With most of the Baby Boomer Generation going into retirement over the past decade or so, many of the businesses they founded are being sold to diversify their net worth and fund their retirement years, and this trend is expected to continue for the next 10-12 years. A large part of these businesses are lower middle market businesses, with pre-tax profits in the range of $3 million to $50 million.
Traditionally, smaller businesses are acquired by larger businesses, either privately or publicly held, in the same industry. However, the rise of private equity (PE) funds in the past decade has resulted in them dominating the acquisition market. PE funds buy companies with a goal to improve the companies’ market value and sell them at a profit. While this has resulted in great returns for PE funds and their investors, the dominance of private equity shifts business ownership away from local communities and concentrates capital in the hands of the institutional investors behind the PE funds.
According to Perpetuate Capital, an investment firm that specializes in employee trusts and other creative investment solutions, the distant and impersonal corporate governance style of PE firms has had a negative effect on workplace culture, especially of purpose-driven companies. A purpose-driven company is one that is guided by a shared vision regarding a social issue, which permeates its entire organizational culture, as well as its products, customer base, and employee policies. This vision can be religious, environmental, political, or any other belief or cause close to the founders’ hearts. Many purpose-driven businesses also support the local community through charitable efforts, either directly or through partner nonprofits.
Being snapped up by a private equity fund often results in the stripping of the founder’s vision and the company’s character, as the business becomes reoriented towards increasing its valuation as much as possible, with a goal to be sold at a higher price a few years down the line, usually between three to five years. The business ends up as an institutionalized commodity that just gets traded back and forth between private equity groups and discards the decades some founders have spent cultivating a specific purpose and culture in their organization.
“A business acquired by a PE fund does not lose its economic value, but it loses its purpose value. From what we're seeing, lower middle market businesses over the next 20 years are going to be overwhelmingly private equitized. While that may be good for wealthy investors, it will be bad for corporate culture and purpose-driven outcomes. It will also be bad for employees, because now they're under way more pressure to grow the business rapidly. Furthermore, knowing that the business is going to be sold again in a few years can have a really debilitating impact on employee morale,” says Brandt Brereton, general partner of Perpetuate Capital.
According to Brereton, employee trusts are a more sustainable alternative for business founders looking to divest from their companies for retirement, while keeping the business’ purpose and character intact and the sellers receive the same amount of cash on sale as they would have received if they sold to a private equity group. Employee trusts are non-government vehicles that advances employee ownership of the businesses they work for. These trusts help all members of society gain access to capital and wealth creation opportunities, which are typically only within reach of the capital class.
Brereton estimates that around 300,000 companies in the US have undergone the employee trust process since the laws came into place in the 1970’s, where the owner has sold their company to an employee trust and received fair market value. When a business owner sells $50 million worth of business ownership to an employee trust, that monetary value sits inside the trust, with the employees slowly vesting into becoming beneficiaries of the dollar value of the stock that was sold to the trust. He clarifies that the employees don’t become actual stock owners, so they don’t get shareholder rights. However, an employee trust allows employees to receive a larger benefit upon retirement, typically four times higher than what they would’ve received through a typical 401(k) plan.
There is bipartisan support in the US government for employee trusts, as it helps stimulate the economy and it reduces the government’s burden of funding social security. Furthermore, by selling their business to an employee trust, a founder can avoid paying capital gains tax by meeting certain conditions. This is because Congress gives tax incentives to both the owner and the business, allowing more of the profit generated from that point forward to stay within the enterprise, making it available to pay back the capital that funded the transaction.
“Through our extensive investing experience, Perpetuate Capital operates within the private equity market, providing private equity-like returns, but, at the same time, advancing employee ownership and the economic and social benefits of employee trusts. We structure transactions by taking advantage of existing laws by Congress that allow businesses to not pay taxes because they are benefiting all their employees and the economy at large. Furthermore, through employee trusts, the owners of purpose-driven businesses can rest assured that their endeavors in building their company’s culture and vision will not be for naught,” Brereton says.
Media contact:
Name: Bill Dunn
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