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How Employee Ownership Can Address the Racial Wealth Gap

By Todd Leverette

This article was originally published by Nonprofit Quarterly (NPQ) on October 5, 2022, We publish it with their kind permission

In the United States, worker-owned models of commercial enterprise have been practiced for centuries—and have been codified into law over the last several decades. From the many worker cooperatives documented by Jessica Gordon Nembhard in Collective Courage, such as the Freedom Quilting Bee of Alberta, AL, to the large majority employee-owned enterprises that employ tens of thousands, such as Publix Supermarkets and W.L. Gore and Associates, employee ownership has long been among us. For example, Publix started its employee ownership plan shortly after the store’s founding in the 1930s and today has over 200,000 employee-owners, who collectively own about 80 percent of the company.

However, for those of us who have tirelessly fought to bring employee ownership into the mainstream, it seems as if we have come into a “moment.” Once relegated to the niche, if not novel, corners of social movement strategies and wealth management tax schemes, employee ownership as a concept and practice has begun to challenge long-standing dogmas about what business ownership is and who can—and should—have access to it.

The signs of this shift are many. They include the increasing prevalence of bipartisan federal legislation such as the 2018 Main Street Employee Ownership Act and the RISE & SHINE Act (Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg), which is currently moving through Congress. In the private sector, these signs include the rise of for-profit investment funds like our own and others such as the Fund for Jobs Worth Owning in Massachusetts. In short, the idea that employees should own a stake of the businesses where they work has become increasingly popular.

The Problem

Even so, the expansion of employee ownership models into the far reaches of the US economy is not inevitable, despite such models’ current popularity, COVID’s exposure of the plight of essential workers, and a “silver tsunami” of business transfers from retiring “baby boomer” owners. Indeed, without concerted efforts by both old and new economic actors in both the philanthropic and private sectors, the chance that employee-owned businesses will lead to a paradigm shift in the US economy remains small. Crises create opportunities for change, but they don’t guarantee it.

Moreover, the all-too-common idea that the expansion of employee ownership will inevitably lead to positive and equitable outcomes in communities of color, such as by closing the racial wealth gap, is not only erroneous, but dangerous. Sadly, such blind faith has the potential to leave Black and Brown workers and families even farther behind.

The Solution

Today, the economy is at a crossroads; our decisions will determine if the nation continues down the path of greater inequality and diminished opportunity or chooses something better—an economy in which employees share in the rewards of a business’ success.

The creation of a world in which employee-owned businesses thrive as an economic sector and asset class—while not exacerbating the wealth and ownership gap between white and Black and Brown families—requires doing three fundamental things. Each strategy is detailed below.

1) Reducing the Cost of Capital

For employee-owned businesses to become a significant sector of the US economy, capable of capturing investment from broader capital markets—including public pensions, insurance companies, and private investors—employee ownership advocates must work to reduce the perceived risk of, and thus the cost of capital for investments in, employee ownership.

A firm’s cost of capital reflects both how risky a company or sector is perceived to be by those looking to invest, and the availability of investment capital. Functionally akin to a personal credit score, a firm’s cost of capital determines what type of investment—whether equity, debt, or mezzanine (which, as the word suggests, offers a form of financing between debt and equity, such as a loan that is convertible into company shares)—a company can receive and at what cost. Indeed, significant research shows that the cost of capital is a key determinant of a firm’s long-term success.

The cost of capital becomes even more important if the goal is to expand employee ownership because rapid expansion requires outside investment. Indeed, while certain firms with highly paid workforces or altruistic owners may be able to self-finance and essentially “buy their labor back from their employer” (for example, an accounting firm that employs certified public accountants), the employees of most small businesses that could thrive as employee owned—such as a landscaping company or manufacturing plant—can’t afford to finance the buyout themselves.

There is a work-around for these businesses, but the traditional route requires a patient and oftentimes independently wealthy seller who is willing to delay their own exit by selling the business in tranches to its employees, often over seven to 10 years. For very many business founders, the decision to retire and sell their “baby” after decades of work will be one of the hardest decisions in their lives, and completing such a sell over the course of a seven-to-10-year process is simply not an emotional option, whether or not it is a financial option. This is to say nothing of the regulatory red tape that accompanies most employee-ownership transitions.

Absent a seller willing to go through the traditional process, expanding employee ownership in sectors where workers do not earn enough to be able to self-finance requires external investor capital. However, if investors do not understand employee ownership, have little experience of how it works, and are unaware of how conversions to employee ownership can be profitable for the investor at lower risk than traditional investments, then fewer investments will be made, and those that are made will be priced at an inflated cost. As a result, the opportunity to convert many businesses, as baby boomer owners retire, to employee ownership will be missed—resulting in lost jobs, lost local businesses, and a lost opportunity to achieve greater equity.

What can philanthropy do to help de-risk conversions? Three key interventions are to: 1) support and promote research and real-world examples that establish the strong financial performance of employee-owned businesses; 2) invest “catalytic capital”—this can take many forms, including “credit enhancements,” such as loan guarantees or capital grants to provide firms focused on employee ownership with the operational runway to fundraise; and 3) provide early, first-in capital.

2) Requiring a Focus on Racial and Class Equity

The above indicates how to make conversions to employee ownership easier. That is important, but without an explicit commitment to addressing race and class specifically, employee ownership will fail to narrow the racial wealth gap and income inequality. This means that the who of employee ownership matters as much as the what.

Employee ownership can only reduce income and wealth inequality if investments are made in firms that employ both a large number of workers of color and a significant number of low- and moderate-income (LMI) workers.

At the firm where I work, Apis & Heritage Capital Partners, we only care about employee ownership opportunities to the degree that they serve as effective tools in reversing the immoral trends that leave the majority of families in the wealthiest country on earth incapable of handling a $1,000 emergency expense, with trend lines indicating that, absent a change in how the economy functions, Black and Brown families are on track to fall below a median family household net worth of zero in the coming decades.

Employee ownership can be a powerful tool for interrupting this trend. Nonetheless, it is dangerous and erroneous to assume that employee ownership will inherently result in a fair and more equitable economy. Indeed, research shows persistent racial inequality within employee-owned companies. A 2021 Aspen Institute report, for instance, found that the average white employee-owner had a ownership share value of $63,000, while Black and Latinx employee-owners had an average ownership share value of less than $39,000. Now, $39,000 is well above the median Black household wealth of $3,600 or the median Latinx household wealth of $6,600 (2016 figures). Still, no one would claim that a $24,000 gap is equitable.

Moreover, when investment is made in the creation of employee-owned firms absent any goals to reduce the racial wealth gap, outcomes will likely reproduce the same systemic mechanisms that plague the traditional investment community, resulting in underinvestment and predatory investment in Black- and Brown-owned businesses and Black and Brown workforces and communities.

In short, to address systemic inequity while investing sustainably and profitably, it’s vital to demand not just the tracking of impacts, but the institutionalization of goals to reverse these trends.

3) Investing in Ownership Culture and Democratic Practice

Does employee ownership lead to good jobs? It can, but again, not automatically. Employees holding equity in the companies where they work does not guarantee quality jobs. While the alignment of company, worker, and investor interests through governance structures that are accountable to workers as both stakeholders and shareholders—a model that has been institutionalized in Germany—can help, decades of diminishing worker voice and influence coupled with extreme disconnects between company profitability and worker wealth will not be undone overnight. Investment in employee training and education to “think like owners”—internalizing their own fates with that of their business—and management and executive training on worker engagement and investment are key to creating firms where employee ownership doesn’t just mean having a low-quality job with an “enhanced retirement account.”

For these reasons, developing an ownership culture, democratic governance practices, and human-centered human resources are not just “nice to haves” but essential. Nonprofits can help ensure that firms invest in these practices. Our firm, for instance, has partnered with the Democracy at Work Institute to support extensive training to empower workers to engage fully as employee owners and to coach management on how to internalize and build on this culture. This training is designed to cover a variety of topics, including “open book management,” a practice of sharing key company financial information with every employee at the firm; democratic governance, enabling workers to vote for representation on the companies’ boards of directors; and a variety of human-centered human resources practices.

Can Employee Ownership Be Both Profitable and Beneficial for Employees?

One may ask whether investment into matters like an ownership culture pays off. The answer is, it does. A significant body of research—both quantitative and qualitative—shows that engaged workforces have lower turnover and are more productive. This in turn creates companies that are more resilient during economic downturns, even as they grow faster and are more profitable during good times. Indeed, as the pandemic and the newest generation of workers are showing us—better said, reminding us—investment in people is the best way to build a business.

Again, employee ownership models, whether visible or invisible to the broader US economy, will always exist, both through worker cooperatives and companies owned by employee stock ownership plans. However, existence is not the most important question facing employee ownership.

The reality is that employee ownership—if widespread—can be a vital tool for reducing the racial wealth gap. The reason for this is simple: business asset ownership in the United States is presently distributed in an astonishingly unequal manner. Economist Ed Wolff, drawing on data from the Federal Reserve’s 2019 Survey of Consumer Finance, reports that the top one percent own 36.9 percent of all stock (even when accounting for retirement holdings), 54.9 percent of direct stock and mutual fund holdings, and 64.5 percent of business equity. Distributing business equity among all workers through employee acquisitions of strong companies from retiring founders—a strategy that that is commonly called an employee-led buyout—could dramatically change those numbers.

Nonetheless, without intentional and strategic investment by both public and private actors to promote greater race and class equity, employee ownership will fall far short of its potential. That would be a shame because the need to create an economy that is democratic, equitable, sustainable, and resilient has never been more urgent.

Todd Leverette is co-principal of Apis & Heritage Capital Partners and program manager of Legacy Business Initiatives at the Democracy at Work Institute.

Note : This article was originally published by Nonprofit Quarterly (NPQ) on October 5, 2022, Used with permission.