Can Employee Ownership Hold Back a Tsunami of Small Business Closures?

To paraphrase John Oliver, it is hard to find two words in the English language more likely to put you to sleep than “business succession.” Oliver famously made that claim for “net neutrality,” but the phrase “business succession” might be even more mind-numbingly boring.

And yet, a business succession crisis that could cause millions to lose their jobs is looming. Nearly half of US small business owners are baby boomers, aged 53 to 71. Many are likely to retire soon. Collectively, according to the Oakland, California-based nonprofit Project Equity, baby boomers own 2.34 million businesses, employ 24.7 million people, and have combined annual sales of $5.14 trillion. It is estimated that 80 percent of these businesses lack a plan for what they are going to do when their owner retires or, if misfortune falls, dies unexpectedly.

In short, people’s livelihoods across the nation are at stake—not because of the usual culprits, such as globalization or automation, but for the simple reason that hundreds of thousands of companies are likely to shut down due to a failure to develop adequate business succession plans. The impending mass retirement of baby boomers has been labeled by some a silver tsunami.

The usual business succession paths are to pass the business on to your children, sell to a competitor, or sell to private equity, but, as an article in Forbes noted a few years ago, “Only a third of all family businesses successfully make the transition to the second generation.”

One option that’s increasingly being used, however, involves transferring ownership to employees. It has a lot to recommend it. For one, it dramatically increases the chance of business survival, preserving community jobs in the process. This fall, an Ohio-based grocery chain that employs 2,100 was saved from oblivion using this mechanism.

There are different ways that employees can own a company, but the most common mechanism involves what is called an “ESOP,” or employee stock ownership plan. Douglas Kruse, an economist at Rutgers University, has been studying employee ownership for over two decades. Kruse notes that ESOPs “have been around since the 1970s. They are a form of pension plan that invests primarily in company stock.”

Joseph Blasi, who has long worked with Kruse, adds, “The simplest way to understand an ESOP is it is a trust set up by a company that can borrow money to buy worker ownership; the company pays back the loan and pledges the company as collateral for the loan. The workers are then able to get employee ownership by using credit and not using their wages or savings.”

As Kruse elaborates, “Basically, it allows employees to buy a company in the same way a deep-pocketed capitalist does. They don’t shell out their own money, they get a bank loan, which they pay back based on the proceeds of the company. As that loan is paid back, the stock builds up in the employee accounts. Employees are not putting up their own money or houses, they are putting up the business’ assets.”

Today, Kruse adds, about 10.5 million private sector workers own all or part of their companies through ESOPs, “which is almost 10 percent of the private sector workforce.” Kruse notes that the average ESOP assets are now about $124,000 per worker, “so it is a significant amount.”

Bill Castellano represents the kind of new talent being recruited to help build an infrastructure to support the conversion of more existing businesses to employee ownership. Castellano used to work on Wall Street, where he served “mostly in corporate HR [human resources] positions.” Now, he directs the New Jersey/New York Center for Employee Ownership, which opened at Rutgers University in New Brunswick, New Jersey, last year. The university financially supports the center with “upwards of $200,000” in core funding. To date, the Center has provided in-depth technical assistance to over 30 companies, most of whom employ between 50 and 500 people that either are already employee-owned or are considering converting to employee ownership.

For Castellano, the looming business succession crisis helped lead him to this work. “This is an area of my own research interest. I do look very closely at demographic trends and how it impacts business strategy and human resources,” Castellano says. “Over 50 percent of US business owners are over the age of 50. The vast majority of companies are privately owned. The transfer of ownership will probably create $5 trillion worth of transactions over the next 20 years.”

Castellano notes that, “You can sell outright to a competitor or private equity, [but] we are focused to help business owners think about selling the companies to their employees. It helps the continuity of the business, save jobs, financially they will be paid, and they can also keep an interest in the company. For a lot of the privately held companies, I think this ESOP option is something that is appealing. Right now, it is a small percentage, but we hope and expect it will be a growing and much larger percentage.”

Employee ownership has other benefits. Kruse notes that, “There have been well over 100 studies on the productivity and performance. There is a new meta-analysis coming out on 102 studies of 57,000 firms.” Meta-analysis is a technical term referring to combining the results of multiple studies to identify overall trends. Among the findings is that there is a “small, but significant positive relationship between employee ownership and firm performance.”

At the same time, Kruse notes, “there is a lot of dispersion. Some firms do great; some firms do not. We have spent a lot of the past 15 years to figure out some of the conditions. We do find that the employee ownership companies that do better are the ones that create an ownership culture with more participation in decision-making and more information and training of the workers to make them feel like owners.”

Job security, Blasi notes, is another major benefit of employee ownership. Blasi says that a study that Kruse coauthored with Fidan Ana Kurtulus this year found that employee-owned companies had “half the layoffs as non-employee owned firms in the last two recessions.”

Slowly, policymakers are waking up to the importance of worker ownership. In New York state, a number of Democratic Party state senators came together to issue a report calling for greater promotion of employee ownership. This year, New York state also passed Assembly Bill 5191, which establishes an advisory panel to “make recommendations on how best to support existing employee-owned enterprises and promote new employee-owned enterprises.”

In Colorado, the Rocky Mountain Employee Ownership Center led a successful campaign to pass HB17-1214, which sets up a revolving loan program to help finance transitions to employee ownership. In Massachusetts, the state legislature this year allocated $150,000 to restore funding to a state employee ownership center that had laid dormant for nine years. Meanwhile, within the field, nationally, according to Blasi, “The National Center for Employee Ownership is trying to activate 50 or more state or regional centers to provide more local support to business and workers and professionals like lawyers who need more information on employee ownership and want to get technical assistance or education or training.”

A growing number of cities and states have also embraced worker cooperatives, a less common but powerful form of worker ownership in which workers directly exercise control over their company through democratic governance processes. In many communities, citieshave developed technical assistance programs to support worker cooperatives, both for start-ups and conversions. Sometimes, city procurement, too, is used as a tool to support worker co-ops. New York City is most prominent, but other cities supporting worker co-ops include Rochester, New York; Madison, Wisconsin; Cleveland, Ohio; Oakland, California; Minneapolis, Minnesota; Austin, Texas; and Richmond, Virginia. At the state level, Rhode Island’s governor signed Senate Bill 676 into law in October, which creates a framework to make organizing worker-owned cooperatives easier under state law.

Meanwhile, at the federal level, Blasi notes, “There is more legislation on employee ownership than at any time since [Senator] Russell Long authored the ESOP law and in the 1980s when the program expanded under [President Ronald] Reagan.” Two bills are supported by Vermont Senator Bernie Sanders; one provides federal support for technical assistance centers and the other creates employee ownership banks that would provide dedicated loan funds.

Blasi adds that, “Senator Tammy Baldwin of Wisconsin introduced a major bill on employee ownership that includes ESOPs and worker co-ops. Baldwin’s bill would provide new loans for worker-owned firms. It would remove the tax deduction for executive pay unless they have a broad-based ownership plan. It would allow banks to deduct their interest income when they loan to a worker-owned firm and thereby offer lower interest rates. It would create an Office of Employee Ownership in the White House. This is a major bill.” Meanwhile, in New York State, Senator Gillibrand is also preparing to introduce supportive federal legislation.

The above said, the main current federal support for employee ownership is a tax break for exiting owners that allows owners selling to their employees (must sell at least 30 percent of the company) to buy stock and defer capital gains tax until that stock is sold. To the extent that the federal government approves cuts in capital gains tax rates, that would, of course, reduce the value of the existing tax incentive to retiring business owners. As Blasi observes, “The fact that $1.5 trillion in tax benefits are flowing out mostly to corporations in the tax reform bill without any requirement that those companies have broad-based employee ownership or profit sharing would be a major policy reversal for economic democracy.”

When asked what can be done at the local level to support employee ownership as a succession strategy, Blasi made three suggestions:

  • Create state tax incentives to “encourage every retiring business to think of conversion to employee ownership.”
  • “Encourage the development of a state center, which is a low-cost nonprofit way to educate the people at the grassroots that are likely to start these companies.”
  • “Make having a broad-based employee ownership plan a condition of any company receiving local or state tax abatements.”

In his work with nonprofits and businesses, Castellano says one key strategy for him has been “to build awareness, lift companies that are thinking about this as a strategy, and share our own research and information or connect them to people to provide with technical advice.” Castellano adds, “We do have relationships with other companies that have the technical expertise. We pride ourselves in being an objective assessor of service providers. That is a tremendous benefit. Companies looking for technical assistance can come to us for impartial advice.”

Steve Dubb is a senior editor at NPQ. Steve has worked with cooperatives and nonprofits for over two decades, including twelve years at The Democracy Collaborative and three years as executive director of NASCO (North American Students of Cooperation). In his work, Steve has authored, co-authored and edited numerous reports; participated in and facilitated learning cohorts; designed community building strategies; and helped build the field of community wealth building. Steve is the lead author of Building Wealth: The Asset-Based Approach to Solving Social and Economic Problems (Aspen 2005) and coauthor (with Rita Hodges) of The Road Half Traveled: University Engagement at a Crossroads, published by MSU Press in 2012. In 2016, Steve curated and authored Conversations on Community Wealth Building, a collection of interviews of community builders that Steve had conducted over the previous decade.

This article originally appeared in Nonprofit Quarterly

Leave Comment