Employee Ownership: A Solution that Preserves Retiring Owners’ Businesses

Posted by: 
Steve Dubb

Crossposted from Rooflines: The Shelterforce Blog


Reflecting growing enthusiasm for worker co-ops, the Eastern Conference for Workplace Democracy—held last month in Worcester, Massachusetts—attracted a record 300-plus participants. One item on the agenda: the possibility of creating new worker cooperatives through conversions in which employees buy a business from an exiting owner.

The stakes are large—and not just for worker co-op advocates. Indeed, literally millions of businesses will be affected, as the baby boom generation retires at the rate of 10,000 people a day. This means there are going to be a whole lot of business ownership transitions. And how those transitions occur will have very significant consequences for communities everywhere.

As the late John Logue, founder of the Ohio Employee Ownership Center, often remarked: “The failure to plan for business succession is the number one cause of preventable job loss in this country.” Logue also used to remind folks that “only 30 percent of family businesses will pass to the 2nd generation,” even though half of exiting owners think they will transfer their business to family members. 

The employee stock ownership plan or ESOP has long been recognize as a means to preserve jobs while building wealth. But because an ESOP is a pension plan, an ESOP also carries federally mandated compliance costs. This often makes using an ESOP costly for smaller companies. The National Center on Employee Ownership writes, that, “As a rule of thumb, ESOPs work best for companies with over 20 employees.”

But what about the 14 million Americans who work for small businesses with between 5 and 19 employees? Conversion to worker cooperatives might be one important strategy for them.

In Worcester, discussion centered on ways the worker cooperative sector can seize this opportunity. Under federal law, owners who sell to an employee cooperative can defer their capital gains tax. This is known as a 1042 rollover, named after section 1042 of the IRS tax code. The basic concept: as long as the exiting owner sells more than 30 percent of the business to the employees, the exiting owner is entitled to use the proceeds to purchase domestic stock and only pays capital gains tax when the stock is sold. This mechanism is used commonly for ESOPs, but only rarely for worker cooperatives. Nonetheless, the tax provision applies equally to both.

As Melissa Hoover, executive director of the Democracy at Work Institute (DAWI), the nonprofit arm of the US Federation of Worker Cooperatives, noted, the notion of converting an existing business to cooperative ownership is not new. Hoover said that a recent survey found that 42 percent of all existing worker cooperatives converted from another business form. Camille Kerr, director of field building at DAWI emphasized that building an ecosystem for conversion required four main areas of activity: business outreach, developing sources of capital, developing a set of service providers, and broader education.

Noemi Gizpenc, executive director of the Cooperative Development Institute, talked about lessons learned from the largely successful effort to form resident-owned cooperatives that buy out owners of manufactured housing communities (often called “trailer parks”). Among these: 1) Know the industry; anticipate dangers and difficulties and address these up front; 2) understand when seller financing is needed; 3) create mechanisms such as forgivable loans to support the pre-development work needed to assess initial conversion viability; 4) incorporate requirements for borrowers to pay for post-conversion technical assistance to ensure long-term business success; 5) consider implementing strong outside financial or management controls, at least in the early stages; and 6) develop low-cost sources of capital.

recent study by Project Equity lays out the case for worker co-op conversions and describes 12 cases. The examples span many regions and industries, which speaks to the community development potential of this approach. Industries profiled include bakeries, manufacturers, construction firms (including a solar installer), a supermarket, a mental health counseling firm, a printer and copier firm, and a caterer. Locations include Montana, Colorado, Ohio, Massachusetts, Maine, California, Illinois, and Wisconsin. Alison Lingaine, who coauthored the study, said she also saw potential in light manufacturing, logistics/shipping, commercial printing, and health care.

In the closing plenary of the conference, John Abrams, a founder of the South Mountain Company, who helped lead the conversion of South Mountain to a worker co-op in 1987, observed that he saw  “tremendous growth in the interest in worker co-ops as an entity of choice. . . There is a large group of retiring Baby Boomer owners who would be interested in conversion to worker co-ops.” Melissa Hoover challenged the movement to take the risks necessary to reach out to retiring owners who might not have ever heard of worker cooperatives: “In order to grow, we have to enter into relationships that are going to be uncomfortable and rich and amazing and are going to push us. Taking the first step is the most important and that is the most uncomfortable one.”