Inštitut za ekonomsko demokracijo

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Succession Challenge in German SMEs: Is it Time for a German ESOP Model?
Succession Challenge in German SMEs: Is it Time for a German ESOP Model?

Succession Challenge in German SMEs: Is it Time for a German ESOP Model?

Written with: Tej Gonza.

 

According to Jens Krane, Head of M&A in Commerzbank AG, “the number of German SMEs coming up for sale has been piling up for years”. This process is largely driven by the wave of retirement of business owners which is taking place in European economies. Of course, the decision about whom to sell to rests ultimately in the hands of business owners. But the broader implications of these transactions require a responsible intervention by the German government. Succession strategies are not only about facilitating business transitions; they are also about safeguarding economic prosperity and social welfare.

The impending wave of retirements among German business owners is expected to trigger significant changes in the ownership structure of German businesses in the years to come. Research by KfW suggests that 125,000 German SMEs are set to experience a change in ownership every year until 2027, meaning that 500,000 SMEs will change hands in the next four years. This process carries substantial risks for all stakeholders involved: employees, local communities, the businesses themselves, and for the backbone of the German economy as a whole.

German SMEs, commonly owned by individuals actively involved in local communities, serve as cherished pillars for stakeholders, providing value that extends beyond mere economic impact. They offer economic stability, often actively contribute to sports, cultural, and recreational programs, and form an integral part of the local identity. Locally anchored ownership ensures job creation and fiscal stability for municipalities and the German government.


Preserving local ownership in the long term is essential for a thriving German economy

Maintaining local ownership is not a simple task. One established method for ensuring continuity in business ownership is through family succession. However, various studies indicate that younger individuals are becoming less inclined to take over family businesses and instead prefer exploring opportunities outside of the family circle when building their careers.

“The mindset of heirs has changed, and fewer and fewer company heirs are willing to take over responsibility as chief executive officers for their parents.” – Jan-Philipp Pfander, Proventis Partners

As a result, and due to a lack of alternatives, an increasing number of local SMEs are being sold to external buyers such as private equity firms or large competitors. These new owners frequently lack the founder’s dedication to the legacy of the business, the local communities, and the team of employees. Ownership priorities shift from the sustainability of business operations, good working conditions, and concern for the community to the extraction of value, maximization of returns, and socialization of losses, which often comes at the expense of stakeholders and society as a whole.

 

Reflection of the Reichstag (Berlin)


To ensure the long-term sustainability, a strategic developmental policy is needed that will provide tools for addressing the issue of ownership succession in local businesses.

Alternatives exist, and they can be highly successful if appropriately supported. One of the more widely adopted tools for ownership succession in the US and the UK is the use of special vehicles for employee buyouts known as Employee Stock Ownership Plans (ESOPs). ESOPs provide a model for broad-based employee buyouts facilitated by a special purpose vehicle and financial leverage.

In the US alone, there are more than 6,500 ESOPs employing around 15 million workers, constituting approximately 10% of the entire US private workforce. The UK introduced their ESOP equivalent, known as an Employee Ownership Trust (EOT), in 2014 and has witnessed a surge in transactions since. In 2023 alone, there were 410 conversions to employee-owned businesses through the EOT. Most ESOPs in both countries are the result of addressing the succession challenge.

Sustainable and inclusive employee ownership helps to preserve the local legacy of the business over the long term. Hundreds of empirical studies conducted in recent decades show that employee-owned businesses are more productive, resilient, and sustainable. Moreover, employee ownership generates additional positive externalities, including a more equitable distribution of wealth, greater local responsibility, and increased financial literacy among employees, and more.

In recent years, countries including Denmark, Spain, and Slovenia have been looking into the possibilities for adoption of innovative employee buyout models. EU is actively participating in these efforts, supporting research on the models and dedicated financial instruments, which could help to facilitate business transitions in the hands of the employees.

Over the past 5 years, the Institute for Economic Democracy (IED) has been leading the conversation in this field. IED has introduced a standardized European ESOP model as a concept, which could be adopted by different countries across the EU. The European ESOP is currently undergoing a pilot implementation phase in Slovenia, where several businesses are embracing the model to address the succession challenge, with the largest being an engineering company, Inea, employing 110 workers. Additionally, IED is collaborating with the Slovenian government to introduce precedent-setting ESOP legislation in an EU Member State.

As the German economy grapples with an ownership succession crisis, which may have far-reaching socio-economic consequences, it is the German government’s responsibility to incentivize succession tools that can ensure the sustainable development of the SME sector and contribute to a fair and green economy. The ESOP model has been a time-tested strategy to do exactly that, but the time window is closing fast with aggressive investors entering the EU space.

Kosta Marco Juri

Kosta Marco Juri

Vodja raziskovalnega in policy oddelka na Inštitutu za ekonomsko demokracijo.

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