ESOPs: The Answer for Retaining Jobs?

The state of North Carolina could be facing massive job losses in the near future. And encouraging retiring business owners to sell to an ESOP—rather than closing up shop—might be an especially effective way to stop that potential job hemorrhage, according to a new report from the North Carolina Justice Center, an anti-poverty group.

According to the report (Down Home Capital: How Converting Businesses into Employee-Owned Enterprises Can Save Jobs and Empower Communities), the potential for business-closure job loss is particularly dire in North Carolina, and the possible benefits of encouraging ESOPs may be especially well suited to that state.

But the coming storm of retiring business owners—referred to by some as the Silver Tsunami—is something all states will face. So, encouraging the transition to ESOPs might help other states retain more jobs as well.

Job Losses Caused By Business Closures

Since 2000, 2.2 million jobs in North Carolina were lost due to business closures. In any given year, more than 25 percent of job losses occur because businesses decide to close their doors.

These types of job losses “have seriously hampered North Carolina’s economic recovery,” the Justice Center report states. Since 2010, the number of jobs lost in the state due to business closures is larger than the net job gains made in the state during the same period. Conditions in the state are ripe for those losses to continue.

“A huge share of the jobs lost to business closure happen in relatively mature enterprises. North Carolina is particularly reliant on older businesses,” the report found, noting that the percentage of the state’s businesses that are 15 years or older is twice the national average.

These mature, viable companies are a tremendous source of value—and jobs—to the communities in which they are located. And if these businesses close, it can be a tremendous hardship—especially for communities that are economically challenged, or have few available employment options to replace the shuttered companies.

The Perfect, Rural Storm

Patrick McHugh, the author of the study, says many of the states’ most economically challenged areas sit right in the cross hairs of this coming trend.

Many of these areas are rural, have a high density of individuals approaching retirement age, and are particularly dependent on mature companies as sources of employment.

And because these regions are less populated and less affluent, they may struggle to provide an adequate pool of local buyers for retiring business owners. And local buyers—including employees—are key to boosting the financial health of these areas, the report finds.

Buyers from outside the local area are more far likely to move the business—even to reap only modest, short term gains—the report states. By contrast: “When firms are locally owned, the profits are more likely to be spent or reinvested locally, keeping that capital flowing and creating opportunities within a community.”

The report states that: “All other things being equal, communities with more local business ownership tend to achieve faster economic growth than areas where comparatively few of the firms are locally owned.”

Some of the regions poised to suffer most from the coming Silver Tsunami also are ones that have been economically depressed for multiple generations, says McHugh.

Better Than No Option

Some argue that owners who sell to an ESOP may be leaving money on the table. But in some of the less affluent regions of North Carolina, ESOPs can provide an opportunity to find a buyer where few, or even none, might otherwise exist.

What’s more, a business sold to the current employees will have an easier time transitioning than one sold to an outsider, who must take the time to understand the customer base, employees, suppliers, and more, McHugh says.

Perhaps most importantly, programs that help keep existing jobs—rather than investing valuable resources in luring outside businesses to create new ones—are inherently more efficient. “It is often more cost-effective to save what already exists than to bring in something new,” the report states.

The report found that North Carolina’s traditional job creation efforts are far more costly than comparable efforts of the Ohio Employee Ownership Center. The result, the report states: “Compared to the traditional economic development incentive programs, expanding employee ownership is an incredible bargain.”

A Penny Saved

The report makes note of the potential benefit to sellers of using the 1042 rollover, which allows owners of C Corporations who sell stock to an ESOP to defer capital gains from the sale, in certain conditions.

The 1042 rollover became a source of controversy last fall, when the Joint Committee on Taxation determined that applying it to S Corporations would cost the United States treasury more than $7 billion in lost revenue over a 10-year span.

Does the potential for ESOPs to cost-effectively save jobs in places where they are needed most—like the areas in North Carolina identified by the report—provide an argument for expanding the 1042 roll over? For the moment, McHugh steers clear of conversations about tax deductions. He is more interested today in programs that might help business owners pay the cost of initial inquiries that help them see if an ESOP is right for them.

But, he adds, if a tax incentive were the reason that business owners were prompted to sell to an ESOP—and retain to jobs in areas where they are needed most—that would be a positive outcome he would welcome.

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