As Baby Boomers Reach Retirement, Can Employee Buyouts Keep Small Businesses Open?

About 10,000 baby boomers turn 65 every day, fueling a retirement surge unlike previous generations — including a “silver tsunami” of retiring business owners who are faced with succession and ownership questions.

At stake is not only billions in wealth, but millions of jobs. Boomers own 2.34 million U.S. companies with payrolls of almost $1 trillion for their 24.7 million employees, according to data from Project Equity, a nonprofit that promotes employee ownership. Six out of 10 of these boomer-owned business will be sold, in some cases to private equity firms or rivals, which increases the likelihood of layoffs or relocation. Many others could shut their doors.

But several experts and advocates are pushing a different exit for these boomers: Let the employees buy you out.

“Selling to your employees benefits not only the owner, because they will get compensated for the fair value of their company, but it will benefit their employees,” says Bill Castellano, executive director of the NJ/NY Center for Employee Ownership. “From a community perspective, it clearly keeps the company based where they are. It’s a win-win-win.”

Employee buyouts aren’t new, of course. Employee stock ownership plans, or ESOPs, have been around since the 1950s, when an economist developed the vehicle to allow a newspaper’s employees buy out its owner. Today, they’re the most common type of employee ownership plan, with about 5,800 across the U.S. But another type of employee buyout is gaining in popularity, so-called worker cooperatives.

Experts say employee buyouts are worth a closer look, especially given a new provision in the defense spending bill that gives the greenlight to the Small Business Administration to lend money for employee buyouts. That could pave the way for more of these ventures, since securing funding is one of the hurdles facing small business owners and their employees, says Castellano.

Buyout benefits

Employee buyouts have a number of benefits, Castellano says. For starters, employee ownership helps build wealth for low- and middle-wage workers who typically wouldn’t own a stake in a business. The average ownership stake in an ESOP is about $134,000, or about one-third higher than the average 401(k) balance of about $100,000.

That’s important at a time when incomes for most workers have stagnated, he adds.

“People accumulate wealth through equity,” Castellano says. “It’s hard to accumulate it through income, particularly if it’s not growing much over the past few decades.”

Employee buyouts also tend to be less stressful for employees than a sale to a rival or private-equity firm, given that these strategies can increase the risk of layoffs or relocation. And ESOPs come with significant tax advantages, which can make them attractive to both owners and employees.

The basics on buyouts

ESOPs tend to be utilized by companies in the 50- to 500-employee range, Castellano said. They can be created to buy out a minority stake from a co-founder, or to purchase the equity of an entire business.

Worker cooperatives tend to be used for businesses with fewer than 100 employees, says Alison Powers, program officer at Capital Impact Partners, a lender to businesses including worker cooperatives. Cooperatives involve a complete buyout of the owner’s interest, and the board of directors answers to the new employee-owners.

One of the first steps is to conduct an objective valuation of the business, Castellano says.

In an ESOP, the new owners create a trust that will buy the owner’s stake. The venture secures a loan, using the business as collateral, which will pay the owner for his or her stake. Over time, the business repays the loan. Employees don’t have to invest their own money in the buyout, unlike worker cooperatives.

Employee buyouts often appeal to business owners who are concerned not only about succession, but about providing security for their employees and community, Castellano says.
Some business owners have “become successful because of a core group of employees that have been with them for a significant period of time,” he adds. “They do want to take care of their employees.”

“It’s not a cut-and-paste thing like 401(k)s.”

That’s the case for Harpoon Brewery, which converted to an employee-ownership structure through an ESOP in 2014. The catalyst was the desire of one of its co-founders to sell his stake and move onto other ventures, yet he wanted to ensure the stability of the business, says Rich Ackerman, the director of human resources at Harpoon Brewery.

Lessons of an employee buyout

But jumping into an ESOP has a steep learning curve, recalls Ackerman, who joined Harpoon early in the process of creating the employee buyout.

Pitfalls included learning how to effectively communicate the ESOP structure to employees, Ackerman adds. Harpoon also relied on experts to help with everything from compliance to internal communications, while Ackerman notes he also turned for advice from other brewers who had previously switched to an employee-owned format.

“It’s not a cut-and-paste thing like 401(k)s,” Ackerman says. Harpoon created a system where every worker was eligible to receive shares in the ESOP, yet the qualifications differed depending on the type of worker. For instance, part-time workers need to log 1,000 hours to qualify for the plan, he says.

“That was a real struggle for us, to communicate to them that they are part of it,” Ackerman says of part-time workers.

Relying on experts

Because of the complexity of ESOPs, it’s important to have a strong team to help with legal, compliance and tax issues, including third-party experts like ESOP administrators, Ackerman says. And he adds the companies need to be prepared to spend more money during and after the process of converting to an ESOP.

“You have to make sure every “i” is dotted and “t” is crossed,” he says.

Part of the process is fine-tuning how to communicate the culture of employee ownership to workers, he adds.

“When we first became an ESOP, we’d say, ‘You’re getting free money because you will be part of an ownership of an independent craft brewery,’” he recalls “But they would say, ‘Could you give me more money or vacation instead of an ESOP?’ What’s more successful is someone who understands the benefits of ownership.”

The rise of worker cooperatives

Worker cooperatives aren’t as widespread as ESOPs, but they are an increasingly popular option, says Capital Impact Partners’ Powers. There are about 400 worker cooperatives in the U.S. that employ about 6,800 workers, according to a study from the Democracy at Work Institute, a think tank that focuses on the topic.

“A lot of these folks don’t have anyone to sell their businesses to and so they end up closing, and as a result good jobs are lost and communities are left without services.”

A cooperative can be financed a number of ways, such as through a loan, but it also includes an investment from the workers themselves, although it might be a small portion of the overall capitalization. “It’s critical to have skin the game,” Powers says.

From a lender’s perspective, a promising worker cooperative should not only have a viable business model, but work with local partners that can help them build their management structure, including board and voting structures and conflict resolution, Powers adds.

“All these factors can contribute to the success or failure of a cooperative, in addition to the hard business skills,” she says.

As for the silver tsunami of retiring business owners, Powers says it’s already arrived.

She says, “A lot of these folks don’t have anyone to sell their businesses to and so they end up closing, and as a result good jobs are lost and communities are left without services.”