Ownership — For a While
In April, a new employee ownership organization, Ownership Works, was announced in the Wall Street Journal. The really novel aspect of this is that it is sponsored by Peter Stavros, a major figure in the private equity firm of KKR. They even claim that they are a “movement”:
Ownership Works is uniting the private, public and nonprofit sectors in a movement to expand shared ownership across the business community. Over 60 prominent foundations, corporations, labor advocates, investors, and pension fund leaders have made unprecedented commitments of expertise, resources and influence to increase adoption of this innovative strategy. Together, we’re developing and deploying new models of shared ownership for public and private companies that create financial opportunity for all employees and build stronger businesses in the process.
Private equity (PE) usually operates by buying a company, usually with borrowed money, moving the debt to the purchased company, making a number of changes in the company to increase short-term cash flow (e.g., eliminating R & D departments, trimming budgets, and reducing employment wherever possible), paying off the loan, and then selling the “streamlined” company for a price that represents big profits for the PE firm.
The new ingredient in the Stavros recipe to make the purchased firm more profitable is to establish a broad-based employee ownership program, complete with programs for an ownership culture that have been shown to improve profitability.
What are employee ownership (EO) advocates to make of this new initiative?
On the good side, this should at last answer the EO skeptics who always ask: If EO makes firms more profitable, why aren’t there more of those firms? Obviously, market competition has selected against them.
If PE is betting on employee-ownership + ownership-culture to improve profitability, then who are the armchair skeptics to differ?
Of course the real answer to those skeptics is that the choice of legal form of a company is determined by the founders, long before market competition has any say.
For solidarity-minded folk, the critical “founder’s choice” is: Should we set up the company to share all future profits and decisions with the future workers? Or should we keep those ownership rights in the founders’ hands and hire all future workers as simply employees? That is the real choice that leads to the current distribution of types of firms.
A little investigation into the Stavros-inspired Ownership Works plan generates a number of dubious aspects from the viewpoint of employee ownership:
- Under this time-constrained approach, the employees’ status as owners is necessarily temporary since PE operates through temporary funds that are liquidated after five or so years. What does so-called “ownership culture” mean in that context? ESOPs, by comparison, are typically set up in private companies to perpetuate EO, since the ESOP eventually buys back an exiting employee’s shares and recycles them to the current employees.
- The Stavros scheme hence does not use ESOPs, which by far are the most common form of EO in the U.S., with around 7,000 ESOPs covering 10% of the private workforce. Instead, the Stavros approach uses special restricted share grants to the employees which will be liquidated when the firm is sold in a few years by the PE firm. Free share grants also bypass the ESOP mechanism wherein the employees at least partially earn their shares through creating the income that goes as the contribution to the ESOP to pay for those shares.
- The 19 PE firms that are partnering with Ownership Works are not required to use restricted stock grants as opposed to ESOPs. But as PE firms, they need to liquidate their current fund’s portfolio in a few years so many may well follow Stavros’ example.
- The 19 PE firms in the “movement” are offering to develop at least three EO schemes by the end of 2023. The rules for a qualifying scheme are not yet clear but its seems that the grants will be “broad, providing all employees with the opportunity to become an owner; meaningful, providing the potential to earn at least half of an employee's annual earnings; and free, for all employees who earn less than $100,000 annually.”
As employee ownership becomes better known, it is to be expected that the current “powers that be” will find ways to exploit it and to subvert its long-term goals. It is early days yet, but it appears that the Ownership Works group of PE firms is fitting into that pattern.