Why employee ownership is the next big thing in impact, and America, with Jack Moriarty

From the newsroom of Impact Alpha, I'm Brian Walsh, and this is your impact briefing for Friday, May 26th. Happy Memorial Day weekend to our American agents of Impact. On today's show, Jack Moriarty of Ownership America speaks with Impact Alpha's David Bank about employee ownership and new legislation. Designed to help investors back companies that are turning workers into owners. If you're going to focus on economic mobility and addressing economic disparity, equity ownership has to be part of that strategy. But first, here's what you need to know from this week in Impact Investing. Mui bonds are going social. The city of Philadelphia is issuing social bonds of nearly $100 million to fund affordable housing and commercial revitalization as part of the city's neighborhood preservation initiative. The bond is the latest to be highlighted as part of our ongoing collaboration with Hip Investor on upcoming bond issues with social and or environmental significance. Social bonds have recently attracted impact and ESG investors to the $4 trillion Muy bond market, increasing demand and lowering borrowing costs for cities. Can Appalachia become a climate haven? With its forests, water, and biodiversity, Appalachia's hills and hollows could be a refuge for climate migrants fleeing rising sea levels in coastal areas. That's according to Invest Appalachia, which is raising a philanthropic investment fund for the region. To become a climate haven, however, the region needs investment in affordable housing, community health, and economic development to be able to welcome and prosper from the influx of newcomers, according to a new report. Gender equality, especially in agriculture, may just hold the key to climate resilience. Author Isha Chhabra writes in her new book Working to Restore, harnessing the power of regenerative Business to heal the world. Chowbra tells the story of female farmers in India, Kenya, Uganda, and Nicaragua who are using organic and regenerative techniques like mulching, intercropping, and cover crops. You can read the full book excerpts on Impact Alpha. And in Utah, workers at a chain of 4 auto body repair shops have been getting a bonus in their paycheck, a share of the company's profits. The company's shareholders last August transferred ownership of the 25 year old chain of shops to a perpetual purpose trust that elected to introduce profit sharing for employees. Common Trust, which advises and finances companies pursuing such transitions, helped design the perpetual trust of software company Code Weavers, which announced its conversion last week. The founder of Patagonia adopted its structure last year, and Michael Bloomberg is considering moving Bloomberg LP into a purpose trust to finance Bloomberg philanthropies. And speaking of employees, it's time for David's feature conversation with Jack Moriarty, founder and executive director of Ownership America, a nonprofit policy and research outfit that aims to turn Americans into owners. Let's jump right into their conversation. Jack, you've been one of our guides and teachers on this, um, whole set of issues around worker ownership and employee ownership, which seems to be having a a a kind of moment. Uh, Jessica Rose at the New York Federal Reserve Bank event the other day called it the next big thing in impact investing. Um, maybe even the next big thing in America, I think you might say, but what do you describe this kind of, kind of a boom in interest in in worker ownership? It's an unbelievably exciting time for this issue area, and I agree, David, it really is starting to pick up steam, so I couldn't agree more with Jessica. I think there are a couple of factors at play that are really feeding this momentum. The first is, I think there's been a realization that if you're going to focus on economic mobility and addressing economic disparity, equity ownership has to be part of that strategy. Of course we need to focus on wages and benefits. Those are necessary, but they're ultimately insufficient. We really need to find what are the Opportunities to broaden the distribution of equity ownership, and employee ownership happens to be one particularly powerful and bipartisan strategy of doing that. The second factor I'd say is we have this this demographic opportunity that I'm sure your listeners have heard of called the Silver tsunami. This is the generational opportunity as baby boomers start to exit their businesses en masse, and there's just unbelievable market opportunity. Nearly half of all privately held businesses are owned by Baby boomers and they employ over 30 million workers. And so the question that we ask in Ownership of America from a policy perspective is what's going to happen to those businesses when they're sold? Can we position employee ownership as an alternative succession plan and we know when that happens it's an opportunity to preserve and create high quality jobs that build retirement wealth and create financial outperformance for those businesses. Now you say an alternative. Now the alternative, what the alternative is to is generally either. Um, private equity ownership or maybe the competitor buys it or in some cases the owner just shuts the business down and there's often a going healthy revenue generating business that could not only continue providing jobs but also continue providing, you know, services, goods and services. No question about it. And, and that's not to say that those alternatives are always uh problematic, but I, I think broadly speaking, we know that jobs can be, uh, you know, exported out of the community. There can be a loss of, of community, regional domestic investment. And so, you know, we really focus on employee ownership as a way, as you say, to preserve those assets and to preserve those jobs and investment in in local communities. And what I think is exciting is that it's not necessarily zero sum to traditional sources of institutional investment like private equity. I mean, we'll we'll get into some of the investment opportunities here, but we really feel that employee ownership can be an additive tool as part of a broader investment platform tool. OK, whether that's an existing private equity or private credit platform, we view employee ownership generally and the ESOP investment strategy in particular as something that can be additive to those platforms that can enable optionality both for investors but also for sellers that may want to preserve the intrinsic legacy of their businesses that may want to reward their employees for their role in that value creation, and we know that employee ownership can be an opportunity to do that. Let's just make this really basic. You talked about the investment opportunity. What is the capital need in an employee ownership transition and why is there a shortage of such of such capital? Employee ownership is not a new idea. It's actually been around for a long time. We've got ESOPs in ERISA in the 1970s, and since then we have about 6500 or so ESOP companies, most of which are privately held. But there's been a ceiling on that adoption, and the core reason for that is there's this absence of capital. There is this capital gap, and what that looks like is that most SOP transactions and this applies to worker cooperatives as well. It's a shared problem. Most of these transactions require a substantial subordinated seller's note. So for example, the commercial bank might come in and lend, let's say 30% of the transaction, and there's often, you know, 50, 60%, even 70% of the remaining financing in the capital stack is taken back by the. And that's worked really well for sellers that are comfortable with a long-term payback period that may not be ready to fully exit the business, but it hasn't been attractive for most sellers that want their liquidity and want a true efficient exit. And so the policy problem to be solved from our perspective is, well, how can we mobilize private investment to replace or at least substantially reduce. The position of the seller in that capital stack. And we've seen a number of funds come into the market to do just that, to functionally behave like private equity, to participate in auction processes, to come in with scale capital and say we will provide you that liquidity and to get into the weeds a little bit, it's actually, it's functionally private equity, but it's really more Structured equity subordinated debt with some minority equity upside, usually through a stock warrant position. And so what that looks like is the seller is able to experience the kind of exit they might otherwise from an institutional buyer, but instead of a typical sale, that transaction is typically a 100% ESOP transaction. As the note is paid off over time by the company, which is now in the case of an ESOP tax-free if it's a Lex S Corp status. The stock is allocated proportionally to the full-time worker. So you can think about this, David, almost like paying off a mortgage. The employees, to be clear, are not paying anything in. It's all being financed by third party investment, but as the company pays back that leverage over time, stock is getting allocated to individual employee accounts. So when those employees retire, it can be a tremendous source of wealth and value creation. Now the company, just to be clear, the company has to pay back this financing from its revenues. Is that a burden on the company? Does that disadvantage the the company vis a vis other Investments they might make and are they, is there, is there a downside to this? One of the core tax benefits that's already in place I alluded to earlier, is that 100% ESOP Scorp companies pay no federal income tax. And so what that does, David, is really provide some flexibility from the standpoint of free cash flow for companies to take on that leverage and pay it off over time. And that's where you, you have this opportunity again because employees aren't paying anything in, you're taking an asset in this case the company that's generating income, that's generating cash, and using that to amortize the loan used to purchase the stock on behalf of the workers. And so It's been a tremendously powerful and successful model to do that. Now, to be clear, it's not a clear fit for every company. You tend to be looking at mature companies with stable cash flows, and those are the kinds of companies that can appropriately deal with that leverage and pay back those investors over time. OK, as you said, there have been a number of of funds we've written about Apis and Heritage. I think folks know about that has come out in recent months and and and and maybe a handful of others, but there's not enough funds um and not enough capital, I think, as you said, to really finance all of the companies for which this might be appropriate, especially as you said, there's this demographic wave of of aging baby boomers um and and those owners may want to get their exit. So what is the policy. Solution you've been working on. Ownership of America has advised closely and really been a policy development partner on recently introduced bicameral bipartisan legislation, and that's called the Employee Equity Investment Act or EEIA. And the, the underlying concept of EEIA is that historically we've used credit enhancement to enable families and individuals to purchase assets that they might not otherwise be able to afford. And, and the classic example here is home ownership. Before the Great Depression, we had a very different mortgage market, very low uptake on home ownership, and what we did is we entered that market with credit enhancement. We guaranteed mortgages, we created secondary markets, and the result of that is we opened up a whole new source of asset building opportunities for for American homeowners. The idea of the Employee Equity Investment Act is to take that playbook at a high level and apply it to the acquisition of companies, to apply it to the need for if workers and managers generally don't have the capital to purchase their businesses when they're up for sale, then how can we deploy the federal. Credit enhancement toolkit to help enable that. And so what the EEIA does is it takes an existing program at the Small Business Administration called the Small Business Investment Company program. It's a program that's been around since the 1950s. It's actually credited with helping to catalyze the early American venture capital industry. And what that program does is it enables private funds to have access to low cost federally guaranteed debt. So the way this works in practice, David, is let's say you're going to stand up a fund, we'll call it the Impact Alpha Fund 1, and you're going to go raise, let's call it $50 million of private capital from from your LPs. You then go to SVA, get underwritten, apply for a license, and when you receive that license, you can be eligible to get access to up to an additional $100 million of capital on your balance sheet. And so what does that do? That obviously gives managers more capital to deploy. It subsidizes the return profile for those private investors and in return for that benefit. SBICs need to go invest in small businesses and so that's been a very powerful driver. The kicker is that it operates the entire program operates at what's called zero subsidy cost, meaning it doesn't cost the taxpayer anything by way of their appropriation, which is very fiscally competitive. So what we've done with the Employee Equity Investment Act, and I should say this is co-sponsored by Senator Chris Van Hollen and Marco Rubio in the Senate on the House side, Representative Dean Phillips. And Representative Blake Moore of Minnesota and Utah respectively. We've got a great group of additional co-sponsors on both sides of the aisle in both chambers, and what the EEIA does is it would stand up an adjacent credit facility of $5 billion right next to the existing SVIC program. But instead of a generally flexible pool of capital for small business investment, this pool of capital would be available for funds that are investing the bulk of their capital to create, grow, and sustain employee-owned companies, and that's how we're trying to attack this capital gap that's preventing employee ownership from really scaling. And though so by making low cost capital available to fund managers, that you would incent them to come into this market that um has these positive characteristics, but they might not have gotten into, and there would be then not a handful of funds helping finance employee buyouts, but um hundreds or or thousands of funds. Is that the idea? That's exactly right. That is no question the aspiration. We have seen this early stage innovation in the market with these funds, but you can generally count them on one or two hands. And so the question is, well, how do we really scale that up and use the federal toolkit to catalyze that, that investment. Model in the marketplace. What's really important is that there are a couple of barriers to this investment model scaling, and the first is, if you think about it, David, it's an investment model that's inherently diluted. So you're taking third party capital. This is very much at risk capital. It's very subordinated in the capital stack, and you are transferring a majority of the economic value of the business over time to the employees, right? So that subsidy through this low cost debt. approach helps to subsidize and make whole those investors to make this a very competitive, not only an impact thesis, but also a competitive source of market rate return. And that's really, I think our, our philosophy on how do we, how do we push markets to make them more inclusive to and scale impact. You really need to use public policy in tandem with capital allocation to create the kinds Markets that will intrinsically reward impact. So that's really the theory behind this idea. And the second is that at least with the ESOP, it is, you know, it has some complexity to its structure. It's, it's ERISA regulated. It has some features to it that are a little bit unusual relative to your traditional sponsored transaction. And so, you know, part of what we see here is an opportunity not only to overcome. A financial return hurdle and make this attractive for investors, but also a complexity hurdle for managers. I think some of the listeners may agree that there's complexity to this when they listen to the acronyms that you've slung around from ESOP to ERISA to SBICs, but it's clear that you understand the nuances and the details of this quite well. What I want to take you back up to a higher level is you seem to have a policy issue area that both helps low income. And and other workers, um, has bipartisan support, and then as you said, is a 00 cost to taxpayers, at least over over time. Um, uh, sounds like a, you know, the trifecta of policy winners. Um, how do you think it's gonna play out over the next few months? Well, first I'll, I'll give you a quick story on, on the coalition. We've done some work at the state level as well, and, and we worked with a group down in Texas, an ESOP company that was successful in getting employee ownership into the Texas GOP state party platform. Fast forward a few months, we work with partners up here where I'm based in Massachusetts to get a similar outcome in the Massachusetts Democratic Party platform. And you might imagine there's very little overlap between those two documents, but employee ownership is a source of of agreement, and I think that's representative of the kinds of coalitions that can be built around this issue. And I don't think it's hard to see why. From, from a conservative standpoint, this is, this is not redistribution. This is a voluntary market exchange that is preserving capital often in rural areas that might otherwise lose it due Bus succession. It's also a financial outperformance opportunity. If we're going to create resilient supply chains, if we're going to outperform our international competitors, employee ownership is a source of competitive advantage and it helps us preserve our productive capacity, which, as we've seen during the pandemic is so critical. And, and on the more progressive side of the of the house, this is an opportunity to broadly Economically enfranchised workers and to close wealth gaps and really be a source of agency and opportunity and mobility for low and moderate income workers, including workers of color. So it's been such an exciting issue to work on because it can authentically address so many different policy priorities across the political spectrum. In terms of where we go from here again, we have wonderful co-sponsors with Senator Rubio and Senator Van Hollen. And the next few months will be very likely bringing on additional co-sponsors in both the House and Senate. We've got great advocacy partners helping us as well. And from there, typically how this goes is, is there will be, uh, you know, ideally a hearing scheduled and then bills will move to committee markup and then you look to to see if you can try to, to get it passed. And so you know that will take, uh, you know, it's difficult to, to project from here but um you know, We have an opportunity, I think, even in a divided Congress, this is probably one of those few issues that can generate bipartisan support. Last question for you, Jack. How did you get to be the, the national expert on worker on worker ownership? What, what, what brought you into this? Well, I got to know a lot of other experts that have come before me, but in all seriousness, I got excited about this issue right before I was going to business school, and I was looking for answers to the question of how do we create a more inclusive capitalism? What are the policy opportunities that are available to help make that happen. And employee ownership really came up. I saw Senator Gillibrand give a talk 5 or 6 years ago now and she highlighted this idea and it really had never crossed my radar screen. The more I dug in. The more I got to know the field and the research and the companies and the investors that were that were part of this movement, the more convinced I became that there's a real transformative opportunity here. And, and if we can solve these capital gaps and use public policy to help make that happen, we can really, we can really scale this, this opportunity and create a much more inclusive, resilient, dynamic capitalism and that's, that's why I get up and do this work. Well, that's so interesting, Jack, and I've heard that sort of aha moment uh around worker ownership now from at least a half dozen folks that I that I talked to, and I think that there's going to be many more that are gonna sort of wake up to the, to the opportunities and to the possibilities. Um, so we'll be tracking the, the bill, we'll be tracking your work, we'll be tracking the funds, and uh we'll be tracking the, the trends and, and we hope you'll come back again and, and let us know how it's going. So thank you very much. Thanks so much, David. A appreciate it. And that's going to do it for this week's Impact briefing. You can read more about all of these stories at impactalpha.com. Thanks to Jack Moriarty, David Bank, and our producer extraordinaire, Isaac Silk. Ready to try Impact Alpha? Sign up for Impact Alpha Open, totally free directly at impactalpha.com. Want to go deeper, grab a subscription and get full access to Impact Alpha, including the award winning morning brief and our popular agents of impact calls. Just go to impactalpha.com/subscribe and choose an annual subscription. I'm Brian Walsh. Be sure to check back for next week's briefing, and until then, take good care.