How can employee ownership reduce wealth inequality? We talked to Jon Shell, Managing Director of Social Capital Partners, to learn more about the “leveraged employee buyout”.
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The richest 26 people on earth own as much wealth as the poorest 3.8 billion. The wealthiest 10% control 84% of global wealth. Meanwhile, 4.8 billion people fight for just 2% of the entire world’s capital.
Reducing wealth inequality is possibly the biggest moral imperative of our time. It also happens to be one of the largest threats to global peace and geopolitical stability. So, what can we do to fight it?
Organizations around the world are exploring solutions to the problem. Social Capital Partners (SCP), a Canadian-based organization focused on broadening opportunity, has narrowed in on one tactic that they think could be a game-changer: employee ownership.
On this episode of the Impact investing Podcast, we caught up with Jon Shell, Managing Director and Partner at SCP. After years of experience in the private sector, Jon started to realize the impact of his role on the economy at large. That’s when he joined forces with Bill Young, founder of SCP, to work towards a balanced and fair economy for all Canadians. (Learn more about SCP in Episode #1 with Founder Bill Young)
What exactly does this work look like? And how can employee ownership help? We explored all of these questions (and more) in our conversation with Jon.
What is wealth inequality?
Around the world, money is not distributed fairly. The majority of people face countless barriers to capital and good-paying jobs. However, wealth inequality is often confused with income inequality. This causes organizations and governments to focus on income issues only, like tax cuts and universal basic income. These initiatives are important, but they don’t address the whole problem.
With everyone else focused on income, SCP has chosen to focus on the other two subsets of wealth inequality: capital and ownership. Jon says that, without finding solutions for all three, inequality will continue to grow.
“If we can’t broaden ownership, we can’t affect wealth inequality. Inequality can’t be fixed through government programs alone. So, how do we create other programs that can reduce that inequality through creating opportunity?”
SCP has an interesting history where the organization’s focus has shifted many times. Perhaps what defines the organization best is its goal to achieve impact at scale and its willingness to completely pivot away from years of hard work if it isn’t producing big enough results.
SCP started by funding and supporting social enterprises. Next, they pivoted to lending money to small businesses in exchange for them hiring from local community service agencies. This initiative led to 500 jobs created for people facing barriers to employment. Not too shabby.
But SCP wanted to figure out how they could scale the success of these initiatives through governments or banks. After several years of trial and error, their most recent pivot sees the organization laser focused on employee ownership.
How does employee ownership work?
An Employee Ownership Stock Plan (ESOP) is a mechanism that allows employees to receive or purchase shares in the company they work for. In this way, it is a means of transferring and equalizing wealth.
The process involves business owners selling their shares to employees. This grows employee wealth while providing incentives for the company, like tax cuts and enhanced corporate culture.
ESOPs are far more common in the US because there is an entire infrastructure built around it. The result? 14 million Americans sharing in $1.4 trillion of wealth at the 6,600 employee-owned companies in the US. Here’s how it works.
If a company is worth $50 million, the owner essentially loans $50 million to the employees (typically with the help of a bank). Then, they get paid back over time through cash flow and the share price goes up. The US ESOP is distributed in an equitable way so that any level of employee at any point in time can participate. When employees finally leave the company, they get paid out based on the wealth they’ve accumulated.
This is a huge opportunity for alleviating wealth inequality in America. According to Jon, the average employee ownership worker has 92% more wealth than someone at a non-employee owned company. Plus, employee ownership provides three times more wealth for people of colour in the US. The trouble is, ESOPs are still not as common as they should be in the US. According to Jon, about 4,000 to 5,000 companies get sold to private equity investors each year while only about 200 to 250 are sold to employees. This happens because owners of these companies can get more money if they sell to private equity investors rather than to employees.
ESOPs exist in Canada but are far less common and far more limited. Instead of offering ownership to all employees, most Canadian ESOPs only extend ownership to upper management, usually as a reward for hitting a certain performance target.
“How do we be more resilient? How do we be more inclusive? Here in Canada, that's a conversation we're trying to have, but it doesn't just happen. You have to actually do things that create different mechanisms for that to be true. And employee ownership is absolutely proven to be one of those mechanisms.”
What is Social Capital Partners doing to help?
SCP is working in the US to find ways to provide more flexible debt for companies that would like to sell ownership to their employees. This would provide more leverage to employee-sold deals, significantly narrowing the gap in profitability between selling to private equity or selling to employees.
One of the ways SCP hopes to do that is by convincing pension funds to provide the flexible financing necessary to fund these Leveraged Employee Buyouts. (Shortly after our interview with Jon, SCP announced it had completed its first pension-financed LEB for Taylor Guitars - a US based brand with 2,000 employees)
In Canada, SCP is working to create awareness of the issue. They are collaborating on an inclusive wealth agenda for the Canadian government and they recently produced an extensive public policy report to support the move towards an employee ownership economy. Politicians across Canada are taking note of the clear benefits for all parties.
“It’s good for local economies because employee-owned companies don't tend to leave, right? They don't focus on consolidation or scale. They stay in their local communities. The rewards for owners, the obvious wealth benefits for employees, and the resiliency of the company. All of these things are super important to an inclusive wealth agenda.”
Eventually, SCP wants to work with pension funds to finance Leveraged Employee Buyouts north of the border, too. Once they can fill in the cash flow gaps, that uneven ratio of private equity to employee-owned businesses should start to balance out and perhaps even flip toward employee ownership.
To learn more about employee ownership and what Social Capital Partners is working on next, go to www.socialcapitalpartners.ca.