Employee ownership: Primed to scale

Generational shifts and policy developments mean that employee ownership structures are ready to become more common in private markets. Work needs to be done, however, to demonstrate how these relates to specific impact goals, according to panellists at Impact Investor Summit: North America.

“Due to the current silver tsunami, the ageing baby boomers, there are opportunities to support employee ownership transition,” Mission Driven Finance co-founder David Lynn said. “There are founders who want to exit. If we can help engineer that exit so that the employees become owners, whether partially or entirely, that’s phenomenal.”

Mission Driven Finance is a Californian social impact manager that provides commercial financing to small businesses, social enterprises, and non-profits. The firm is developing capital solutions that increase shared ownership opportunities, according to its website.

Though by no means mainstream, some private markets firms have been exploring more equitable ownership strategies in recent years. Ownership Works, an initiative founded by KKR’s Peter Stavros to facilitate equity participation among employees, was founded in 2021. Some of the most prominent buyout firms are now part of the network, including: Apollo, TPG, Warburg Pincus, Ares, KKR, Goldman Sachs, Silverlake, Altamont Capital Partners, Oak Hill and Capitol Meridian Partners.

There are a variety of different structures available to managers looking to adopt such strategies, including employee stock ownership plans (ESOPs), employee ownership trusts, perpetual purpose trusts and co-operatives. External financing can be provided through debt or equity; Mission Driven Finance frequently provides capital to support ownership transitions by lending to the company itself, rather than employees.

“There’s different structures, there’s different mechanisms in order to deploy that capital, but it all becomes a highly investable asset in a small business that, at the end of the day, rewards workers too,” Lynn said.

“The way we think about employee ownership is that it’s obviously great for [reducing] inequality and generating impact metrics, but it’s also great for generating outcomes,” explained Philip Reeves, founding partner of Apis & Heritage Capital Partners. “We find that, particularly in the service sector, when the largest line item in your profit and loss is labour, if you can get alignment between the front-line workers, the front office and the boardroom, that’s powerful.”

Apis & Heritage is a US mezzanine debt private equity fund. Through its employee-led buyout strategy, the firm finances the conversion of companies with substantial BIPOC workforces into 100 percent employee-owned businesses. Its first flagship fund closed on $58.1 million in 2022 following commitments from The Rockefeller Foundation’s Zero Gap Fund, The Ford Foundation and The Skoll Foundation, among others.

The firm uses an ESOP when changing the ownership of its companies, Reeves explained, as 100 percent ESOP-owned businesses do not pay federal or state tax in the US. As a result, “you have cash going out of the business that was going to the IRS that now we use to create value, one way or another”.

One of reasons that employee ownership has not gathered more momentum so far, according to Jack Moriarty, is that such transactions have not been able to offer enough liquidity. Moriarty is executive director at Lafayette Square Foundation, a US non-profit focused on using public policy to enable private capital to address inequality. Prior to that, he founded Ownership America, another non-profit.

According to Moriarty, firms such as Apis & Heritage are acting as an example to the wider market by providing liquidity comparable with conventional buyout strategies. “There’s a lot more sellers out there that would take this up if they could get liquidity on par with other exit options” he added.

At the legislative level, the Employee Equity Investment Act was introduced to the US Senate and House of Representatives earlier this year. If passed, the Act will utilise the Small Business Administration’s existing Small Business Investment Company (SBIC) programme to provide loan guarantees for investment funds focused on expanding employee ownership.

“We expect that once enacted, there will be asset managers that will find the resulting low-cost leverage attractive in financing ESOP buyouts while generating competitive risk-adjusted returns ” Moriarty said.

The impact angle

Some institutional investors look at ownership structures as a way to meet their racial and social equity goals, Lynn said. However, in practice it is difficult to know at the outset what benefits changing ownership will have .

“How many [BIPOC] employees do they have? What’s the wage increase going to be? Most of that is future state and you may not even know the day you invest in the company. I think that’s where the work is needed. It is important to draw the connections, particularly for the racial and social equity-motivated investors, to see how that investment can directly change lives in the long run,” he explained.

To help with this, The Predistribution Initiative is conducting research on the relationship between different forms of employee ownership and impact, according to executive director Delilah Rothenberg.

The Predistribution Initiative is a non-profit focussed on developing investment structures that promote equality. It led efforts to form the Task Force on Inequality-related Financial Disclosures (TIFD) alongside Rights CoLab, a civic engagement group focused on human rights and sustainability. TIFD merged with the Taskforce on Social-related Financial Disclosures to form the Taskforce on Inequality and Social-related Financial Disclosures earlier this year.

She said: “We are undertaking some exercises where we’re starting to map the space and say: what’s the menu of options available for institutional investors within existing and emerging asset classes? What sort of return profiles? What are the pros and cons in terms of impact depending on if the investor has particular impact lens or criteria?”

On the other hand, investors with different motivations may have an easier time. “If institutional investors are thinking about human capital management, then employee ownership fits very clearly into that framework. It’s a proven driver of performance, it’s a driver of employee retention, and resilience during a downturn,” Moriarty said.