Thinking globally, acting locally:

Promoting employee ownership at the subnational level

 

Report on the COG Subnational Discussion Group

 

John Logue, Moderator

 

 

There are at least six reasons why we should be concerned with encouraging employee ownership at the subnational level: at the level of the state, the province, the region, the municipality, or other subnational governmental units.

 

The first is that in many governmental systems, particularly federal systems, legislative measures beneath the national level may be effective in promoting broadened capital ownership. In many federal systems, the writ of the federal governmental does not extend beyond broad national agenda items; state and local legislation speaks to the local economic development questions.

 

Second, in larger nation states, be they federal or unitary in structure, the national government is not a very effective provider of technical assistance for companies, employee groups, retiring owners, unions, or community economic development groups. Subnational provision of technical assistance through state, provincial, or municipal programs, or through non profits -- 501(C)(3)'s in the United States, and their equivalents elsewhere -- is far more efficient and appropriate.

 

Third, employee ownership is, in its nature, not only a strategy for broadening capital ownership at the national level, but also a strategy for anchoring capital and jobs where employee owners live. This localistic strategy is best implemented through subnational action.

 

Fourth, employee ownership is intrinsically a micro economic strategy, implemented at the level of the firm. As we will discuss below, many of the opportunities available for employee-owned companies are available at the local level where the companies are situated and where their employees live. These areas of activity include collaborative networks, training cooperatives, establishing employee-owned supplier networks, and other strategies for community involvement. The substantial multiplier effect that employee-owned companies can have in spreading employee ownership and increasing community economic activity takes place typically at the state or, more generally, municipal levels.

 

Fifth, employee ownership tends to stabilize local and state economies by anchoring capital and jobs. Moreover, its productivity enhancing effects “help to narrow the divide between those who favor and those who fear more growth in Hawaii by slowing workforce/population growth in future economic expansions which, in turn, could reduce the need for wage cuts and lay-offs in future recessions” (Tom Brandt, 4/4/2000; see also his “Impossible Dream for Hawaii’s Future? 9/10/99).[1]

 

Sixth, with economic globalization, the nation state gradually ceases to be the appropriate unit for economic policy, and the traditional national economic management tools -- whether fiscal, monetary, or exchange rate policies, capital transfer restrictions, domestic content, requiring a controlling domestic ownership stake, domestic preference in the award of public contracts, etc.,-- cease to be effective or are struck down by international trade rules. In this environment, employee ownership is a particularly attractive alternative, especially for high wage areas.

 

Thus, it makes sense to look at employee ownership at the subnational level as distinct from the promotion of employee ownership nationally and from the promotion of employee ownership at the transnational level. These levels impact promotion of employee ownership at the regional and local levels but that state and local implementation is also distinct from national action.[2]

 

The goals of the COG subnational discussion group and of this paper have been to canvass existing subnational initiatives, to select best practices worthy of dissemination, and to propose innovations in order to promote the expansion of employee ownership through subnational initiatives by both governmental units and other organizations, including both non-profits and for-profits. Our overarching goal is to find mechanisms to expand the employee-owned sector that are within our scope of control.

 

We will look at what subnational actors -- both public and private sector -- can do to promote employee ownership through (1) legislation and other governmental action, (2) technical assistance, (3) using their purchasing power, (4) establishing investment funds, (5) building company networks, and (6) using the economic power of employee-owned firms within their communities.

 

This paper concludes by looking at issues and problems raised in the subnational discussion and by enumerating measures which can be taken by subnational actors to broaden ownership of productive assets.

 

 

1. Subnational public policy

 

Subnational political units can act to encourage employee ownership within their jurisdictions. From the subnational discussion on the COG website and during COG’s annual meeting, that seems to date to have been done primarily in the United States and Canada. There is, however, no particular reason why similar measures cannot be undertaken in other federal systems and in unitary political systems which give some latitude to subnational governmental bodies in economic development.

 

Employee ownership hit the state policy agenda in the United States shortly after Congress passed the Employee Retirement Income Security Act (ERISA) in 1974 which legitimized ESOPs as a pension plan. In all, twenty-eight states have passed some sort of legislation encouraging employee ownership. Such measures run the gamut from policy declarations to substantial financial commitments. They include:

 

·                    Policy declarations endorsing employee ownership

 

·                    Publicity for employee ownership including workshops, pamphlets, etc.

 

·                    Tax credits

 

·                    Exemption of Employee Stock Ownership Plans from state securities regulations

 

·                    Legal recognition of workers cooperatives

 

·                    Loan guarantees

 

·                    Earmarked loan funds

 

·                    Interest rate subsidies

 

·                    Funding for or the direct provision of technical assistance

 

·                    State employee ownership offices or programs

 

·                    Use of employee ownership in privatization of state services

In the aftermath of ERISA, Minnesota and Michigan passed legislation supporting employee ownership in 1974. The big push for state legislation was between 1979 and the end of the 1980s as the one-two punch of the recession of 1979-80 and the overvalued dollar in the middle of the decade sent manufacturing into a long-term crisis. While no more than two or three percent of employee owned companies have been set up to avert job loss, much of state legislation in this period focused on employee ownership as a defensive, job retention strategy. Between 1979 and 1990, twenty-three states passed legislation encouraging employee ownership in a variety of ways. These included all the states in the industrial heartland from Massachusetts and Connecticut through Illinois and Wisconsin as well as the Pacific Northwest.

 

By contrast, state legislation in the 1990s focused primarily on employee ownership in privatization (Virginia 1995; North Carolina 1998).[3] Maine also passed new legislation driven by job retention interest in 1997 and, in 2000, established a commission to study ownership patterns in the state. “The commission is charged with recommending to the next legislature the specific eligibility criteria for accessing grants from the feasibility fund and which agency or organization should manage the outreach program.... The commission is charged with documenting current patterns of ownership of Maine businesses, the characteristics of those businesses (size, number and quality of jobs), and the impacts of changes of ownership on the state and local economies, and civic and environmental accountability. One area of particular interest is the patterns of small Maine‑owned growth companies, particularly technology firms, and their need for large infusions of capital as they grow: how many are bought out, do they continue to operate in Maine, does their growth take place in Maine? The commission will also look at policy options for broadening ownership through employee, consumer and community forms of ownership in firms operating in the state” (Carla Dickstein, 4/4/2000; see also her discussion of 4/5/2000 and 4/7/2000 and “LR: 3751: An Act To Broaden Business Ownership in Maine” in the COG library).

 

Maine’s interest in keeping a high tech growth sector in local hands is similar to the perception in Manitoba that we will meet below in the discussion of the Crocus Fund.

 

Other initiatives proposed in the COG subnational discussion include:

 

·                    States could provide tax credits to companies for setting up more participatory ESOPs with caps based on a sliding scale varying with the percentage employee-owned (COG meeting, April 14-15, 2000).

 

·                    Unemployment contributions could be cut for employee-owned firms (COG meeting, April 14-15, 2000).

 

·                    Local governments could issue local currencies to finance expanding employee ownership locally (Shann Turnbull 8/6/2000).

 

·                    Community foundations could receive stock from local companies (charitable contribution at stepped up basis for donor) and create market by selling to employees (COG meeting, April 14-15, 2000); I would add that educational institutions and churches can do the same thing, though all of them would need some assistance with appropriate uses of employee ownership.

 

·                    States can encourage electrical consumer co-ops in electricity deregulation (COG meeting, April 14-15, 2000).

 

Preferential bidding arrangements for government contracts

 

We have a variety of set asides in government contracting varying from state to state. These include set asides based on ownership by minorities and women. Why not set asides or preferences for employee owned firms?

 

Carla Dickstein (email to Deb Olson, 4/18/2000) notes that both the French and Italian governments provided preferences to cooperatives in bidding on government contracts.

 

State and local privatization

 

With the hegemony of neo-liberal ideology reaching the local level in the 1990s, subnational governmental units joined nation states in divesting themselves of ownership of public utilities and services, from hospitals through water works. Since privatization is handled in a separate paper, suffice it to say here that subnational privatization of municipal and state enterprises has represented a major missed opportunity to broaden ownership in the West. In general privatization has occurred through sale of locally owned public enterprises to conventionally owned corporations, not to employees, with revenues flowing into general coffers, rather than into trusts or other funds which provide a lasting benefit for citizens.

 

In effect, the public sector has liquidated assets to finance current consumption. While this procedure has been justified by the unsubstantiated ideological assumption that private markets are always superior to public provision of goods and services, in fact much of the political motivation for local privatization has been covering revenue shortfalls or paying for tax cuts, usually for the well to do, quickly consuming the value of public assets. At least in the United States, this has been “free” funding for the governmental unit, because public sector accounting practices do not provide balance sheets to citizens charting asset liquidations.

 

Distribution of subnational public ownership rights to citizens

 

The Alaska Permanent Fund constitutes a unique case in the United States of using public ownership rights of subsoil resources (in this case, oil) to convey quasi ownership rights to citizens. Since 1982, a portion of state oil royalties have been distributed to every man, woman, and child resident in Alaska for all of the previous year. Every resident who qualifies gets an equal share. These rights are not tradeable (i.e., cannot be sold), cannot be inherited, and cannot be taken with you if you move out of Alaska. In effect, Alaska treats its residents as beneficial owners of royalty rights. In 2000, dividend checks from the Permanent Fund were almost $2000 for each of the state’s 585,000 qualifying residents. The state retains the formal ownership right but chooses to pass-through the economic benefit to its citizens.[4]

 

It is not difficult to imagine a similar treatment for other profitable public ownership rights at the state or local levels when those streams of income are sufficient to be divided. Public income from royalties, easement and concession income, fees for private use of public property, and the like are often consigned to general revenues and not as jealously protected as they might be if citizens derived a more direct benefit from public ownership. Of course, most of these public ownership income rights are already committed to other worthy public ends, especially public education as is the case for Texas oil royalties and most state lottery profits.

 

Is there any reason why profitable, publicly owned electrical utilities, parking garages, etc., could not pay dividends to citizens?

 

 

2. Subnational employee ownership support organizations

 

One promising mechanism for encouraging employee ownership at the subnational level is the establishment of organizations which provide information, technical assistance, training, and the like for employees seeking to purchase companies or to establish cooperatives. This can be done by governmental units (as has been done in several American states), by not-for-profits organizations (again there are several American examples), by unions, by labor-sponsored investment funds, or, conceivably, by for-profit groups.

 

State employee ownership programs

 

During the latter part of the 1980s and early 1990s, seven state employee ownership programs (Hawaii, Massachusetts, Michigan, New York, Ohio, Oregon, and Washington) were established. A quasi-state entity -- the Steel Valley Authority -- provides similar services on a regional basis in Southwest Pennsylvania. More than anything else, these programs focused on outreach and assistance to union locals in plants facing shutdown and to retiring owners who might be interested in selling their companies to their employees.

 

A study of three of these programs -- New York, Ohio, and Washington -- in 1990-91 by the National Center for Employee Ownership found all of those studied to be efficacious in increasing the rates of ESOP formation in the states in question.[5]

 

Practically all we know about the impact of employee ownership at the state level is a consequence of studies done by those state programs (Michigan, Ohio, and Washington[6]) or supported by them.[7] In addition, a number of foreign scholars have reported on American state programs and their results.[8]

 

Despite the apparent success of these programs, their political support ebbed with improved economic conditions in the 1990s and party transitions in a number of state governments. The consequence was the defunding of state employee ownership programs in Hawaii, Massachusetts, Michigan, Oregon and Washington, although state personnel continued to provide support and technical assistance for employee ownership in Massachusetts, Michigan and Washington.

 

Why were clearly successful programs dismantled? They were largely anchored in state governments; only Ohio’s and Oregon’s were contracted out by those states to, respectively, a state university and a non-profit organization. This made them susceptible to the slings and arrows of state politics, especially because several state programs had clear partisan backing at the time of their establishment. Placement outside of state government was no panacea, however: while the Ohio program has continued to grow despite reductions in state support, loss of state funding terminated the Oregon program.

 

Jim Houck, who ran the Michigan program while it existed and who continues to promote employee ownership in that state reflected in the COG discussion that “why many of the earlier state programs have disappeared probably relates to changes in priority in succeeding administrations and the loss of an employee ownership champion either in state government, the legislature or in the Governor's office of these respective states. State programs are inevitably vulnerable and most have a somewhat limited life expectance. There is always the temptation to try something new and programs are constantly being scrapped, merged with others and replaced by the latest fad incentive.”

 

“Employee ownership must compete with a lot of other program applications in government,” says Houck. “It must constantly evolve its marketing appeal (attracting and retaining employees is a major concern to most all states in today's economy) and specific applications if it is to retain its support by state government officials” (Houck, 3/27/2000).

 

One aspect of state programs is particularly important to note: most got their bang for the buck by targeting retiring owners to encourage them to sell their businesses to their employees when there was no heir eager to continue the family business. For the seller, the employees constitute an often enthusiastic buyer that is willing to pay a market price for the company, rather than bottom fishing. For the employees, buying the company averts uncertainty and avoids the dubious aims of outside owners. Additionally, in the United States, special Federal tax incentives encourage the sale of closely held businesses to employees.[9]

 

A number of subnational programs have this focus. In the early 1990s, Hawaii’s employee ownership program was funded to identify owners within 5 years of retirement and to let them know about the advantages of employee ownership (Tom Brandt 4/4/2000). The New York state program actively promoted employee ownership in retiring ownership situations by funding preliminary feasibility studies. The Ohio Employee Ownership Center, which always stressed outreach to retiring owners, has run a broader ownership and management succession planning program successfully since 1996 in the Cleveland area; between 1996 and 1999, 246 business owners from 204 area companies employing more than 20,000 participated in the program.[10] Massachusetts recently funded a state-wide succession planning program patterned on the Ohio model.

 

This retiring owner focus pays off in broadening ownership. A 1991 NCEO study of several state employee ownership programs found a startling impact on the rate of ESOP creation in closely held companies; in Ohio, for example, where the state program targeted small business, the rate of ESOP creation in closely held firms rose 45% faster than the national average.[11]

 

Have these state programs made a difference? Houck argues that it is “very important to have legislation which more or less permanently supports the establishment of some sort of government response encouraging employee ownership. Ideally, that legislation will also establish a modest funding level to support staff and program initiatives. It does not have to cost a lot of money. From $100,000 to $200,000 annually will provide a substantial administrative effort. Legislation will help a state to override inevitable political shifts” (Houck, 3/27/2000).

 

Non-profit employee ownership organizations

 

In addition to public sector employee ownership assistance organizations, there are a handful of subnational not-for-profits which promote employee ownership in the United States. These include the Industrial Cooperative Association (now ICA Group) in Boston, the Center for Democratic Solutions in San Francisco, and the Southern Appalachian Center for Cooperative Ownership in North Carolina.[12]

 

A number of local non-profits have been set up to encourage employee ownership. In Ohio alone there have been three: Common Wealth in Youngstown, Worker-Owned Network in Athens (now ACENet), and Jobs for People in Cincinnati. Generally speaking the catchment area for such local organizations is simply too small for them to focus exclusively on employee ownership and, over time, they have come to broaden their scope to include such other admirable goals as low and middle income housing development (Common Wealth) and flexible manufacturing (ACENet).

 

Employee ownership as a tool for general economic development organizations

 

A handful of general purpose economic development organizations have developed special employee ownership competence. These include Coastal Enterprises, a community development corporation in Maine; Social Action for a Just Economy (SAJE), a 501(c)(3) Hispanic community organization in Los Angeles; the Center for Community and Labor Research, a labor-related economic development and research program in Chicago; and the Steel Valley Authority, a quasi-governmental economic development agency established by a number of municipalities in the Pittsburgh area.

 

These organizations use employee ownership as one of their tools for economic development. While their regional catchment areas are not sufficient to focus on employee ownership alone, through their economic development activities they screen enough firms that some individual firms are identified as appropriate candidates for employee ownership.

 

Given the successful experience of these organizations in using employee ownership in their regions, it would be worthwhile to train additional economic development organization personnel in the appropriate uses of employee ownership.

 

Industrial sector strategies

 

An alternative to the regional geographic focus of the previous organizations is a sectoral strategy. Several organizations have undertaken to promote employee ownership nationally within particular economic sectors. These include Childspace Cooperative Development, a national cooperative daycare developer; Cooperative Homecare Training Institute, which seeks to replicate in other urban areas the outstanding success of Cooperative Home Care Associates in New York City; and the Industrial Cooperative Association’s temporary service cooperative initiative.

 

The first two of these cases build off the success of single cooperative enterprises. Childspace, a parent-teacher cooperative daycare program, originated in Philadelphia where it developed an enviable track record of providing high quality daycare services in a low income community. Cooperative Home Care Associates (CHCA) in New York is an outstanding example of how a cooperatively organized and well led company can provide higher wages and benefits as well as ownership in a low income, female service sector branch. In both cases, national replication projects have been funded by foundations.

 

The ICA’s employee-owned temporary employment agency initiative similarly attempts to improve employee’s economic conditions in what is usually a benefit-less service branch while also providing ownership. It uses the strength of an existing employee ownership organization to seek to spread the model nationally.

 

All of these initiatives seek to improve economic conditions for low wage or contingent workers while improving services to children and the elderly. As such, they have received foundation support. To have large scale consequence, however, they need linkages to other large organizations with the purchasing power to take these attractive models to scale.

 

Private sector consultants

 

Private sector consultants specializing in employee ownership in the United States outnumber public and non-profit staff by a factor of 25 - 50 : 1. Indeed, the rapid growth of employee ownership in the United States stems from its promotion by private sector consultants who are paid on a fee-for-service basis for providing professional services. This appears to be a substantially more lucrative area of endeavor in the United States than in other countries, possibly because of the fact that the most common form of employee ownership in the United States is the ESOP, a government-regulated pension plan.

 

As a consequence, most of the outreach done to the business community to encourage the creation of more employee-owned companies is done by the professional community. This has been successful in spreading ESOPs (but not cooperatives, which provide few fees for professionals) in the United States, but it is driven almost exclusively by the tax breaks provided by the Federal government. A reduction in tax expenditures or in the regulations which encourage the professionalization of ESOP services would reduce the private consulting sector’s interest in promoting ESOPs.

 

Maximizing leverage

 

In the United States, Federal tax advantages are accorded to good, bad, and indifferent ESOPs alike. In fact, in terms of the total dollars in tax expenditures, the bad and indifferent ESOPs (those with little employee participation, communication, or training) account for the lion’s share of tax incentives. An Ohio study found that the bottom two-fifths of firms in these areas accounted for just over 90 percent of the corporate tax expenditures for ESOPs in Ohio. By contrast, the roughly three-fifths of firms which provided more opportunity for employee owners got under 10 percent of the corporate tax dollars (John Logue and Jacquelyn Yates, The Real World of Employee Ownership [forthcoming, Cornell University Press, 2001], chapter 6)

 

Although compelling for corporations, Federal tax incentives are expensive. They probably exceeded $3 billion annually in the 1990s. By contrast, public sector funding for all employee ownership support organizations did not exceed $2 million annually at any point in the 1990s.

 

A modest Federal program to provide matching funds for state and regional public and non-profit sector employee ownership assistance programs would be highly cost effective in generating both more employee-owned companies and in improving their performance.    

 

In addition to matching funds, a $1 million marketing budget annually to promote the idea of employee ownership would be valuable (COG meeting, 4/2000).

 

Replicating the agricultural extension service for employee-owned companies

 

One of the most successful American innovations in economic development is the Agricultural Extension Service. For decades it has been transferring research results from the lab to the farm, bringing knowledge and technology to the family farm. The Ag Extension Service has helped keep American family farms competitive with corporate farming and promoted a continual process of intellectual renewal in agriculture.

Creating an employee ownership extension service could be done at the state level to supply a variety of technical and organizational development assistance to smaller firms without Federal support; once in place in a couple of states and successfully field-tested there, an employee-ownership extension service could be spread by Federal matching funds.

 

 

3. Action by local governments/faith-based communities/ESOP companies

 

Why should we limit ourselves to actions by state, provincial, or regional governmental entities? Once we move out of Washington and turn to state and local initiatives, the possibilities are legion. Much can be done to encourage broader employee ownership by municipalities, by charitable and religious organizations, and by employee-owned companies themselves.

 

Little has been done to promote employee ownership by local government outside of using local revolving loan funds to save jobs in employee buyouts. This probably reflects a lack of imagination rather than a lack of ability.

 

Among the proposals which have come to our attention during the COG process are

 

·                    Municipal or local economic development authorities can establish industrial parks for employee-owned companies and for other high performance companies which provides a joint training facility, a cooperative day-care facility, and a co-op lunch facility.

 

·                    Municipal governments can provide preference in purchasing for employee-owned firms as is the case in Northern Italy, aiding the growth of production cooperatives there (Carla Dickstein (email to Deb Olson, 4/18/2000).

 

·                    Municipalities can issue local currency to fund broadening employee ownership locally. “Self‑Help Associations for Regional Economy (SHARE) ...[are] described in our book Building Sustainable Communities.... The significance of the SHARE program is that it used the local banking system to finance the acquisition of self‑financing assets to democratise wealth. It provides a format for achieving the same objective with interest free local currencies” (Shann Turnbull, 8/5/2000).

 

·                    The Catholic hospital system can use institutional strength to replicate New York’s Cooperative Home Care Associates, creating better jobs and ownership for home health care aides and improving care for the homebound simultaneously (under discussion in the Diocese of Cleveland currently).

 

·                    Local churches can encourage employee ownership within their spheres of influence through their purchasing and through social justice work within their congregations.

 

·                    Make sale of religious or public hospitals to for-profit chains contingent on their contracting home health care, janitorial services, and other services to employee-owned firms.

 

Further, individual employee-owned firms can act to grow capital stakes for their employee owners by simple leverage strategies. One interesting outgrowth of the discussion of opening the Federal Reserve’s discount window for lending for employee ownership (which is clearly a national level issue, rather than a subnational one) was the proposal that ESOP firms borrow to purchase a diversified portfolio of securities held in the “other securities” portion of employee ESOP accounts (Dan Bell 4/6/2000). Company securities already held by the ESOP can collateralize the loan. Annual company ESOP contributions can then be used to pay off the loan. Portions of the portfolio of other securities can, from time to time, be sold to cover repurchase obligations. While the leverage required for this strategy increases its risk, the diversification reduces risk. (See also Michael Harrington 4/12/2000.)

 

ESOP companies can themselves become cornerstones of local employee ownership efforts by building networks of employee-owned suppliers. They can serve as incubators for new employee-owned companies, providing an initial base market in addition to the physical space, telephone answering and accounting services provided by other business incubators. Employee-owned companies can -- and should -- examine which of the goods and services they currently purchase externally can be better provided (in terms of quality and reliability as well as cost) by local employee-owned suppliers. ESOP firms can also go beyond the individual enterprise to build cooperative networks, including export cooperatives and cooperatives providing services to ESOP firms. These possibilities will be explored in Section 6 below.

 

It would be useful to build coalitions at the state or regional level between traditional cooperatives (agricultural, rural electric, mutual insurance companies, credit unions, consumer co-ops, etc.) and the growing employee-owned sector. Substantial synergies are possible, including developing hybrid consumer-employee cooperatives.

 

 

4. Employee ownership funds

 

Should there be special financing institutions for employee ownership?

 

Opinion is divided. Some feel that it is salutary for ESOPs to utilize the standard market financing sources: commercial banks, asset-based lenders, venture capital funds, and bond market. Others argue for at least a partially separate financing stream for the employee-owned sector.

 

Over the years, a variety of public and private financing mechanisms for the employee- owned sector have been launched with mixed success. These include

 

·                    state loans and loan guarantees,

 

·                    a national banking institution with a preference for employee ownership, the National Cooperative Bank;

 

·                    local and regional revolving loan funds aimed at development of cooperatives; and

 

·                    private sector venture capital funds.

 

·                    regional labor-sponsored venture capital funds with special preference for employee ownership, such as the Crocus Fund in the province of Manitoba, Canada, and the proposed Framtid I Norr fund in the north of Sweden;

 

Some of these funds do only debt financing while others provide a source of friendly equity financing as well.

 

State employee ownership financing programs

 

Establishing special state credit facilities for employee ownership -- particularly to avert shutdowns -- was a relatively popular initiative in the 1980s as the one-two punch of the 1979-81 recession and the overvalued dollar in the mid 1980s clobbered American manufacturing. Few have been established since then. These credit facilities came in four primarily varieties:

 

·                    state loan funds specifically earmarked for employee ownership were established in Massachusetts (1984/1989), Michigan (1985) and Maine (1997);

 

·                    state loan guarantee programs were established in New Jersey (1983), West Virginia (1983) and Pennsylvania (1984);

 

·                    below market interest rates or rate subsidies were authorized in Illinois (1982), New Jersey (1983), New York (1983), and Connecticut (1985); and

 

·                    specific authorization to use state loan programs for employee ownership in Wisconsin (1983), West Virginia (1983), New Hampshire (1983), Pennsylvania (1984), Connecticut (1986), Indiana (1986), Hawaii (1987), and Maine (1997).

 

A number of other states, including Ohio, used existing state lending programs to support employee buyouts.

 

The effectiveness of such programs varied. Earmarked employee ownership lending funds have generally been rolled into other economic development loan funds as small pots of money were either underutilized or overdrawn. (Jim Houck also notes that Michigan’s threshold requirement of 75% employee ownership was too high to attract a sufficient number of borrowers [3/27/2000].) On the other hand, both below market interest rates and public sector lenders willingness to subordinate their loans to commercial lenders seems to have played a significant role in supporting employee purchases of troubled and/or divested plants and firms. Loan guarantees -- which are very cheap for the public sector -- seem to have been underutilized.[13]

 

None of these programs, however, addressed the systematic lack of friendly equity investment which has hampered the growth of the employee-owned sector. Only one state -- New Hampshire -- provided for a public sector equity stake through the New Hampshire Community Development Finance Company. That was left to private venture capital which sought a much higher rate of return than most employee-owned firms found pleasing.

 

[Does anyone know whether the NH CDFC has actually done any employee ownership deals? If so, how did they turn out?]

 

[Does anyone know anything about North Dakota’s state bank and whether it has ever done any preferential lending for co-ops and ESOPs??]

 

Specialized lenders nationally

 

Since the New Deal, the agricultural cooperative sector has been underpinned by specialized Federal lending institutions. Similarly, the expansion of home ownership from a third of American families to two-thirds of American families since the New Deal has been fueled by Federal home-ownership financing institutions. As described in the COG national paper, during the Carter administration, the National Cooperative Bank (NCB) was established as a specialty lender for housing, consumer, and worker cooperatives. Privatized during the Reagan administration, the NCB has become a preferred lender for many worker-owned businesses because it is in itself a cooperative owned by its customers.

 

While the NCB and its Development Corporation (the soft-loan window) are more appropriately a subject for the national level paper, they have undertaken a policy of supporting regional cooperative lending funds, like the Northcountry Cooperative Development Fund. These serve as regional intermediaries for the NCB, working hand-in-glove with local borrowers who are too small to be serviced efficiently from Washington.

 

This model of decentralization is potentially very valuable both in employee ownership lending and employee ownership venture capital in the United States and elsewhere.

 

Revolving loan funds with preference for employee ownership

 

There are several revolving loan fund which have a preference for employee ownership or are exclusively employee-ownership lenders. These include A New Beginning/ANB Fund in the Shenango Valley of Pennsylvania; Commonwealth Revolving Loan Fund in the Youngstown, Ohio, area; LEAF - the Industrial Cooperative Association’s revolving loan fund in Boston; and Northcountry Cooperative Development Fund in Minnesota. Some of these funds, like ANB and Commonwealth, are community-based and make loans only in a limited geographic area. Northcountry, the biggest of them, is a regional lender, covering the Great Plains and Midwest. LEAF lends nationally.

 

Raising venture capital on Wall Street for ESOPs

 

Five national venture capital funds have been created in the United States that have special preference for employee ownership.[14] The first was Minneapolis-based Churchill Capital’s Churchill ESOP Capital Partners which raised $188 million in a private capital partnership in 1995 in cooperation with Houlihan Lokey, a law firm with special expertise in ESOP transactions. It was designed to provide subordinate debt, preferred stock, and minority or majority equity stakes in mid-market companies in placement of $5 to $25 million in management-owned or employee-owned companies. Among its first eleven companies financed were four ESOP acquisitions and one recapitalization.

 

It is our understanding, however, that after the investment of this initial pool, Churchill decided against raising a second ESOP fund; the market was too limited.

 

American Capital Strategies was founded as an investment banking firm in 1986 specifically to arrange financing for ESOP transactions. It was one of the most successful firms in the country in this regard, arranging financing for 32 ESOP companies between 1986 and 1997. In 1997, it raised its own venture fund through a public offering as a “Registered investment company,” which permits it to avoid paying Federal corporate income tax by paying out practically all its earnings to its shareholders. Since then it has completed ten transactions for eight ESOP companies creating close to 2000 new employee owners (John Hoffmire, 4/11/2000).

 

American Capital raised $155 million in its initial public offering on the NASDAQ in August 1997. In 1999 and 2000 it returned to the public market with follow-on offerings which raised roughly $100 million each. As of June 2000, it had assets of $650 million.

 

While American Capital has prospered and has become a leader in internet financial services for mid-market companies, ESOP companies have played a less prominent part in its portfolio of investments than some of its principals expected (e.g., Malon Wilkus in Owners at Work 9(2): 17). “We continue to be involved in approximately the same number of ESOP transactions per year as compared to years prior to our IPO in August 1997,” John Hoffmire, American Capital senior investment officer told Owners at Work (forthcoming Winter 2000/01). “But we would do more if we could find more ESOP transactions.”

 

The bulk of American Capital’s investments have been in conventionally owned, mid-market companies. Of the 39 companies it has invested in since it raised its venture fund, 31 are conventionally owned. ESOPs are part of its exit strategy here. “American Capital looks forward to long-term relationships with the companies we work with,” says Hoffmire (forthcoming, Owners at Work, Winter 2000/01). “We believe that such a relationship is good for us, good for our shareholders, and good for the companies. Long term we look forward to selling our interests, when possible, to the employees.”

 

The KPS Special Situation Fund was established by Keilin and Company, the New York investment banking firm which had arranged the United Airlines buyout for the pilots, in 1994. The KPS fund raised $205 million, primarily from institutional investors, although a small portion of the fund was raised from multiemployer pension funds [check], a major breakthrough into this funding source. As of this writing, the KPS Fund has made two major equity investments in employee-owned companies.

 

The first ($35 million) is a 55% equity stake in Blue Ridge Paper, formerly Champion Paper’s DairyPak division. The remaining equity is divided between management stock options (5%) and the employees through an ESOP (40%). The Blue Ridge buyout, with 2200 employees in seven plants in six states, was the largest labor-initiated buyout since United Airlines.

 

The second is a 60% equity stake in Blue Heron Paper, a newsprint mill in Oregon City, Oregon, divested by Smurfit Stone Container. Blue Heron employees received 35% ownership through an ESOP, and 5% of the equity was reserved for a management incentive plan.

 

There are two new funds organized in 2000 [?] which focus on management and employee buyouts: Prairie Capital and Central Park Capital Partners. The latter, established by Houlihan, Lokey seems to be a replacement for Churchill ESOP Capital Partners [Do either of these funds have a track record yet??? Check and expand on any peculiarities].

 

All of these funds have mobilized conventional venture capital sources including institutional investors and high net-worth individuals. Despite the fact that both American Capital and KPS clearly identify themselves with the labor movement, neither had much success tapping the Taft-Hartley jointly administered multiemployer pension funds or, for that matter, collectively bargained single employer funds. A small portion of the KPS fund was raised from these sources, but given KPS’s strong labor orientation, it was a surprisingly small portion.

 

The primary reason for this seems to be the conservatism of multiemployer plan trustees and advisors and the pure Wall Street orientation of the trustees and advisors of collectively bargained single-employer plans. Both look askance at anything which smacks of “alternative investments” that meld social goals, such as broadening capital ownership, with decent investment returns.

 

Judging from their experience, the employee ownership market is not big enough or lucrative enough a niche for venture funds to specialize purely in employee ownership on Wall Street premises. Funds begun with a preference for employee ownership have found themselves broadening their investment portfolio as a consequence.

Still, every venture capitalist wants to exit. Employee ownership venture funds may create more owners at the time they sell their equity than in the initial transaction.

 

Further, one genuinely promising idea is to encourage conventional venture capital funds to consider employee ownership as an exit strategy. Selling to the employees is particularly attractive when the company has done decently but spectacularly; in the latter case, it commands a market premium above what the employees can finance. This idea would appear to be potentially viable in all countries with significant venture capital markets. The real question is how to educate venture capitalists about this possibility.

 

Canadian labor-sponsored investment funds

 

The Canadians have developed a very different means of raising venture capital that has important implications for the future development of employee ownership in that country and for other countries where it might be replicated.

 

In response to the economic crisis occasioned by the second oil shock in 1979 and to the perceived shortage of capital availability for local investment in small and medium-sized businesses, the Quebec Federation of Labor undertook to establish a local investment fund -- the Solidarity Fund. Endorsed by the Federation of Labor in 1981, the Solidarity Fund was established in 1983 and raised its first funds in 1984 with the support of a provincial tax credit. Since then the Solidarity Fund has grown into the largest single source of venture capital in Canada, and the Federal Government of Canada has spread the labor-sponsored investment fund idea by establishing a Federal tax credit to match provincial credits. Today, provincial and Federal tax credits encourage labor-sponsored investment funds in six of Canada’s ten provinces.

 

The Canadian labor-sponsored investment funds are designed as vehicles for investment of the Canadian equivalent of US Individual Retirement Accounts (IRAs). They collect small investments (typically capped at $3500 Canadian) from large numbers of employees.

 

While the Canadian labor-sponsored funds generally focus simply on reinvesting locally with certain screens (for good employment practices, environmental record, workplace safety, etc.), Manitoba’s Crocus Fund has added a preference for employee ownership to its investment criteria. In the last seven years, it has raised $165 million (Canadian) from 28,000 working Manitobans – in a province with little more than one million residents. To date it has invested about two-thirds of that, saving 150 jobs that would otherwise have been lost, creating 3500 new jobs and stabilizing an additional 5200 jobs.

 

Crocus’s employee-ownership strategy has two thrusts. The first is that Crocus is a friendly investor with the employees, partnering with employee owners in purchasing or growing employee owned businesses. The second is that Crocus’s preferred exit strategy is to sell its equity stake to the employees. As of 2000, one quarter of the employees in Crocus’s investee companies had become employee owners while another quarter are expected to become owners at Crocus’s exit.[15]

 

Following in the Canadians’ footsteps: Framtid I Norr - Sweden

 

In the mid and late 1970s, the Swedish labor movement promoted the development of wage-earner funds(popularly known as Meidner funds after the trade union economist Rudolf Meidner who conceptualized the plan) as a mechanism to increase worker influence in companies and to redress the tendency of Swedish labor’s “solidaristic wage policy” to create windfall profits for the largest and most efficient Swedish firms. The wage earner funds were to be the capstone of the comprehensive program of labor market reforms in the early 1970s that included a dozen or so contractual and legislative measures increasing employee and union influence on the job.

 

Whatever their economic advantages, the wage earner funds were a political millstone around the neck of the Swedish Social Democrats in election campaigns, and probably contributed to the Social Democrats’ loss of power between 1976 and 1982 -- the first time the Swedish Social Democrats had been out of government since a few weeks during the summer of 1936.

 

The Social Democrats reformulated the wage earner fund proposal around the establishment of a regional funds. This regional fund system was enacted by the Social Democrats after they won the election of 1982. These “regional” funds weren’t particularly regional in their investment policies. They invested primarily in the secondary market for public companies. No one was very happy with this hybrid which yielded a modest increase in employee influence in the board room and little more. They were dismantled after the non-socialist parties returned to power in 1991.[16]

 

The political disaster that the Wage Earner Fund proposal occasioned blocked further Swedish debate until the mid-1990s. The Social Democrats were leery of any fund proposal, and the non-socialist parties saw funds as an opportunity to beat up their opponents. For a country which prided itself on a factual political debate, the fund issue aroused an unusual amount of passion and generated far more heat than light.

 

Sweden’s dismantling its capital controls in the end of the 1980s and joining the European Union in 1995 fundamentally altered the equation. Swedish Social Democratic policy had been premised on the assumption that Sweden was the relevant unit for economic policy making. By the mid 1990s, that was simply no longer true. While some Swedish flagship companies like L.M.Eriksson flourished, outlying areas of the country began to suffer from the disinvestment that has characterized older industrial areas in the United States.

 

In 1996, Per Åhlström, a Swedish Social Democratic journalist in Västernorrland in the northern part of Sweden, took the initiative to organize a conference on worker ownership in Ornsköldsvik. What was clear to Åhlström and others in the region regardless of their partisan affiliation was that the northern areas of Sweden had an unusually high degree of absentee ownership and were susceptible to rapid systematic disinvestment that could have devastating consequences. After research in the US and Canada[17] and staffing a high profile trade union delegation study visit to several of his research sites in 1997, Åhlström set about organizing the Framtid I Norr (Future in the North) fund. While the fund is not yet operational, it has obtained the backing of union locals representing more than 1/3 of the union members in the region and investment commitments from several unions’ strike funds and the union’s insurance company Folksam. It is continuing to seek additional funds from other unions, the European Union’s structural funds, and the governmental Norrland fund. It is seeking initial capitalization of Skr 100 million (about $12 million) to service an area with a population just under one million. “The investment activities,” wrote Åhlström (4/5/2000), “are planned to be blueprinted (as far as possible) on the Crocus Fund in Manitoba, which we have found to have an investment policy which is well suited to the needs of our area.” Framtid I Norr’s preferred exit strategy will be to sell its equity stake to the employees.

 

Åhlström’s initiative won a key endorsement in September 2000 when the Swedish national trade union federation’s convention unanimously endorsed labor taking the initiative to form regional, labor-sponsored investment funds patterned on the Canadian model. Furthermore, the convention also agreed unanimously to reassess Swedish labor’s previously negative stance on worker ownership of individual firms (Åhlström, as posted by Logue, 9/8/2000).

 

The Mondragon Model: The Caja Laboral Popular - Spain.

 

The Mondragon co-operative complex in the Basque region of Spain -- which is the outstanding example of organizing a major component of the regional economy along cooperative lines -- is built around the Caja Laboral Popular as a financial institution. The Caja Laboral is a consumer cooperative -- a credit union -- with a special mandate for investing in worker co-operatives. The Caja Laboral has become one of Spain’s biggest financial institutions with assets in excess of $7 billion.

 

The Caja Laboral has provided the financing to grow the Mondragon cooperative complex from a handful of co-ops at the Caja’s establishment in 1959 to its current size of about 21,000 employees in the industrial sector with sales of more than $3 billion and 23,000 employees in the retail sector with sales of more than $4 billion in 1999. Mondragon’s financial sector itself employs more than 2,000. (For current information on the Mondragon cooperatives, see http://mondragon.mcc.es.)

 

Australian researcher Race Mathews (4/5/2000) suggests that credit unions and mutual insurance companies can play the same role elsewhere as the Caja Laboral does in the Mondragon region. The Desjardins credit union federation in Quebec has developed economic development subsidiaries “albeit to date infrequently along co-operative or worker-owned lines.” The central body of the Australian credit unions, the Credit Union Services Corporation of Australia (CUSCAL) is moving into business lending.

 

Possibility of labor-sponsored ESOP funds in the US

 

This situation represents a striking contrast to that in construction financing where the AFL-CIO Building Trades Department began encouraging the development of labor-sponsored building investment funds in the 1960s. The AFL-CIO’s Housing Investment Trust (HIT), established 1964, and Building Investment Trust (BIT), established 1988, draw primarily investments from multi-employer building trades plans; their scope of activity is national. Regional building trades funds, like the Employee Real Estate Construction Trust (ERECT) Fund in Western Pennsylvania and Northeast Ohio, typically find practically all their capital in local and regional multi-employer building trades pension funds. It is worth noting that although the building trades construction funds invest only in unionized construction projects and have a penchant for affordable housing projects and promote a “high road” strategy of high skill labor and high quality construction, they have also matched investment industry benchmarks in their fields.

 

Since 1996, the Steelworkers have explored the feasibility of starting labor-sponsored investment funds in the United States through the Industrial Heartland Investment Forum. In addition to developing a robust analyst of the problems -- from employees’ perspective -- of the investments of the existing American pension fund system, the Heartland Forum has provided the intellectual ammunition to justify multi-employer pension fund managers’ exploration of alternative investment strategies.

 

An Industrial Heartland Investment fund involving the Steelworkers and several other unions is said to be close to raising its initial capital.

 

An ESOP partnership fund?

 

A final possible investment fund strategy is to raise an equity investment fund from existing employee-owned companies -- and possibly from ESOP retirees seeking a diversified ESOP portfolio -- to invest in partnership with employees in new employee-owned enterprises.

 

This employee-owned company investment pool could become a general captive financial institution for employee-owned firms more generally, including securitizing the debt of ESOP companies to lower interest costs and extend terms.

 

 

5. Building company networks

 

Existing employee-owned firms tend to be islands unto themselves. One positive step would be to associate them as archipelagoes, and to build linkages between them that would strengthen them individually and as a group. The Mondragon group of cooperatives provide evidence that such linkages are productive.

 

Mondragon Co-operative Corporation

 

Perhaps the most outstanding company network in any Western economy is the Mondragon Co-operative Corporation network in the Basque region of Spain. This is a network of firms owned by their employees. The Mondragon co-ops trace their origins to a technical school established by a Catholic priest. The graduates of this technical school in turn created the first of the Mondragon co-operatives in the mid 1950's. The Mondragon co-operatives’ industrial group is one of the largest industrial groups in Spain with more than $3 billion in sales; it is among Spain’s top ten exporters, selling 47% of its production outside Spain last year. The Mondragon cooperatives’ retail group does an additional $4 billion in sales; it ranks number three in the Spanish retail sector. The Mondragon cooperatives’ bank is one of the largest in Spain, with more than $7 billion in assets. All in all, the Mondragon cooperative network constitutes the seventh largest closely held business in Spain and employs more than 46,000.[18]

 

The average size of a Mondragon co-op is quite small -- most are less than 500 employees -- but the Co