Was the use of employee ownership by private equity firms just a form of financial greenwashing, a step in the right direction, or a threat to the broader employee ownership movement?
The discussion is important because the CHI model is being actively promoted by a new organization, Ownership Works, founded by Pete Stavros, co-head of KKR’s Americas Private Equity platform. It now has 60 organizational members, 19 of which are private equity (PE) firms that have agreed to follow a model for sharing equity with employees in at least three deals per year. While PE firms have historically offered stock options or restricted stock units to the CEO and key executives, what is new is that Ownership Works is encouraging broad-based employee ownership.
KKR has used this equity-sharing model for a number of transactions over the past five years. Typically, employees have ended up with under 10% of the company’s ownership, a stake that has nonetheless translated into tens of thousands of dollars per person. When KKR took Gardner Denver public in 2017, $100 million was granted to employees (an average of about 40% of one year’s pay per person). Most companies in KKR’s portfolio are middle-market firms, often in manufacturing. Ownership Works also works with public companies, such as Harley-Davidson and Ingersoll Rand, to create broad-based equity plans. Employees usually get some form of restricted stock.
PE firms that join Ownership Works agree that the transactions will share equity worth at least 20% of the equity given to management or an amount equal to at least six months’ pay as measured by the projected equity value at sale, usually three to five years after the PE firm buys the target company. Those firms also commit to creating high-involvement management practices, not unlike those used in most ESOP companies.
Outside of Ownership Works, some other PE firms, such as InTandem, have embraced their own versions of this model.
Is this a good or bad for employee ownership—or employees? Many employee ownership advocates have been skeptical, arguing that the model KKR and now others are using provides far fewer benefits to employees than ESOPs or worker cooperatives. ESOP companies lay off people at a far lower rate than companies in general and generate 2.5% more new jobs per year. In contrast, research shows PE deals typically result in job and/or benefit cuts and lessened support of the community, although a few studies paint a more positive picture.
Employees in ESOPs often get 100% ownership for the long term, not the less than 10% employee ownership in the PE deals. The companies are usually sold in a few years, sometimes leading to further rounds of headcount and cost reductions. While the payout at CHI was substantial, some PE deals will result in little or no employee equity growth. By contrast, the mean ESOP account balance is $132,000, a number that includes people who have worked just a short time and people who have worked for decades. Payouts for long-time employees will average a multiple of this amount.
Stavros would argue, however, that debating which plan is better misses the point. I met Pete in the 1990s when he was getting his MBA and reading about ESOPs. He was strongly drawn to the idea, and when he eventually joined KKR, he tried to sell them on the idea of ESOPs or employee ownership in some other form, like restricted stock units. He eventually succeeded in the latter, after finding a lot of internal resistance to ESOPs.
There are a lot of barriers, he notes, to having an ESOP as part of the capitalization structure when acquiring a company. ESOPs for global businesses are possible but very complicated. Some public companies have small ESOPs, but most that share equity use discounted stock purchase plans or equity grants because they don’t like the rules for ESOPs. Broad equity grants, however, are limited mostly to the tech sector. PE companies also don’t like the rules and litigation risks of ESOPs.
Public companies looking to divest a division don’t want to sell to an ESOP because of limitations on what the ESOP can pay and the debt it would have to take on to make the sale. A private equity firm can offer a higher price and payment up front. In fact, selling to an ESOP could lead to shareholder litigation if it means a lower price.
In short, PE investors have not chosen to use ESOPs as their employee ownership model, and there is no reason to see Ownership Works causing this to change.
The amount of money in PE firms dwarfs the capital available to ESOPs. Market observers believe PE firms are planning to deploy over $3 trillion in the coming years. Getting these firms to share some ownership with the entire employee base is a step forward in what for some is a troubling trend. Employees can come out with at least modest gains, while the idea of employee ownership will gain more currency.
As that happens, it is likely that some private companies, now having heard the idea of employee ownership from PE suitors, will look to see how else it can be done and land on an ESOP as a better alternative for their companies, employees, and community than selling to PE.