There was another very intriguing paper presented during the Mid-Year Fellows Workshop in Honor of Louis O. Kelso titled ‘Opportunity Knocking’. The paper suggests a transformation in financing of employee-ownership transfers. The authors of the paper, Jessica Rose, Marjorie Kelly, Sarah Stranahan, Michelle Camou, and Karen Kahn, propose that “impact investors and other capital providers could be the agents to give this crisis a silver lining by catalyzing employee ownership buyouts at scale.”
The Institute for Economic Democracy has already been discussing the issue of the so-called silver tsunami – the phenomenon of discontinuing the businesses owned by the generation of baby boomers, as they reach retirement age. With the sales decreasing and the risk of infection during everyday operations, we expect that the COVID-19 pandemic will speed up this process of business withdrawals.
The authors above seem to have similar expectations: “According to Project Equity, as many as 1.2 million baby boomer-owned businesses with more than ten employees could be put up for sale or closed in the next decade, and many of these sooner than expected as a result of the current economic crisis.”
Why opt-in for employee ownership
A possible solution to pandemic crisis is transferring ownership to the employees. This creates a win-win situation, because “investments in employee ownership buyouts could offer attractive midrange returns, while at the same time ensuring worker-owners are set to achieve long-term financial security.”
Decades of research shows that employee-owners are more engaged and motivated, thus the main business KPIs are expected to improve after the transfer. Moreover, a reduction in both voluntary and involuntary employee turnover is an appreciated side-effect in employee-owned firms. But the benefits do not stop there. There are positive outcomes at the level of the entire community. “Firms owned by employees are more likely to remain committed to their local communities over the long run, keeping wealth circulating locally and contributing to civic life.”
Impact investors, who seek opportunities to tackle social issues (eg. wealth inequality), will surely be willing to financially support companies that provide the mentioned benefits. Such investors need not spend hours looking for the ideal social enterprise or the perfect responsible business – instead, they could reach out to any employee-owned company and be certain that their goals are aligned.
Capital catalyzing the transfers to employee ownership
Taking into consideration the well-documented benefits of democratic ownership, one would expect that the number of employee-owned companies is dramatically growing over time. The numbers are not showing this; in reality, this number has stagnated for almost three decades.
The authors dedicate the first part of their paper on “Solving the Agency Problem”, where they discuss the possibility that the reason behind the lack of growth of employee-owned companies is a problem of agency.
“For far too long, the field has assumed that owners ready to sell or employees, with the right information, could be that agent, but experience tells us that is not the case.
Our thesis is that risk capital is the agent most likely to bring about desired change because it is already poised to capture firms as their ownership changes hands.
The entities most likely to catalyze change, we argue, are impact private equity funds, which are modelled after traditional private equity funds but use worker-friendly value engineering to improve productivity.”
Ensuring authentic social impact
Given that impact investors base their decisions on the social value of the investment, there must be a mechanism to restrict redundant capital withdrawals and safeguard the desired equitable results to ensure the success of the investment.
“Taking lessons from the field of microfinance, which was undermined by an influx of capital, we make the case that capital must be appropriately channelled and restrained, through the use of guardrails and protections.
We propose developing impact metrics to assess the success of employee ownership transitions in three key areas: building wealth, establishing democratic and empowering workplace cultures, and implementing broader socially and environmentally responsible business practices.”
Building an employee ownership capital ecosystem
Investors must choose between two scenarios: participating in risky investments with high returns or accepting safer and impactful investments with lower returns. There is a gap between the current impact investment vehicles, so what if there was a middle ground? This would be an incredibly attractive third option for many investors. Innovators and investment funds have already started filling in this gap in the middle.
“13 funds have begun to fill the gap, but private market innovators, we argue, are not sufficient to get employee ownership to scale. Catalytic capital, from philanthropic investors and others, is crucial to seed intermediaries and create demonstrable successes.
Additionally, government action will be needed, including direct public financing and the establishment of policies and risk-reduction strategies, such as loan guarantees, to facilitate private financing.
If it is done right, capital could indeed be the missing agent that takes employee ownership to scale.
Public awareness of and enthusiasm for employee ownership are rising. What is needed now is the growth of the underdeveloped supply side: employee ownership investing vehicles that are built in employee-friendly ways and also deliver real value for investors, while limiting potential abuses.”
Scaling of employee ownership through finance
“Fifty by Fifty: Opportunity Knocking” provides several suggestions that tackle both the supply-side – expanding opportunities to invest – and the demand-side – strategies that make investments more attractive. This enables the authors to establish a variety of employee ownership investment options which cover the entire risk-return-impact spectrum:
- “Develop new investment funds for employee ownership.
- To create the ease of investment that investors require—and the ease of ownership transition that sellers need—depends on the continued creation of new intermediary funds targeting employee ownership conversions. Many of these intermediaries will resemble today’s private equity funds but will be designed to attract impact investors and generate beneficial, authentic social impact.
- A flood of capital into a new area can promote excessive capital extraction, as happened with microfinance. To guard against this and attract impact investors, new employee ownership–focused funds will need robust deal guidelines and metrics. The Guidelines for Equitable Employee Ownership Transitions provide a pilot version of impact metrics and guidelines.
- Rather than creating investor value through traditional private equity practices such as downsizing, impact private equity can create value through employee-friendly practices, which has been shown to increase productivity.
- Ultimately, government action will be needed to fully develop this capital ecosystem and take the field to scale, via direct public funding, the provision of incentives, the de-risking of investment, and the encouragement of new institutions.”