New paper examines how the tools of finance can advance employee ownership
by Tomás Durán and Melissa Hoover
With millions of small businesses emerging from a COVID-induced deep-freeze and facing a long, slow recovery, now is the time for those who care about the small business sector to get behind innovative strategies to save it. Here’s a shortcut that most people overlook: selling to employees.
For many small businesses, it took less than 30 days of shutdown to create an existential crisis: beg, borrow, and steal to keep going, or cut their losses and shut their doors for good. With more than half of small business owners at or past retirement age and with no clear successor, many will turn to a fire sale liquidation to rebuild their retirement nest egg. Others may sell to private equity “vulture capitalists” who lie in wait for a business to die and then swoop in to acquire its assets. The result is the same: jobs lost, manufacturing base eroded, access to goods and services reduced, local tax revenues diminished, and commercial corridors left eerily quiet.
Before small business owners call it quits for good, they should explore an option that can be accomplished in under 30 days: selling to insiders.
But there is another option that can save those jobs and recirculate money in the local economy. Before small business owners call it quits for good, they should explore an option that can be accomplished in under 30 days: selling to insiders. Employees and/or other local stakeholders already familiar with the company have a different profile from traditional speculative buyers, competitors, or those who see companies as commodities. Quite simply, they are buying their own jobs, and this makes all the difference. They know the business and their interests usually align with the owners. Moreover, unlike a speculative buyer, they don’t need to worry about sheltering personal income from taxes or managing a portfolio of unrelated businesses.
What employee-buyers generally don’t have is cash lying around to buy the company outright. Nor do they have appetite and ability to take on a lot of debt to purchase a company whose value is uncertain. What they do have is access to private sector tools for acquisitions (the traditional tools of “merger and acquisition” specialists), which can be strategically employed to give “insiders” an edge in a competitive marketplace.
Concerned Capital, a social benefit company based in Los Angeles, CA, researched and analyzed the tools used by merger-and-acquisition specialists to buy distressed companies and/or transfer ownership of an operating business at a discount. In a new study, New Financial Models to Spur Worker to Owner Conversions, researchers examined three traditional transaction tools through the prism of gaining a competitive edge for employees to buy their businesses:
- Stock Sale, which provides tax advantages to lower a seller’s tax liability
- Bargain Sale to a non-profit sponsor, as part of a two-step conversion to buy a company at a below-market price
- Charitable Remainder Trust, used to lower a company’s sale price but provide ongoing income for the seller
Ultimately, Concerned Capital found the stock sale model to be the most viable means for business owners to quickly transition businesses to their employees. Such transitions save local jobs and keep economic activity in the community. In addition, employee-ownership transitions give people of color and women opportunities to grow wealth that may otherwise not be available to them because of systemic racism and inequality.
These finance tools can be successfully used by employees to compete more effectively against financial buyers. They just need to be repurposed, supported, and promoted.
Using this approach, Concerned Capital has saved 200 jobs in Southern California since 2013. Other economic development organizations have also used this approach. For example, the Cooperative Development Institute helped Ward Lumber, a family-owned C Corporation in upstate New York, convert to a worker cooperative via a stock sale. The employees incorporated as a worker cooperative under New York law and purchased the C Corporation’s stock. The seller was then able to take advantage of an IRS 1042 Rollover to defer capital gains taxation on the sale. The new cooperative did not have to start over as a new business, but instead was able to assume the trade credit established by multiple generations of the original family-owned business. No employees lost their jobs.
Business owners, brokers, banks, and especially city officials are all shell-shocked right now, managing a public health crisis, a cratering economy, and addressing social justice demands raised by the Black Lives Matter movement. But as we move from crisis response to contemplating recovery, tools already exist to save small businesses and stabilize communities via local ownership. Because almost all small business ownership transitions happen quietly and without fanfare, the tools described in the report are not well known. However, these tools can be successfully used by employees to compete more effectively against financial buyers. They just need to be repurposed, supported, and promoted.
Cities’ small business and economic development departments can tap into these tools and support them with policies that allow for creative use of investment banker techniques. Brokers can bring more employee buyers to the table, and banks can learn how to leverage their funds with alternative sources of money to finance these transactions. A national community of support for business transitions to employee ownership exists and is ready to support the transition that is underway (see www.becomingemployeeowned.org).
The long, slow recovery ahead gives us an opportunity not only to save but also to rebuild our local economies in a way that prioritizes local ownership. This can create sustainable and recyclable sources of wealth in communities where the workers live. With so much economic uncertainty, banks are looking at deals very differently. The pricing of businesses will be governed by more than reliable projections based solely on historic performance, and the “goodwill” value of those who know how to run the company will become a more important consideration. The market that these businesses are emerging into may be unpredictable for a long while. Selling to employees is not a silver bullet, but it may be our only shot at keeping viable local businesses open and communities employed.
Tomás Durán is the president of Concerned Capital, Inc. (CC), a social benefit corporation based in Los Angeles, CA. His team developed the Transfer of Ownership Program, which recycles manufacturing companies by transferring ownership from retiring owners to employees.
Melissa Hoover is the founding executive director of the Democracy at Work Institute, the think-and-do-tank that expands worker cooperatives as a strategy to address economic and racial inequality. A leader in the worker ownership movement for over fifteen years, Hoover helped start and grow the United States Federation of Worker Cooperatives, the national grassroots membership organization for worker-owned businesses.