Reducing racial wealth inequality and preserving beacons of hope through employee ownershipMay 27, 2021 Category: Featured, Long, Purpose
DisclosuresThis guest column was written by Sean Tamba-Matthew, shareholder at Stevens & Lee/SES ESOP Strategies. It was originally published in ImpactPHL Perspectives.
In 2019, Darrick Hamilton and three other researchers and policy analysts authored a report entitled “Ten Solutions to Bridge the Racial Wealth Divide.” The report proposed various solutions to reduce the racial wealth gap, including guaranteed employment coupled with a significant increase in the minimum wage, baby bonds, Medicare for all, postal banking, and a Congressional committee on reparations.
Hamilton, director of the Institute on Race and Political Economy at the New School, stated correctly that the stark racial wealth gap in the United States was “historically created through unjust mechanisms.” As has been recently chronicled in the Philadelphia Inquirer, for instance, Philadelphia’s status as the poorest large city in the United States can be directly tied to, among other things, discrimination in opportunities for well-paying jobs and historically and drastically underperforming schools.
While the compelling proposals suggested by Hamilton and his colleagues have the potential to meet the objective of reducing the racial wealth gap, the chances any of those sweeping initiatives being adopted is remote given that the bi-partisan support required to make them the law is, to date, non-existent. Moreover, the harmful economic effects of the COVID-19 lockdowns have only exacerbated and made ever more urgent the need to enhance the fragile financial conditions of low-to-moderate income Black and brown American workers.
The same is also true of business owners of color throughout the country. Research from the National Bureau of Economic Research demonstrated that the number of African Americans business owners dropped by 41%, and the number of Latina business owners fell by 32% as a result of the COVID-19 pandemic. And for those businesses that survived the pandemic and are owned by people of color, such survival may be short-lived. According to a survey detailed in a report published by the National Urban League and the Democracy at Work Institute, 76% of the business owners of color surveyed did not have a written succession plan. A majority of them have never discussed how they would exit their businesses. Such business owners put at immediate risk the opportunities to pass wealth to later generations of their families and ensure that jobs are retained in the communities they operate.
From our Partners
The daunting task of reducing the racial wealth gap and preserving the beacons of hope provided by successful minority-owned businesses in the United States requires immediate action and cannot wait for the highly unlikely passage of more sweeping policy changes. There is, however, one underutilized solution for addressing these issues that is available now: an employee stock ownership plan (“ESOP”).
ESOPs can be a vital tool for increasing the wealth of Black and brown workers while providing the region’s business owners with an opportunity to get liquidity at fair market value from their businesses and diversify their assets. Some of the largest privately-held companies and the United States are ESOP-owned, like Wawa, Publix Supermarkets, W.L. Gore & Associates, and Sheetz. Additionally, many recognizable local companies are also ESOP-owned, including NewAge Industries, Pennoni, American Refining Group, and Graham Company. Altogether, ESOPs hold over $1.4 trillion in assets and have just over 14 million participants. By building on the example of the employee-owned companies throughout the region and the country, Philadelphia’s stakeholders can begin to close the racial wealth gap and preserve successful legacy businesses by promoting and supporting employee ownership through ESOPs.
What is an ESOP? Structure and impact
An ESOP is a tax-qualified retirement plan that invests primarily in the employer’s stock. ESOPs were formally enabled by the Employee Retirement Income Security Act of 1974, as amended and then expanded through numerous positive changes in the law in the following decades. Through an ESOP, business owners gain liquidity from their companies by selling their ownership interests to the ESOP. Typically, an ESOP transaction is funded with debt financing obtained by the company and secured primarily by the assets and equity value of the business.
ESOPs do not merely provide business owners with an opportunity for liquidity; they are also conduits for transformative impact for employees, companies, business owners, and the communities in which they are established. For business owners, an ESOP eliminates the need to undergo a full sale process to sell a business and can be designed and established within six months through an owner-directed exercise. In contrast, a full sale process typically takes more than a year, often does not result in a viable offer, and frequently ends with selling owner-operators sidelined after the sale of their companies to traditional third-party buyers. In addition to enjoying an owner-driven process, a business owner who sells to an ESOP can be eligible for federal capital gains tax deferral for ESOP sale proceeds reinvested in certain securities of U.S. operating companies. Those owners who want some liquidity while maintaining control of their businesses are eligible for capital gains tax deferral as long as they sell at least 30% of the company.
ESOPs provide companies with several tax advantages, too. For instance, contributions to an ESOP, within limitations, are tax-deductible. Furthermore, a 100% ESOP-owned S-Corporation does not have to pay federal or, in most cases, state income taxes. Allowing it to use the additional free cash flow to pay down transaction debt, invest in growth, make acquisitions, or enhance the benefits received by employees.
In addition to significant tax advantages, ESOPs provide companies with a valuable tool for growth and stability. Data assembled by the National Center of Employee Ownership shows that ESOP companies increase sales by about 2.3 to 2.4% per year and see a 4 to 5% increase in productivity in the year after an ESOP is adopted. Additionally, ESOP companies have 25% higher job growth than comparable companies without an ESOP and are 25% more likely to stay in business.(11)
For Black and brown workers in Philadelphia, participation in ESOP provides an opportunity for increased wealth, higher income, and stability. ESOP participants were four times less likely to be laid off during the 2008 and 2009 recessions. Companies that were majority-owned by an ESOP were three to four times more likely than non-ESOP companies to retain staff at all levels during the COVID-19 pandemic. Employees at ESOP companies have 2.5 times greater retirement accounts than comparable employees at non-ESOP companies. A recent study published by Rutgers University, Building the Assets of Low and Moderate Income Workers and their Families: The Role of Employee Ownership, demonstrated that the Black ESOP participants surveyed had three times the median household wealth of African Americans nationwide and that the Latina ESOP participants surveyed had 12 times the median household wealth of Latina households nationwide. A recent report from the Aspen Institute, Rutgers University, and the Democracy at Work Institute highlighted research that demonstrated that, in addition to the economic benefits of employee ownership, ESOP employment was associated with decreased depression for both formerly incarcerated and non-incarcerated ESOP participants.
Creating new employee owners — obstacles and opportunities
Given the significant benefits of employee ownership through an ESOP for business owners and their employees and companies, it may be surprising to know that there were fewer than 6,300 ESOP-owned companies as of 2018. A few factors can explain the low number of ESOPs throughout the country.
- There is a lack of awareness (or a misguided view on the part of a few) of ESOPs and how they work among professionals (attorneys, accountants, and financial advisors), community stakeholders (political and government officials, economic development organizations), and business owners.
- ESOPs are considered complex by business owners and their advisors because they often involve a leveraged buyout in a regulated environment (ESOPs are regulated by the Department of Labor and the Internal Revenue Service).
- For MBE-certified businesses, there are limitations on the extent of ESOP ownership associated with retaining minority business enterprise status.
However, these obstacles can be overcome through the work of stakeholders here in Philadelphia and political officials at the local, state, and federal levels. Here are a few actions that can drive increased employee ownership for workers of color in Philadelphia and successful ownership transitions for the city’s minority-owned businesses:
- Promote and Support Impact Funds Dedicated to Employee Ownership: Impact Alpha recently highlighted 12 impact funds throughout the country that have been formed to tackle the complexity of designing, implementing, and (most importantly) financing ESOP and other employee ownership transitions. Included among these funds are Apis and Heritage Capital Partners. They (in partnership with co-op developer Democracy at Work Institute) are raising a fund to facilitate the transition of businesses that have workforces of color to employee ownership through “ESOP-eratives” (ESOP-owned companies with democratic, worker-cooperative style governance). Another example is a fund recently started by Project Equity, a nonprofit dedicated to expanding employee ownership through consulting and awareness building, which intends to make ESOP investments and other employee ownership transitions. By funding such impact funds and connecting them to opportunities to deploy their capital in Philadelphia, community stakeholders facilitate more employee ownership transitions in the region.
- Bring the “Cleveland Model” to Philadelphia: Launched in Cleveland, OH in 2008, Evergreen Cooperatives has become an innovative, global model for wealth development for economically disadvantaged workers. Evergreen leveraged the supplier/vendor needs of Cleveland anchor institutions like the Cleveland Clinic, University Hospitals, and Case Western Reserve University to bring quality jobs to the residents of those institutions’ neighboring communities by having laundry and energy services provided by worker-owned cooperatives that employed residents of the area surrounding the institutions, which had a median household income of $18,500. Evergreen has evolved to include a fund that invests in employee ownership transitions of local businesses to worker cooperatives. By building on the work of the Economy League, ImpactPHL, and other community organizations through the Philadelphia Anchors of Growth and Equity (PAGE) initiative, adopting a version of the “Cleveland Model” in Philadelphia that couples opportunity sourcing from Southeastern Pennsylvania’s anchor institutions and employee ownership through an ESOP-perative holding-company could be the catalyst for substantially reducing wealth inequality in our city’s poorest neighborhoods.
- Work with MBE-Certification Organizations and Congress to allow employee-owned companies to retain MBE status when appropriate: A minority business owner whose business is MBE (minority business enterprise certified) can facilitate an employee-ownership transition of up to 49% of his or her business to an ESOP and retain the business’s status as an MBE. Beyond that, retaining MBE status becomes challenging. Part of the fix will need to be done through legislative action. To that end, there are promising developments with the bi-partisan introduction of the Promotion and Expansion of Private Employee Ownership Act of 2021, which will tackle SBA-related issues regarding employee-owned companies retaining MBE status. Additionally, employee ownership advocates need to work with organizations like the Minority Supplier Development Council to create certification criteria that will expand wealth creation opportunities for workers of color by allowing ESOP and other employee-owned companies to retain MBE status.
- Build More Awareness: Through the work of community leaders like Philadelphia City Council member Derek Green, organizations like the Pennsylvania Center for Employee Ownership, Certified EO, the Employee Ownership Foundation, and the National Center of Employee Ownership, university-based programs like the Beyster Institute and the Rutgers Institute for the Study of Employee Ownership and Profit Sharing, and new initiatives like the Baker Center of Excellence for Employee Ownership and Business Transformation at Montgomery County Community College and the Employee Ownership Expansion Network, awareness of employee ownership has never been higher. Philadelphia-based organizations need to better leverage the work of these organizations and others to further disseminate information about employee ownership transitions throughout the region.