In a capitalist society, there are two ways to build wealth: wage labor and capital returns. Despite our ideals, the overwhelming majority of Americans are far more familiar with the former than the latter. While most have some exposure to capital returns, such as through homeownership or retirement accounts, they are often modest. For far too many Americans, these do not constitute a large enough proportion of their income to consider them earnest participants in the ideal of American capitalism.
However, even a staunch anti-capitalist would find it hard to argue that the system isn’t working for those with a much higher-than-average proportion of their income derived from capital returns vs. wage labor. So how do we create this balance for more Americans? How do we ensure that every machinist, nurse, landscaper, and engineer is not solely reliant on their direct labor to support themselves, but also on the capital returns generated by that labor?
Two recent trends offer the greatest opportunity in our country's history to do just that.
First, the well-documented and impending "Silver Tsunami" of Baby Boomer-owned small businesses looking for buyers suggests that the next decade will present one of the greatest wealth transfer opportunities in US history. Many aging business owners find themselves in the strange position of operating a profitable, attractive business without children or other successors willing or able to take them over. By itself, the Silver Tsunami does not present an opportunity to help America live up to its broad-based capitalist ideals. Instead, it threatens to erode our position even further as wealthy LP-backed private equity firms buy up these small businesses, which employ roughly half of private sector workers.
As for the second trend? A 5-year effort since the passage of the Main Street Employee Ownership Act of 2018 to make good on the bill's promise to expand access to capital for Employee Stock Ownership Plan acquisitions. In late 2023, this effort produced a truly riveting document from the Small Business Administration (SBA): Standard Operating Procedures 50 10, effective November 15, 2023.
It's hard to imagine why one wouldn't be interested in reading this 420-page document, but here are the highlights, just in case:
Employee Stock Ownership Plans (ESOPs) are a popular way of structuring a company so that a broad-base of its employees have an ownership stake in its stock. In some cases, the percentage of such a company's stock owned by its ESOP — and thus by the employees — is the minority. In other cases, however, 100% of a company can be owned by and fairly allocated among its employees via an ESOP.
As you might imagine, this altered incentive structure works well for employees and for overall company performance. A 2017 study conducted by the National Center for Employee Ownership found being in an ESOP was associated with 92% higher median household net wealth, 33% higher median income from wages, and 53% longer median job tenure. Plus, several studies have shown that when compared to their peers, ESOP companies have a higher return on assets, higher profit margins, and are only 75% as likely to go out of business.
Despite these advantages, only 18% of US private sector workers have any ownership stake in their company, which is where the SBA comes into play.
SBA 7(a) loans are federally-backed and can be used to acquire an existing business. Often, would-be business buyers are unable to secure a loan due to a lack of sufficient collateral or a number of other reasons. In these situations, the SBA backing empowers banks to take more of a chance, knowing that if the borrower defaults, they can recover part of the loan from the US Government. ESOPs are often in this class of would-be buyers that lack sufficient collateral, but until 2023, the SBA 7(a) program was not practically available to them. This meant that if a business owner wanted to sell to their employees via an ESOP, they had to wait years, sometimes up to a decade or more, to be paid for their business. Many business owners simply don't have the time or financial security to wait, and thus couldn't consider an ESOP.
However, SOP 50 10 lifted the two major financial roadblocks which effectively barred 100% ESOPs from receiving SBA 7(a) capital. First, the SBA made an exception for ESOPs to the requirement that business acquisitions be made with a 10% equity injection (down payment). Second, they removed the requirement that an owner of the business make a personal guarantee, often putting their primary home on the line, to secure a 7(a) loan for a majority-owned ESOP. Neither of these rules were practical for a 100% ESOP, as ESOPs don't require cash or personal guarantees from participating employees, and they are the only owners. Now, with SOP 50 10 in place, an incredibly powerful method of financing the formation of ESOPs has become available.
Staring down the Silver Tsunami and its wealth-transferring potential, armed with such a powerful new financial tool, there's no reason why America cannot harness these two converging trends to shape itself into something closer to what it has always sought to be: a land of opportunity for all.
The only question that now remains is whether it will.