Private equity is devouring the economy as boomer entrepreneurs exit—but a new approach to employee ownership can change that

Private equity companies are in the business of making money, and industry roll-ups present an opportunity to do so efficiently for several reasons:

• Many private companies exist in fragmented industries, where consolidation provides clear advantages.
• Many private companies are owned by baby boomers who lack sufficient succession planning.
• Buying companies at a relatively low price/earnings ratio, aggregating them, then selling at a higher price/earnings ratio is lucrative.

Private equity companies recognize this model enables them to extract significant financial rewards. But company owners are beginning to realize they can beat private equity with a compelling alternative approach.

This became apparent to me through conversations with several past clients from decades ago. Few had successfully transitioned their companies to new owners. Several had been acquired by private equity firms. While they were pleased to seal the deal, I sensed a level of regret.

One president told me that he had been acquired by a private equity company. He was subsequently asked to stay on as a consultant to help them acquire even more companies and share the same best practices we had applied at his company. The first part went according to plan. They were successful at acquiring more companies. However, he admitted there was little success in sharing best practices. As he put it, PE companies are good at transactions, but not very good at operations.

The truth is, while PE companies have the unique capital and experience to acquire companies, they have little expertise in specific industries or running a company. Yet they extract a fortune for their efforts at industry roll-ups. Why can’t company owners create roll-ups like this themselves, without any private equity involvement?

Another past client, a civil engineering company based in Wisconsin, did just that. They made over 20 acquisitions in their sector with the following characteristics:

• No involvement of private equity firms.
• Implementation of an Employee Stock Ownership Program (ESOP), resulting in substantial tax benefits.
• Integration of acquired companies into the ESOP structure, fostering common stock ownership among a growing number of employees.
• Emphasis on sharing best practices through “communities of practice,” enhancing employee engagement and performance.

The result? Their valuation surged more than sixfold in the last five years, with no sign of slowing. It’s a win-win in which customers benefit, and the wealth created remains in the hands of those who work hard to create it. 

Pooling resources under one ESOP structure means the cost of the ESOP per company plummets. Individual companies can operate autonomously. Meanwhile, the employees become company owners, who can directly improve the value of their stock by sharing and implementing best practices. Their chances of succeeding at this are greater than the PE company’s because they understand their industry and people. And if they apply a management approach like economic engagement, which is shown to double profit growth, this further enhances their competitive edge. This industry roll-up alternative is becoming known as “rewarding roll-ups.”

ESOPs are frequently seen as an exit tool for owners, but rewarding roll-ups uses it as a foundation for considerable additional growth in equity, shared by both employees and owners. And there is at least one additional benefit: job security.

In an inevitable downturn, a PE company likely won’t care about laying off employees. But companies courting this novel model can invite more companies into the roll-up at lower costs due to the downturn. The expansion creates plenty of work for existing employees, improving job security and stock value, and ultimately boosting profits for everyone. It’s worth noting that the aforementioned civil engineering company hasn’t had a layoff in the last 20+ years.

Broad awareness and adoption of this approach are limited but growing quickly. By reframing ESOPs as a platform for growth rather than just an exit strategy, company owners can make something even more meaningful of their life’s work.

It’s time we find a compelling alternative to private equity. It’s time to invest back into the people who create a company’s value: the employees and the stakeholders.

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