Fifty by Fifty

A MOVEMENT FOR EMPLOYEE OWNERSHIP

Equity Funds Needed to Further Worker-to-Owner Buyouts

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Using funds from the State Small Business Credit Initiative, states could accelerate transitions

By Bruce Dobb and Tomás Durán

The silver tsunami has begun. More and more business owners from the Baby Boom generation are looking to sell their businesses and retire. Among America’s small manufacturers, for example, 125,000 business owners are on the cusp of retirement. Those businesses represent millions of family-wage jobs that could be lost forever.

With so many business owners looking to sell, it’s an opportune moment for employee buyouts. However, when employees are competing with corporate or private equity buyers, they often lose the deal because they don’t have ready cash for a down payment. That cash is essential for accessing the Small Business Administration (SBA)-backed loans that are used for about 75 percent of small business ownership transitions.

The worker-to-owner financing ecosystem has a significant credit gap: equity financing.

In a typical example, our organization, Concerned Capital, recently worked with a family-owned medical supplies packing and shipping company in the metropolitan DC area. The couple who owned the business, which had about $5 million in revenue, wanted to sell it to the employees. Multiple social investors—a CDFI, a nonprofit, and a social impact fund—were prepared to loan the employees the money to buy the business, but the employees needed to raise $150,000 in equity in order to access the loans. While the employees searched for the cash, a rival company bought the firm and closed in two weeks.

The Equity Gap
We run into this challenge over and over again. The worker-to-owner financing ecosystem has a significant credit gap: equity financing. What’s needed is an equity vehicle that fits snuggly with existing SBA regulations, providing the 10 percent cash down payment on a deal otherwise financed through debt. We believe, along with our partners at the Democracy at Work Institute, that states can create equity funds to satisfy this need using the State Small Business Credit Initiative.

Social justice–focused equity investors are well positioned to bring about a more inclusive economy that helps all employees build wealth.

In the last several years, an explosion of debt offerings have moderately increased transitions to employee ownership. Some of this growth is a direct result of the Main Street Employee Ownership Act of 2018, which resulted in the SBA adopting programs and rules designed to assist with Employee Stock Ownership Plans (ESOPs) and worker-owned cooperative transitions. Impact investment groups, community development finance institutions (CDFIs), and a range of “social benefit” lenders offer a wide range of debt instruments for worker-to-owner deals, including subordinate debt and very low interest rate loans. With greater access to equity, these debt offerings could be leveraged more effectively and the pace of employee-ownership transitions significantly increased.

What Makes Equity Different from Debt
Equity is unsecured funding used to purchase an asset or invest in a company.  It confers a degree of ownership, whereas debt does not. Equity has no fixed repayment terms and is classified as “patient capital” because it must wait for its return until all creditors and secured lenders are paid. In the event of a bankruptcy or default, the claims of equity holders are generally wiped out.  

Bankers loaning money for a deal want to see an equity investment for several reasons. Not only does equity ensure the buyer has “skin in the game,” equity offsets leverage and makes the vital “loan-to-value” ratio look lower and less risky. Moreover, having equity capital demonstrates wherewithal to come up with emergency funding when it may be needed.  

But for worker-to-owner deals, equity adds another type of value that is often overlooked.

Equity Investors Can Influence Democratic Ownership Values and Practice
Unlike lenders, equity investors can have a voice in running the company. The amount of influence granted to equity holders depends on the nature of their agreement with the majority owners. Debt holders, by contrast, can’t dictate governance decisions without jeopardizing the repayment of their loan. The legal construct known as “lender’s liability” means that lenders can either be scorekeepers or players, but not both. Lenders, for example, cannot require that a company enhance democratic leadership or prioritize social purpose, unless such actions are clearly stated in the loan covenants.   

Equity investors have a much greater opportunity to influence company practices. These investors can participate as board members, help write by-laws, and ensure that company employees have a voice in running the company. As such, social justice–focused equity investors are well positioned to bring about a more inclusive economy that helps all employees build wealth.

Equity investors can insist on:

  • A path to ownership for all employees;
  • Some form of profit sharing; and
  • Worker voice in governance (the big decisions, not necessarily day-to-day management).

These are critical factors we consider when determining if a worker-to-owner transition will be a good long-term investment that is transformational for a community. We consider equity investors partners in bringing this vision to fruition.

The Treasury has made it clear that states can use their SSBCI funding to facilitate employee ownership transitions. With the right equity partners, they can ensure that worker buyouts go beyond business as usual and support broad-based shared wealth building over the long term. This is a viable path to addressing income inequality all across America.

Bruce Dobb is CEO and Tomás Durán is president of Concerned Capital, a social benefit corporation that specializes in social impact investments. The firm is a
nationally recognized pioneer in recycling and repurposing community-based small manufacturing companies by transferring ownership to long-term employees.

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