Overcoming the mindset barriers that keep investors away from employee ownership

Employee ownership conversions in the United States represent a $1 trillion financing opportunity, peaking with the mass retirement of Baby Boomers. A growing body of evidence suggests that employee ownership of stable businesses can improve financial performance, reduce staff turnover, enhance job quality and wages, provide wealth-building opportunities, and reduce wealth inequality. 

In response to the opportunity, there has been a recent upswell of innovative funds and financing vehicles positioning employee-led buyouts as a viable alternative to finding a trade or private equity buyer for small- and medium-sized business owners retiring without clearly defined successors. 

The majority of these funds, however, are working with subscale pools of capital and small teams. Employee ownership transactions remain a rounding error in the scale of total private equity buyouts — in 2019, for example, employee stock ownership plans, or ESOPs, represented just 239 of the total 13,000 M&A transactions.

As with any overlooked and undercapitalized opportunity set, there are both rational and structural reasons why more capital isn’t flowing to support transitions to employee ownership. There are also awareness and behavioral dynamics among the people who solicit, structure and allocate capital that prevent business owners and investors from pursuing these transactions. In the recently published Addressing Capital Gaps: A Guide to Strategic Deployment of Catalytic Capital, the Catalytic Capital Consortium’s Harvey Koh identifies some of these as “mindset” barriers, which tend to accompany and reinforce rational and structural barriers.  

Markets, as we are often reminded through the phrase “investor sentiment,” are a reflection of investors’ mindsets and mental models which drive investment behaviors and activities.

There are many behavioral elements that hamper the uptake of employee ownership transitions. Brokers and wealth advisors lack awareness of a company’s employee base as a potential exit path for business owners vs. private equity or strategic buyers. The underwriting models of banks and insurers often don’t encompass shared ownership structures. Private market investors are leery of the unfamiliar regulatory structures of certain employee-owned structures, such as ESOPs. And procurement and licensing agencies frequently fail to imagine how their requirements may apply to employee-owned businesses. 

Not least, employees themselves may lack an “ownership mindset,” and find common practices in employee-owned and -led companies, such as open book management and board elections, initially confounding. 

Familiarity bias

Investors commonly perceive unfamiliar investments as riskier—a mental model rooted in familiarity bias that systematically disadvantages niche or emerging solutions like employee ownership. A perception of higher risk is enough to prevent most investors and business owners from pursuing an exit to employees, regardless of the actual risks it may entail. 

Organizations like Ownership Capital Lab (a grant partner of Spring Point Partners) and the National Center for Employee Ownership are working to dismantle areas of higher perceived risk by growing familiarity with and actionable ways to support employee ownership transitions among investors and other stakeholders. 

At Spring Point Partners, we also support investment firms like Apis & Heritage and advisors like Common Trust as they work tirelessly to raise the profile of the benefits of employee ownership for employees, retiring business owners, and communities at large. 

Thanks to their partnership, I have witnessed this familiarity bias in action – one of the questions we hear most often about employee-owned businesses is “what’s the exit plan?” We are so trained to assume an eventual sale of a business as proof of market validation that even seasoned investors overlook the fact that there is no requirement to ever sell an employee-owned business – because it’s wholly owned by the employees! 

The transitions are largely financed through different forms of debt – usually a combination of senior debt and mezzanine debt, which are eventually refinanced, and a seller’s note which is slowly repaid over time out of profits. 

I appreciated how Koh brought some of these intangible barriers to light as he developed his analysis on capital gaps in employee ownership.  In my experience as Spring Point Partner’s chief investment officer, I see how impact investors can often be reluctant or unprepared to address critical behavioral components of investment markets. It is important to flag when we think these behaviors, and the mental models behind them, are a primary barrier to broader market engagement and investment flows. 

Harvey and I agreed that to close the capital gap and reduce barriers to employee ownership adoption, any structural changes to capital flow (such as targeted debt pools or tax incentives) should be paired with broader mental model shifts for their potential to be fully realized. In other words, we cannot simply financially engineer our way into more equitable and humane capital markets.

We need to build broader understanding and common purpose in ways that shift our collective mental models and resulting behaviors – after which time the right structural incentives can absolutely supercharge the market for a more durable and impactful result.

Margot Kane is chief investment officer at Spring Point Partners