Much ink has already been spilled about the $10 trillion transfer of business assets that is underway across the United States. Millions of small and mid-sized companies, many of them essential anchors of local economies, have baby boomer owners who are getting ready to retire and therefore sell or close their business.
Whether these firms close, consolidate, or continue as vibrant, community-rooted enterprises will depend in large part on who takes them over.
Employee ownership is a powerful solution for this moment. Instead of selling to a private equity fund or a distant strategic buyer, selling a company to its employees keeps it rooted in place while increasing business productivity and building wealth for employees.
Not all companies are well-suited for broad-based employee ownership. In many companies, the departing owner is also the CEO. If the company has not cultivated in-house senior management, or if the timeline for selling the business is very short, it can be challenging to hand over both ownership and management to the company’s employees.
“Entrepreneurship through acquisition,” or ETA, might offer a solution to this challenge.
Funds pursuing the strategy deploy would-be operators, often referred to as searchers, who are looking to buy existing businesses and step in as CEO. As Transform Finance highlighted in a recent report, ETA has grown rapidly from only 14 funds in 1996 to more than 700 worldwide today. Combining new management with employee ownership could be a powerful way to support the continued growth of small and medium businesses while broadening who benefits from their success.
Combining employee ownership and entrepreneurship through acquisition
We have identified three ways that ETA and employee ownership can be combined:
- Transition to employee ownership at the time of the acquisition
Employee ownership is implemented when the searcher acquires a company. While many incoming CEOs say they want to share a portion of the company’s profit with its employees, some go further.
For example, an independent sponsor can bring together an experienced business leader and an employee ownership investment fund as a packaged solution to a selling owner. This happened during the conversion of A-R-T & Associates into an ESOP, in which Southeast Acquisition Capital partnered with Allivate Capital and incoming CEO Geoffrey Easterling.
Similarly, Apis and Heritage Capital Partners, a private credit fund dedicated to financing and facilitating ESOP conversions throughout the United States, and Neatland Holdings, an independent sponsor in the janitorial services industry, recently collaborated to transition B&B Maintenance Inc., a commercial cleaning firm with over 1,500 employees and operations in over a dozen states, to 100 percent employee ownership. While the incoming CEO does not receive direct equity in the business since it’s 100% employee-owned, synthetic equity can be used to make the deal more similar to a conventional funded search. In this situation, the equity is split between the searcher and the employees, instead of between the searcher and investors.
This approach isn’t only for ESOPs. For example, when a group of florists were unable to convert the shop where they worked into a cooperative, they instead acquired another flower shop in town. With financing from the Cooperative Fund of the Northeast, Four Buds was bought by these florists and converted into a worker-owned cooperative.
- Employee ownership as an exit strategy for searchers
In a typical funded search, incoming searchers will acquire and run a business for a few years, and then sell the business in order to return capital to investors. But instead of selling it to private equity or a strategic buyer, the business can be sold to its employees.
This is what Sean Wenger did at Precision Communications, a broadcast tower and antenna construction and maintenance company based in Grove, OK. Wenger led a search with the support of Cleveland-based Promise Partners, an ETA accelerator, to acquire Precision in 2020. After years of realizing the benefits of ownership, Wenger and his investors determined that a 100% ESOP transition was the best exit strategy for Precision, especially given the company’s team-oriented history.
This can be a powerful option provided it matches the return expectations of the investors. Because of this constraint, selling the company to its employees is often easier for self-funded searches, which are financed through a searcher’s personal savings and government-backed loans, instead of investor capital. A benefit of this approach is that the upfront transaction is simpler, and it can also build in time to develop internal leadership and ownership culture in that company before ultimately shifting the ownership to employees.
- Acquisition by an employee-owned holding company
Existing employee-owned companies can also be well-positioned in this area. Successful employee-owned companies can leverage their cash on hand and track record with lenders to finance the acquisition of small and medium businesses, bringing capital, management, and employee ownership structure in one package.
For example, Obran Cooperative has grown as a worker-owned conglomerate, acquiring businesses across several industries and providing shared governance and back-office services. Empowered Ventures, an ESOP-owned diversified holding company, acquires firms with strong fundamentals and integrates them into an employee-owned portfolio. Since 2021, Empowered Ventures has acquired four companies in a variety of industries.
Where to go from here?
When Julie posted on LinkedIn to ask for examples of EO + ETA deals, there was a huge outpouring of interest but the actual examples of completed transactions were few and far between. We have solid proof of concept that EO + ETA can be powerful but more needs to be done to expand this intersection.
- Grow awareness among owners, searchers, and advisors. The investors and ecosystems of support for EO and ETA are not connected, and too often business owners learn about just one alternative exit path, if any, not the full range of them. Similarly, searchers don’t realize employee ownership can be a powerful complementary solution to reach their goals of wealth building and growing business productivity.
- Aligned capital. Investors in search funds often expect returns of 35% and above. Employee ownership investing funds finance transactions using mostly debt, instead of equity which might be better suited to the needs of growing businesses. Searchers who often invest years and significant personal savings to find a suitable business are hoping their investment will build wealth for them and their family. The capital currently well-suited for EO + ETA transactions is limited and should be further developed.
Search and employee ownership could become a meaningful part of the business transition landscape, one that preserves companies, broadens wealth-building opportunities, and strengthens local economies, at a moment when all three are urgently needed. We’re excited to help this dynamic field continue to grow!
Julie Menter is a program director at Transform Finance. Sean-Tamba Matthew is an attorney at Stevens & Lee, SES ESOP Strategies.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.
