'It’s really hard not to be an advocate of employee ownership'

Employee ownership has too long been overlooked as a win-win solution for businesses and workers alike. That’s the view of Bill Young, founder and president of the Toronto-based Social Capital Partners.

That’s because employee-owned businesses offer “a proven wealth-creating vehicle” for individual employees; long-term wealth can be more resilient than income, which may fluctuate over a lifetime. The businesses tend to be more profitable, too – and, during downturns, to lay off fewer people and recover faster. Retiring business owners, meanwhile, get the chance to reward employees and stay involved in the business.

Ahead of the Social Value Matters conference next week, we put some questions to Young, who is a leading voice promoting social finance in Canada and a board member at a number of social enterprises and community organisations. He talked in particular about Employee Stock Ownership Plans (ESOP), the most common form of employee ownership in the US. Almost unknown until 1974, they’re now fairly widespread, with some 6,500 plans in the US covering 14.2 million people. But the potential could be significantly greater – which is why Social Capital Partners is working to reduce the financial barriers that may be putting some off. Read on to find out more.

Pioneers Post: You are a big advocate of employee ownership. Why is this, and particularly ESOP, worth pursuing?

Bill Young: When you look at the economic and social appeal of employee ownership in general, and ESOPs specifically, it’s really hard not to be a big advocate. Studies have shown that employee-owned businesses grow faster, are more profitable, and, during recessions, lay off fewer people and recover faster. Employee ownership also helps business owners create a legacy, as they can reward employees, ensure jobs stay in their local communities, and maintain some involvement in the business. From the perspective of employees, ownership provides more meaning in their jobs and is a proven wealth-creating vehicle, as evidenced by a study showing employees in ESOPs have 92% higher net worth than those who are not. 

At Social Capital Partners we’re particularly excited about ESOPs because of its track record and potential for scale. There are approximately 6,600 ESOPs in the US, and 14 million Americans hold $1.4tn in assets through these plans. This scale has been achieved thanks to an entire ecosystem supporting these businesses, as well as tax incentives. With an increase in business successions looming, we think that most of the puzzle pieces are there to significantly grow employee ownership, and, in doing so, meaningfully address inequality.

PP: Why then, isn’t it happening more in North America – especially given that the US has had ESOP legislation in place for 40 years?

BY: This really merits a longer answer but, in the US, I think it boils down to three reasons:  awareness, incentives, and financing. First, while ESOPs have been formally around since the '70s, relatively few people are aware that it is a viable option when it comes time for an owner to sell their business. 

This relates, at least in part, to the second issue, which is incentives. The unfortunate reality is that there are just far fewer people with the financial incentive to promote ESOPs. While there are dedicated investment bankers, lawyers and lenders in the ESOP market, your more mainstream intermediaries generally have a much stronger financial incentive to promote selling businesses to competitors or private equity firms. 

Third, and where we fit in, a lack of financing often creates a financial trade-off for most owners if they decide to sell to employees through an ESOP. To use rough numbers, an owner might get 80% of the value of their business in cash on closing when they sell to private equity, but only 30% if they sell to an ESOP. We’re trying to address all of these issues, but in partnership with institutional investors are particularly focused on the financing challenge. 

When it comes to Canada, the US-style ESOP doesn’t exist, and the public policy framework for employee ownership is much weaker.

With an increase in business successions looming, most of the puzzle pieces are there to significantly grow employee ownership and meaningfully address inequality

PP: What role can an organisation like Social Capital Partners play?

BY: We’re trying to act as a catalyst to help solve those three reasons that have limited ESOP adoption. We are currently working with a large Canadian pension fund to provide financing to US ESOP transactions. As a part of that we have a strategy to engage the mainstream capital markets, which we think will help increase awareness and incentives. If we can have some success with this, we think it will strengthen the case for other institutional investors to more seriously consider investing in ESOPs, and in doing so increase the share of businesses selling to ESOPs vs. private equity. We are also currently making the case to the Canadian government as to why they need to actively encourage employee ownership. 

 PP: How successful have you been so far?

BY: It's early days for us still as we only began working with the Canadian pension fund late last year. We’ve looked at over a dozen opportunities, and were relatively close to investing in two transactions. One was for US$30m and the other for US$65m. Neither deal closed, in one case because of Covid, and in the other because the owner opted not to sell. As disappointing as those were, we have been able to prove that there are attractive deals for institutional investors to finance ESOPs, and so more and more investors are getting interested. Deal flow has slowed because of Covid, so in the meantime we have been accelerating our public policy work in Canada. 

What is employee ownership?

Employee ownership takes various forms, with different forms popular in different countries.

In the US most large, majority employee-owned companies have an Employee Stock Ownership Plan (ESOP). This is a form of qualified retirement plan and is used to transfer all or part of the company’s shares to a trust, administered on behalf of the employees. Employees don’t usually pay for their shares; they are gifted to them as a retirement benefit. When they leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares). 

ESOPs are suitable for companies of a certain size – generally 40-50+ employees and $2m in revenue; in this case, the tax benefits far outweigh high setup and ongoing administrative costs. 

Other employee ownership forms include worker-owned cooperatives (which are 100% employee-owned) and employee ownership trusts (or perpetual employee trusts; they blend the trust structure with some of the democratic qualities of the worker-owned cooperatives).

PP: What would you like to happen next?

BY: Beyond completing our first transaction, we’d like to see much more awareness among mainstream stakeholders about the success and opportunity that employee ownership can foster, significantly more institutional capital dedicated to financing ownership transitions to employees, and a public policy framework to promote employee ownership in Canada. 

PP: What examples of employee ownership outside of North America have caught your interest recently?

BY: We’d probably say that the developments in the UK employee ownership community have been most interesting to us. In 2012, the Nuttall review of employee ownership was published. In response, in 2014 the UK government created a new vehicle for employee ownership, the UK Employee Ownership Trust, and introduced a range of public policy incentives. While still early days, 60% of the employee owned firms in the UK have been created since the new legislation was introduced, showing that public policy has had a meaningful impact. We’re hopeful that Canada can see even greater success, but time will tell. 

As seen in the Pioneer Post.