Founders get much richer by selling to employees
This is how we create a wave of employee ownership.
In 2019, Julian Richer sold 60 percent of his company for £9.2 million and didn’t have to pay taxes on any of it.
The founder of Richer Sounds sold those shares to his employees—or more specifically, to an Employee Ownership Trust (or EOT) that holds those shares on behalf of employees. In the UK, founders can sell to an EOT without paying any taxes on earnings from the sale. There’s no cap, making this more lucrative than other exit options.
Richer became richer, but so did his workers. He retained 40 percent ownership of the company even as he slowly stepped away from day-to-day operations, watching those shares flourish under employee ownership. The company makes £10 million in annual profits and distributes 10 percent among employees.
The EOT tax break was introduced in 2014 to encourage more employee-owned businesses—it has. In the UK, there are now 1,650 employee-owned companies with 620 created just last year.
A report on the success of EOTs in the UK says growth of the program directly correlates to knowledge of the program. Most founders still don’t know it’s an option, but that’s steadily changing. As the program gets more press and founders become more aware of how much money they’d earn by selling to their workers, it happens more often.
Employee-owned businesses now employ 0.7 percent of total workers in the UK and drive 1.7 to 2.1 percent of economic activity. They contribute £12 to £15 billion in direct gross value added to the economy with a total contribution of £32 to £41 billion.
The UK is now producing more than double the amount of employee-owned companies than the US every year—620 to our 283. Given there are six times more companies in the US, a similar program could expect to create 3,720 employee-owned companies every year. With solid press and marketing, much more.
In the long term, this could be just the incentive that slowly turns every company into an employee-owned company as founders exit their businesses and employees take stake in the companies they work for, drastically altering the ownership of wealth in our country. If private companies in the US become just 30 percent employee-owned, the wealth of the bottom 50 percent would quadruple.
We need that to happen. In the US, $10 trillion in assets will change hands as baby boomers retire. The so-called “Silver Tsunami” affects half the privately owned businesses in the US with founders at or nearing retirement age—that’s 2.9 million companies employing more than 32 million workers.
Republicans and Democrats both want those businesses to transfer into the hands of workers. “Foreign investors currently own approximately 40 percent of US corporate stock, meaning that much of the profits currently generated by American workers are transferred to foreign stockholders,” the bi-partisan Employee Equity Investment Act reads. “That means, if nothing changes, many of these owners will sell their businesses to buyers in the M&A market—or close their doors—ultimately resulting in the loss of jobs and businesses in local communities.”
Which would we prefer? A future where half our companies are either closed or sold for parts, losing jobs and dismantling the legacies of so many innovative entrepreneurs in the process? Or one in which those companies are sold to workers, they get stock in the companies they work for and build wealth as they grow them, expanding the middle class while growing the economy, ushering in a new wave of entrepreneurs who can use their wealth to start new businesses and even sell them to their workers if they want to?
The latter is something both sides of the political aisle want. Employee ownership is better for founders, companies, and workers. In the UK, employee-owned companies are more profitable, perform better during periods of recession, and are more productive. They are 50 percent more likely to expand their workforce and 70 percent less likely to experience high turnover.
Workers at employee-owned companies earn higher annual wages (by £2,900 in the UK), receive dividends and bonuses twice as large, and receive more training for their jobs. Their companies make more charitable contributions and even make more environmentally-friendly choices—turns out workers don’t want their companies to pollute if they can help it.
The easiest way to create more of them is to make it a no-brainer exit option for founders. That’s why Canada has followed suit, copying the UK’s program by allowing founders to sell to their workers without paying taxes on up to $10 million of the earnings. Their new employee ownership program debuted in May of 2024, and founders will now earn $3.5 million more by selling to their workers than to another company.
Steve Storkan, Executive Director at the Employee Ownership Expansion Network (EOX), would like to see that happen in the US too. “Start with the Canadian version—$10 million is free—and see how it goes,” he says. “It starts with the US legislature… Some legislator has to stand up and say, ‘we need more employee ownership and look at what the UK has done, look at what Canada has done. We need to follow suit and make this easy.”
There are already incentives in place for US business owners. So long as the founder sells at least 30 percent of their shares to employees they can defer paying capital gains on the earnings in what is known as a “1042 rollover.” Earnings must be rolled into a qualified replacement property, like US stock, and can then be held indefinitely or until the death of the founder at which point it will go to heirs and they won’t have to pay capital gains either. The founder gets a lot of money without ever having to pay taxes on it and their workers become owners in the process.
“People who take advantage of that, it's dollars that they're probably never going to spend,” Storkan says. “For example, if I sell my company and get a check for $10 million, I might take $4 million of it and do a 1042 transaction and get tax deferral on that $4 million. The other $6 million I might spend, but if I haven’t sold my stock when I die, my beneficiary gets a step up in basis. So I end up selling my company, or that portion of my company, never having paid taxes on it. It’s good estate planning.”
These tax breaks make it easy for founders to sell to their employees—it’s a good business decision rather than an altruistic one. That’s important as nearly all employee-owned companies become that way because the founder wants to exit the company and chooses to sell it to their workers.
If they decide to go in that direction, there are three avenues founders can take: Sell to an existing employee-owned company (acquired), sell directly to workers and convert into an employee-owned company (stand-alone conversion), or gradually sell to workers over time as the company can afford to buy shares from the founder (non-leveraged incremental conversion).
Selling to an existing employee-owned company is the most common, especially for smaller companies. The exiting founder gets their check—just as they would if they had sold to another company—but they can still take advantage of tax incentives and their employees can still become owners.
The other two options involve converting an existing company into an employee-owned company. Whether in the US, Canada, or the UK, that means establishing a trust that represents the employees. The trust then buys shares from the founder (for no more than fair market value) usually using a combination of company reserves, a loan, and seller financing. Over the coming years, the company pays down that debt, releasing those shares to the trust that holds them on behalf of the employees.
The problem is securing those funds. Most companies don’t have $10 million floating around that they can use to pay off the founder so they take out a loan. That’s what Richer Sounds did—their initial payment to Julian Richer was made using existing overdraft and loan facilities from their corporate banker.
If they can’t raise a big enough loan, they might ask the seller for a loan. In this case, the founder can sell shares to the company incrementally over time rather than receive the lump sum all at once. When the founders of Taylor Guitars sold 100 percent of the company to their employees in 2021, they used a combination of debt and seller financing to raise the amount needed. “We took out a mortgage, basically, to buy our company,” Taylor Guitars CFO Barbara Wight said at the time.
Both options work well for founders of medium-sized companies who plan their transition years and even decades before they want to receive their final payout, but they can be a deterrent for large companies or founders who want to exit in the near future. What bank will finance a $10 million loan? Or a $50 million one? And why would a founder take an IOU when they can get a check from another company immediately? Especially if they are looking to retire?
Or as Storkan asks: “How can we provide more capital so the selling shareholder can get their cash?”
Republican and Democrat representatives have worked together on the Employee Equity Investment Act (EEIA) that would utilize the existing SBIC program that currently provides loans for small businesses,to provide loans for much larger ones in the case that they are converting to an ESOP. The Act was introduced in the house and senate in May of 2023, but it is currently idling in place. It would have to be passed by both before it could go to the President and become law.
Another option is to work with mission-driven funds rather than individual banks. Transform Finance has identified 53 funds in the United States and Canada that fund employee ownership conversions—22 of them focus exclusively on that task. These funds provide a combination of debt and even equity financing, with investors earning their money back (with interest) over time.
Transform Finance provides a comprehensive list of players in this space but notes that they are still early in development. “Half of the funds, where the fund size is known, are under $50 million in size,” they say in their guide to financing. “The smaller average fund size creates challenges in fundraising because many asset owners are not able to write checks under a certain size (e.g. $5 million), while simultaneously not wanting to take on more than 10 percent or 20 percent of the overall fund.”
These constraints could be alleviated as legislation drives more employee ownership conversions, and thus more investors and funds to this space. As growth continues we could create more employee owners even as we create more creative ways for investors to help fund them.
We just need more founders to exit to their employees.
“If I know about it as an option, I get a tax incentive to sell my business, and I don’t have to take a note myself because there's access to capital—now we're off to the races,” Storkan says. “I think all three of these things need to happen at the same time.”
For founders interested in selling to their employees, there are two options: In the UK, Canada, and US, the Employee Ownership Trust (or EOT) holds stocks in common on behalf of employees, distributing a percentage of that growth to employees as an annual bonus. In the US, we also have the Employee Stock Ownership Plan (or ESOP). Rather than having one profit-sharing pool, employees have individual stock accounts that accrue shares and value over time, similar to a second retirement account.
EOTs and ESOPs are both employee-owned, not employee-run. They change the ownership structure without changing the business structure. Executive leadership still makes decisions, just as they do at traditionally owned companies, even as employees are incentivized to help their companies succeed and earn dividends when they do. But there is also a third option available in all three places: Cooperatives are employee-owned and employee run. Workers vote leadership into office and share in the profits when the company does well.
“Whereas an ESOP is just a different structure of ownership,” Storkan says, “a worker cooperative is a different mindset.”
For this reason, most cooperatives become that way when the company still has less than 30 employees—it’s something they start out as rather than something they become. Storkan sees this as a good option for small groups of people interested in creating something together, but not as feasible for larger companies looking to convert.
“It’s a hard sell to take a business that's not running as a cooperative and talk about running as a cooperative,” he says. “We have a different idea about business here, we just haven’t been introduced to the concept of democracy at work and spreading the decision-making around. Those who want to sell to their employees as a cooperative are much more likely to have a European mindset.”
In Europe, cooperatives are a much bigger part of the equation. Their historical precedent makes them a more common startup option and I’m currently studying successful models in Spain and the UK for coming essays on the future of work and democracy. In the meantime, at a bare minimum, I think we need employee ownership. We need to popularize and incentivize founders selling their companies to their employees. We need to change the way wealth is owned in this country and around the world. And we can do that by making it a no-brainer exit option for founders, spurring a wave of employee ownership in one of the richest countries in the world as our largest population sets out to retire.
“Employee ownership doesn't mean we have to have democracy at work, it doesn't mean we have profit sharing and better jobs,” Storkan says. “We hope all those things come, but if I simply have shares in my account that no one can take away from me and when I retire or terminate my employment I get a check—I think that's enough.”
Let’s start there.
This is another essay in my capitalism series. Thank you for thinking through how we can make this system work better for humanity. I hope you’ll join me in the comments for further discussion.
P.S. If you can, please share this essay with a friend! Especially your business owner friends….
Thank you so much for being here.
Thank you. Very timely article and wish more owners knew about it. Agree with and David Roberts above that addressing income inequality and giving employees some control are awesome outcomes of this model. Wish my boss had done this before selling to private equity backed for profit healthcare company!! It was a disaster.
I founded one of the investment funds focused on EO conversion you mentioned (SmallCapital.org) and this is one of the best summaries of the rationale and path forward I have read. Thank you!