EOpriv: Financing successful employee-owned companies

[Dan Bell <dbell@kent.edu>]

Here is the final section for comments from the privatization paper.

The entire new draft of the paper should be available by Thursday or
Friday of this week (September 21 or 22) at:
http://cog.kent.edu/lib/privitization.htm

I have already received several valuable comments and additional
ideas from participants like Dave Wheatcroft, David Ellerman,
Don Ward and Joseph Doggett. I hope to incorporate some of these
ideas in a third draft next week.

5.7     Financing successful employee-owned companies

        Financing the acquisition, working capital and development of a
newly-privatized employee-owned enterprise faces several challenges. These
funds can come from a variety of sources including the seller (the
government); traditional private lenders; regional, national and
international development banks; equity partners and the employees themselves.

        The government should consider seller financing of an acquisition by
employees. If the enterprise was a drain on the state budget before, taking
a note does not put the state in a worse position. If it was a contributor
to the state budget, as long as the debt service and income taxes paid match
the previous contribution, it is also not in a worse position. Of course
this assumes that the buyer will preserve and enhance the value of the
assets. It the buyer intends to strip the assets, the state could find
itself holding a note with nothing to back it. Where the workers control the
enterprise operations and effective oversight of management is in place,
asset stripping is less likely to occur.

        Where a portion of the ownership is sold to an outside investor, again 
the
state would be no worse off lending the funds back to the employees of the
enterprise for working capital or capital investments. Alternatively, the
state could accept a note from the employees for the acquisition and the
outside investor could provide the funds for working capital and capital
investments in exchange for a portion of the ownership of the new enterprise.

        Payments on the note could be adjusted to the profitability of the
enterprise. During the early years, payments would be minimal or deferred,
and increased once the business is stabilized. Extending loan terms for long
periods would have a significant impact, as 30 year mortgages have been made
home ownership a reality for millions in the United States.

        One viewpoint is that in exchange for the state assistance, the employee
owned firm should relinquish rights to any excess profits. Defining excess
profits may be problematic. Also, such an agreement could be a disincentive
to operating the business profitably. Perhaps the most effective way to
carry out such an arrangement would be to give the state stock options at a
reasonable future target price.

        Where it is realistic, workers should be required to contribute to the
necessary financing of their company. Such a contribution can establish a
sense of commitment to the endeavor and be a major step towards the
transition to a culture of ownership. While the ability to contribute is an
asset, the lack of such ability should not be used as a barrier.

        In some countries, workers have accumulated retirement assets which can 
be
used. Risking diversified retirement assets to purchase shares in a newly
privatized company is a serious matter and is justifiably seen as a means of
last resort; however, dedicating a percentage such as 20% is not
unreasonable. Where wages and benefits are sufficiently above a comfortable
standard of living, the use of a reduction in compensation to be used to
service additional debt is another possibility. In some cases, workers may
take on personal liability to borrow a portion of the necessary funds, and
then apply future profits to the repayment of this debt. This personal
liability should only cover that portion of the funding which cannot be
collateralized with the enterprise's own assets.

        Another source of funds is an equity partner. Sharing control with an
outside investor may be preferable to taking on personal liability and has
the potential to bring in needed expertise. At the same time, the pure
interests of the workers will be subject to compromise. Side agreements to
define the future disposition of the outsider's shares can enhance the
workers control over the future evolution of ownership.

        Where there are no reasonable methods for financing worker acquisition 
of a
controlling ownership share, non-monetary shares with defined voting rights
may also give the workers a level of protection where an outside investor
acquires the controlling interest. At a minimum the workers would have the
right to veto negative practices such as asset stripping.