A handful of employee ownership funds are raising larger pools of capital to compete with private equity and strategic buyers for the millions of US businesses that retiring baby boomers are poised to sell.
“This is one of the strategies that works for changing the equation for workers and families around their financial well being,” said Alison Lingane of Ownership Capital Lab, which has produced the Employee Ownership Capital Roadmap, a market-making framework for scaling employee ownership through capital markets. “This is one of the few strategies that we know works and is ready to be scaled.”
Scaling employee ownership in the M&A market first requires making the business case for an “exit to workers” to the investment bankers and other intermediaries who often shape which buyers get a seat at the table. Structures like employee stock ownership plans, or ESOPs, confer generous tax benefits.
“What we’re trying to do is to get to the traditional M&A markets and educate investment banks and other intermediaries who don’t currently understand or offer ESOPs on why this is so great,” says Katie Kimble, who brought experience from private equity and investment banking to this year’s launch of Monarch Investment Partners with co-founder Michael McGinley.
Many M&A advisors, bankers and other gatekeepers of the growing pipeline of business buyout opportunities have heard of an ESOP, “but don’t necessarily understand how they can play a role,” Kimble told ImpactAlpha. “They can now have another option to provide to sellers. ‘Hey, here’s the full range of how you could think about an exit.’”
Monarch is seeking up to $250 million for an inaugural fund that will provide up to 100% of a seller’s financing to facilitate up to 10 employee-led ESOP buyouts. The Chicago-based fund is betting that if M&A brokers start to view ESOPs as a profitable opportunity, employee ownership can move from a niche option into the mainstream.
“We like the idea that a seller can get a fair market value for their business from an ESOP and that it doesn’t have to be a diminished buyer,” McGinley says. “There’s also the potential for a tax-advantaged sale to an ESOP in which the net proceeds to a seller could actually be higher.”
Seller’s notes
Monarch is among a growing cohort of private credit employee-led buyout strategies that are raising capital to bridge seller liquidity gaps in ESOPs. That means bringing flexible financing to the negotiation table to help retiring sellers finance their exit. Due to a lack of seller liquidity solutions, only about 250 new ESOPs are formed annually, representing a small share of the tens of thousands of businesses that are sold in the US each year.
Brendan Richardson, who refers to himself as a “recovering venture capitalist,” last year launched Liquidus Partners with impact investor Geoff Woolley to raise a $300 million fund for acquiring seller notes from ESOP transactions. The thesis is that if sellers see a way to redeem their notes, more will be willing to participate in the process of transitioning ownership to their employees.
Apis & Heritage Capital Partners since 2021 has financed seller notes in half a dozen employee-led buyouts to create hundreds of worker-owners. The Washington, DC-based firm raised over $180 million this year towards a $250 million target for its second fund, which aims to create 3,000 worker-owners over five years (see, “Apis & Heritage aims to help business owners ‘exit responsibly’ — to their employees”).
The intent of Monarch, Liquidus and Apis & Heritage is to help potential worker-owners compete more favorably with private equity buyers that often are able to offer more cash at closing. Private equity buyers with larger upfront cash offers appeal not only to sellers, but also to brokers whose incentives are aligned with higher-value, fee-driven M&A deals.
To incentivize the brokers and intermediaries, Monarch is working with several investment bankers to come up with a model where they get compensated based on the highest offer they receive from the market, as long as they sell to an ESOP. Through that strategy, McGinley hopes they will take another look at the full value of such employee ownership exits, including the considerable tax advantages.
“We want to create a win-win scenario, where they’re incentivized to show this option and that they can get proceeds at closing commensurate with third-party offers,” McGinley says, “and actually net more because of the tax savings, and do some good for their employees and their communities at the same time.”
Roadmap to $10 billion
The new employee ownership capital roadmap by the Ownership Capital Lab suggests now is the time to scale employee ownership. Businesses owned by their workers have had a 50-year track record of boosting productivity and financial performance, showing economic resilience and creating wealth for working families.
The roadmap charts the growth of employee ownership as both an investment thesis and a marketplace, and the rapid growth of dedicated EO funds. The Ownership Capital Lab counts 23 employee ownership funds, among them Liquidus, A&H and Monarch, that are raising a combined $979 million to create in coming years new worker-owners through ESOPs, employee ownership trusts, or EOTs, and worker-owned cooperatives.
The funds’ managers say that employee-led buyouts can deliver competitive returns and fit within traditional deal structures, a prerequisite for winning over institutional investors.
“What we’re discussing with our potential limited partners is delivering to them a 10-12% net IRR, which is competitive with private credit returns — and we can do better than that,” says Liquidus’ Richardson, who is looking towards his institutional network to raise a $300 million fund. “These are insurance companies, pension funds, deep-pocketed families, hedge funds and high-net-worth individuals.”
Liquidus is looking to acquire up to 20 sellers’ notes in employee-owned businesses with between $2 million and $20 million in earnings before interest, taxes, depreciation and amortization, or EBITDA, a metric used to measure a company’s profitability. Richardson says the fund will write checks ranging from $5 million and $50 million to acquire each seller’s note.
Monarch is targeting businesses in the $5-$15 million EBITDA range. “We’re focusing on companies that are 100% owned by the ESOP, meaning 100% of the taxable equity shares are in the ESOP,” says Kimble.
Monarch plans to issue warrants to get a piece of the upside of the employee-owned companies. It plans to hold the warrants until the businesses generate enough cashflow to buy out Monarch.
“Our goal is to create 100% employee-owned businesses,” says McGinley. “And as they cash flow us out that they are sustainable well run stable, employee owned businesses that can perpetuate that ownership form forever.
