businesses are entitled to a 5% bid preference on applicable state solicitations. Certified small businesses and microbusinesses are eligible for the state’s Small Business Participation Program. The program sets a goal for the use of small businesses in at least 25% of the state’s overall annual contract dollars.

Current bid preferences and possible impact. Current law provides for various bid preferences for businesses that contract with the state. The most widely used are the small business bid preference, which provides a 5% bid preference to small businesses. There is also the DVBE preference, which ranges from 1% to 5% at the state agency’s option, as well as the Target Area Contract Preference and the Recycled Tire preference, which again ranges from 1% to 5%. According to DGS, the small business bid preference is the most widely used incentive.

If this bill goes into effect, it could affect the ability of small businesses and DBVEs to contract with the state because of competition from ESOP companies. For instance, when comparing small businesses to ESOPs, a small business would no longer enjoy the 5% bid preference but rather a smaller 2% bid preference. This 2% bid preference would result after subtracting the 3% ESOP bid preference from the 5% small business bid preference.

It should also be noted that under this bill, every ESOP would qualify for the 3% bid preference regardless of how many individuals the company employs and regardless of the company’s gross revenue. In comparison, under the current 5% small business bid preference, small business is defined as a company that has 100 or less employees and average annual gross receipts of $15 million or less over the previous three years. This could make it difficult for small businesses to compete with large companies for state contracts.

Finally, the bill would increase state costs, as the state would in essence be providing a 3% discount to ESOP companies. While this occurs with all other bid preferences, it’s unclear if the benefits provided by ESOP companies outweigh those concerns.

Prior/Related Legislation

AB 1080 (Gonzalez Fletcher, 2018) would have required a state agency awarding specified contracts to provide a 5% bid preference to that portion of the total bid performed by a bidder or subcontractor if its employees, during the time that they were employed, were covered by credible, health care coverage, as defined, during the 12-month period immediately preceding submission of the bid. (Vetoed by Governor Brown)

SB 605 (Galgiani, Chapter 673, Statutes of 2017) revised the definition of “small business” and “microbusiness” for purposes of the Act by increasing the dollar amount threshold for a small business to $15 million and for a microbusiness to $5 million and requires those dollar amounts to be adjusted to reflect changes in the CPI biennially.

AB 1068 (Gonzalez-Fletcher, 2017) would have established a pilot program requiring the Prison Industry Authority to contract with a private employer that employs ex-felons to provide goods to the Department of Corrections and Rehabilitation or other state agencies. The private employer would be provided bid preferences, as specified when bidding for a procurement contract with a state agency or department. (Vetoed by Governor Brown)

SB 1176 (Galgiani, 2016) would have revised the definition of “small business” and “microbusiness” for purposes of the Act by increasing the dollar amount threshold for a small business to $15 million and for a microbusiness to $5 million and requires those dollar amounts to be adjusted to reflect changes in the CPI. In addition, the bill would have revised the definition of small business by specifying that, for the purposes of public works contracts, a small business means a business with 200 or fewer employees and average annual gross receipts of $25 million or less over the previous three years. (Vetoed by Governor Brown)

SB 1219 (Hancock, 2016) would have included “employment social enterprise,” which are businesses that provide jobs for individuals who have experienced significant barriers to employment, within the Act for the purpose of allowing them to participate in state contracting bid preferences provided to certified small business enterprises. (Vetoed by Governor Brown)

FISCAL EFFECT: Appropriation: No Fiscal Com.: Yes Local: No

SUPPORT:

Employee-Owned Contractor Roundtable

Pavement Recycling Systems

OPPOSITION:

Associated General Contractors

ARGUMENTS IN SUPPORT: According to the Employee-Owned Contractor Roundtable, “study after study has shown that companies which are principally owned through an ESOP, consistently report better job growth, fewer job reductions during economic downturns, disproportionately higher employee retirement savings, narrower wealth gaps between workers and management, and strong resistance to foreign acquisition. All of these benefits stem from the inherent dynamics that arise when employees have a real stake in the business they contribute to on a daily basis. We believe that passage and implementation of this bill’s provisions would further incent California businesses to adopt the ESOP-business model in order to provide timely and quality services to consumers while simultaneously improving employment security, wages, and retirement benefits.”

ARGUMENTS IN OPPOSITION: According to the Associated General Contractors, “bid preferences, by their very nature, create an uneven playing field for contractors who bid on public works projects. Under state law, the prime contractor must list the names of the subcontractors they plan on using when turning in their bid. Those subcontractors must be properly licensed, and under SB 553 would presumably also need to certify that they qualify for a ESOP bid preference. As such, SB 553 would complicate the bidding process by imposing a pre-condition of a bid preference to all parties involved on a public works bid. The public works bid process is intended to deliver projects at the lowest costs and higher value to the taxpayer in a fair and competitive manner.”