Small business owners are facing catastrophically bad choices these days, with half predicting they will be forced to close as a result of the COVID-19 economic crisis. Meanwhile, nearly 40 million workers have lost jobs and are struggling to get by, as evidenced by miles long lines at food banks and a brewing eviction crisis. Impact investors and other capital providers could be the agents who help square this circle – stepping in to turn the misfortune that has overtaken the old economy into a new era of shared prosperity.
Rather than standing by as a wave of corporate buyouts and consolidations undermine local economies and further exacerbate wealth inequality, social impact investors could become the agents of a sweeping economic transformation anchored in broad-based employee ownership. They could turn the current moment from crisis to opportunity, by ensuring that workers are positioned to receive a fair share of the wealth they help create and that Main Street economies continue to be anchored by locally owned enterprises.
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Even before COVID-19, foundations and other impact investors had begun to seed a handful of new employee ownership investment funds designed to test the theory that taking employee ownership to scale could begin to address the growing wealth gap in the U.S. Proposals to use federal policy to advance employee ownership have also been gaining steam: for example, the Main Street Employee Ownership Act, called “the most significant employee-ownership legislation in two decades,” became law in the summer of 2018, increasing access to capital in the form of federally backed financing. And while we heartily endorse this trend, here’s the caveat we would add: capital investments must be done right. To prevent this from becoming simply another opportunity for maximum capital extraction, proper guardrails and protections that ensure worker benefit are needed.
Those protections — in practical detail — are outlined in the new “Guidelines for Equitable Employee Ownership Transactions.” These guidelines embody the insights of a working group of employee ownership and impact investing experts we at Soros Fund Management (SFM) and The Democracy Collaborative convened with our colleagues at The Open Society Foundations. SFM, a family office, helped lead this work out of our own interest in piloting these guidelines. Now, other groups investing in employee ownership conversions have agreed to pilot them, and our hope is more will join.
Capital influx
Philanthropy is helping to prove the efficacy of a new class of investments. The Kendeda Fund, W.K. Kellogg Foundation, and the New World Foundation, among others, have been active in promoting research, education, and investment to scale employee ownership. In the summer of 2019, the Kendeda Fund provided $24 million in grants to four organizations on the forefront of building worker-owned economy: The Fund for Employee Ownership, The ICA Group, Nexus Community Partners, and Project Equity. The largest portion of these funds was used to seed investment funds intended to finance the sale of businesses to employees.
The Fund for Employee Ownership (TFEO), an initiative of Cleveland’s Evergreen Cooperatives, completed its first deal in February 2020, buying a controlling interest in Berry Insulation on behalf of a new worker-owned cooperative. TFEO in part modeled its strategy on evidence from private equity firm Mosaic Capital Partners that investor capital could accelerate employee ownership transitions.
Mosaic, the first private equity firm to build a strategy entirely around exiting to ESOPs, raised $165 million for its first investment fund and earned market rate returns for its investors. Along the way, the firm saw its investments were also having deep social impact: the portfolio’s focus on rural manufacturing firms was saving jobs and bringing economic stability to distressed communities.
“We’ve possibly impacted nearly 2,000 people, many of them low-income employees, primarily with rural ties,” explained managing partner Keith Butcher in the Daily Yonder. “As ESOP participants, they may end up with three times their annual salary in wealth.”
Today, Mosaic is leaning into social impact by piloting the “Guidelines for Equitable Employee Ownership Transactions.” Adopting the guidelines codifies their commitment, which has helped win the trust from impact investors. Priya Parrish, managing partner at Impact Engine, makes strategic investments in catalytic impact funds and considers Mosaic’s approach to employee ownership buyouts an important paradigm shift for the impact investors.
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Another group considering piloting the guidelines is the Main Street Phoenix Project, co-founded by Colorado law firm Jason Wiener|p.c. with partners in the employee ownership finance and restaurant industries, to address the small-business crisis in the wake of COVID-19. The group has created a cooperatively owned holding company, which is raising capital to acquire distressed restaurants that will be relaunched as employee-owned businesses. The plan is to acquire ten restaurants in the coming year, helping them become resilient through shared back office services via the central holding company.
These capital investments are crucial to scale employee ownership. But an influx of capital can lead to unintended consequences, pulling enterprises away from social impact, as happened with microlending. Too often, ESOP transactions have focused more on benefits to the seller, rather than benefits to workers. Deals that maximize profits for investors could unduly saddle firms with excess debt and limit opportunities for workers to build future wealth. The “Guidelines for Equitable Employee Ownership Transactions,” developed through a field-wide process, are designed to counter this tendency.
Impact of employee ownership
There is no shortage of evidence that the U.S. economy is not working for the vast majority of working families. As a recent United Nations report lays out, the consolidation of wealth in the hands of the top 1 percent has been undermining our democratic institutions and the American middle class for some time. Before the current crisis, 40 percent of the U.S. population reported they did not have $400 to spend in an emergency. Black and brown families, since the Great Recession, have seen their net worth decline to nearly zero. The wealth of typical white families is more than 10 times that of Black families, and 8 times of Latinx families, evidence of the persistent structural racism that has led to the largest series of street demonstrations our country has ever seen.
Shareholder capitalism has persistently increased these inequities, driving down wages and the quality of jobs as executives have prioritized short-term profits over long-term growth. Which begs the question: how can capital be mobilized to build an economic system that has different outcomes, outcomes that are more equitable for all?
In her recent white paper, The Case for Employee Ownership, Hilary Abell, co-director of Project Equity, lays out the growing body of evidence that broad-based employee ownership offers an alternative business model that positively impacts firms, employees, and local communities.
Business performance: In comparing hundreds of companies that transitioned to Employee Stock Ownership Plans (ESOPs, the most common form of employee ownership in the U.S.), the National Center for Employee Ownership found that after becoming ESOPs, firms saw sales, employment and productivity grow more than 2 percent faster per year than otherwise would have been expected. Other studies confirm similar increases in productivity at worker-owned cooperatives.
Workers: Employee ownership enhances job security by reducing layoffs, improving wages and benefits, and significantly increasing wealth building opportunities. Through profit-sharing and share ownership, workers are able to build long-term economic security. According to the Rutgers Institute for the Study of Employee Ownership and Profit Sharing, the average ESOP account in 2018 was valued at $134,000—a significant nest egg considering most Americans have no retirement savings at all. For workers with less than $30,000 annual income, the research shows that employee-owners have 17 percent greater median household net worth than their peers. For workers of color participating in ESOPs, their retirement savings accounts are literally hundreds of times larger than that of their non-owner peers.
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Communities: As locally owned enterprises, employee-owned businesses are engines of community wealth building. When residents have better jobs and the ability to grow wealth, they pay more taxes and are less dependent on government funds. A 2010 study estimated that employee ownership saved the government $37 billion in the year following the financial crisis.
Regardless of the industry target, “employee ownership is an impact investment,” says Todd Leverette, program manager of Legacy Business Initiatives for the Democracy at Work Institute. “It doesn’t matter if you invest in a lawn service or a trash hauling business or a small manufacturer, the investment will be transformative for the firm’s employees and the communities in which they live.”
It is also likely to offer a reasonable return without excessive risk, based on the long-term stability and greater productivity associated with employee ownership.
Structuring deals
Employee buyouts can be opaque to newcomers. To help guide investors, asset managers, and professional advisors in structuring deals that maximize positive impact for employees, the guidelines identify five goals for employee ownership transactions:
- Design equitable deal structures: Balance the interests of sellers, investors, and employee owners by setting a fair price and ensuring the deal is structured to sustain employee ownership for the long run. Importantly, this means ensuring investors don’t leave the firm over-leveraged with debt upon exit.
- Embed broad-based ownership and support employee participation: Create substantial—at least 30 percent—employee ownership and ensure it reaches throughout the organization, from executives to front-line employees. Then build a participatory culture by sharing information and supporting employees in developing financial and business skills.
- Promote quality jobs and working conditions: Improve job quality by ensuring that every employee earns a living wage, has access to meaningful benefits, works in a safe environment, and is supported to grow professionally.
- Consider prioritizing deals that impact marginalized communities and workers: Whenever possible, look for firms where employee ownership would benefit low-wage workers, people of color, women, immigrants, or others without meaningful access to good jobs or asset ownership.
- Measure and report on employee impact: Establish goals and metrics to measure outcomes for employees alongside company and investor performance—and then report progress to a wide group of stakeholders.
In each stage of a deal, from sourcing and selection through closing and post-transaction operations, these goals require making choices that balance stakeholder interests and, at exit, leave employees with a profitable and healthy company. Investors can still do well, but the fair process outlined here means employees will also do well. And that’s key, says Parish, who made the decision to invest in Mosaic:
“Mosaic’s commitment to the Guidelines says to me that the firm is truly focused on social impact, and that the going-forward team will prioritize employee engagement and building a strong employee-ownership culture, factors that have been shown to drive long-term success.”
Jessica Rose is the chief financial officer and director of employee ownership programs at The Democracy Collaborative. Hilary Irby heads impact strategy at Soros Fund Management.
