This page deals with the conversion of an existing business to a worker cooperative, not the demutualization of worker cooperatives. Of primary interest are issues concerning the purchase of a business by the workers for conversion to a worker cooperative.
From a purely financial perspective the question is one of valuation. What is the proper price to be paid for the company? Modern finance provides one answer, the future profits discounted to the present value. This is the market value of any non-cooperative business.
But how do we value a worker cooperative? if we believe in worker ownership then only the current workers (members) are allowed to appropriate the profits. This has dramatic implications regarding the valuation of a business with respect to the conventional view that the present value of a business equals the discounted stream of future profits. The market value assumes the current “owners” are going to appropriate the future profits, not the current members at any future time. Since the profits from the future labor of workers cannot be owned in the present, the standard valuation method cannot apply to worker cooperatives. Then what is the value of a worker cooperative? The only possible answer is that a coop is worth its net asset value, or the value of its assets minus its liabilities. This is sometime approximated as the book value of a firm for accounting purposes.
The supposed value of a firm above its net asset value is called goodwill. Goodwill is an intangible asset. Generally, goodwill is associated with the reputation of the firm, its brand name, or customer loyalty which is assumed to enhance future profits. Whether these future profits will materialize is uncertain. In our “market” economy the sale of goodwill through equity trading is the prearranged theft of the profits of future workers, in violation of their rights. In a cooperative where the members have the profit rights, goodwill cannot exist.
The shares of a typical corporation represent the securitization of labor. It is merely a repackaging of people’s labor for sale in the market. Under slavery the sale of labor was quantized by individual. With modern financial engineering we have unbundled the risk associated with the sale of an individual. Now, the labor of many individuals can be combined and then divided by company. People are grouped by firm, and traded as common stock based on an investor’s preference. Since the abolition of slavery, humans as individuals can no longer be counted as an asset on a companies balance sheet. Today the capitalization of labor is accomplished with goodwill. And it capitalizes not just the present employees, but future ones as well.
Accounting practices are inconsistent on the issue of goodwill. Earned goodwill is not permitted as an asset on a firm’s the balance sheet. This makes sense because a firm can’t record its future expected profits as a current asset. Yet purchased goodwill (when another firm is acquired for more than its net asset value) is counted as an asset. Something than cannot be earned in the first place obviously can’t be sold, but this is exactly what the accounting permits.
The problems with conversions is that few business will be sold at or below their net asset value. The ones that can be purchased at those prices are usually not profitable and are typically either failing businesses or ones in dying industries. There are some exceptions, but they are rare. While there are people who will only engage in conversions at or be low the net asset value, the norm is for conversions to employee ownership (partial or full) take place at a market value above the net asset value.
With a market value (greater than the net asset value) conversion the workers are engaging in a transaction where they pay up front for the entire future profits of the business. It is a financial transaction of precisely zero economic benefit in the event they stay with the firm indefinitely, and negative benefit if they ever leave. While there may be, and often are, other compelling reasons for converting a business, the financial component is dubious at best. It could be that the market value is incorrect (too low), or productivity gains and thus enhanced profitability after the conversion are expected, but it is unclear why the workers should be paying for future profits at all.
The other more important issue is that the time of the sale is also the proper time to compensate previous workers who may have been shorted. In most cases this would involved massive reparations to past employees. And the reality is this is never discussed in buyouts, as it would sink the deal. By analogy, in the sale of a house all the creditors are make whole, not just the owner. If there were contractors who did work on the house and didn’t get paid, or unpaid utilities or taxes, the sale is the time to take care of it. It is not right to only pay the home owner and effectively wipe out the other parties claims. But this is more or less what happens in many conversions.
Converting a business at a market value greater than the net asset value with no reparations for the workers is only acceptable if the capital investment is more valued than labor. But that is the opposite of what the worker cooperative movement is about.
Market value conversions are a strategically flawed approach to creating worker cooperatives. This is simple to see by historical analogy. One can imagine a situation in the antebellum south where a slave shop was being converted to a worker cooperative. When valuing the slave shop one of the key questions would be the value of the slaves on the balance sheet. Is the market value people will pay for the slaves based on their age, gender, physical condition, and disposition? Or is there some reason that the value of the slaves is identically equal to zero, like the slave contract was invalid in the first place or human ownership is illegitimate. A professional dealing with conversions would not say that the slaves had no value because human ownership was wrong and slavery should be abolished. That would sound crazy and prevent the transaction. Instead they would drop all talk about slavery abolition and engage in a discussion about the proper market value of slaves. And the market value for the slaves would inevitably be paid in most conversions. These conversions would be carried out ensuring the owners of the slaves shops were compensated to their satisfaction with absolutely no reparations for the slaves. Questions about whether the incidental purchasing the slaves in the conversion supported the market for slaves and instigated more kidnapping and imprisonment would not surface. Despite these major shortcomings there would be plenty of acclaim for the freedom of the slaves, workplace democracy, and the worker ownership created in the process.
As we would expect from the analogy, conversions today proceed with no discussion of human rental abolition or fundamental labor rights. Arguments in favor of net asset value conversions are buried. Valuation issues are confined to determining a market price the owners view as fair, with worker reparations are off the table. The self censorship on these issues of enormous strategic importance is virtually complete.
The price paid for agreeing to the owners valuation preferences in a conversion is steep. But there are ways to do worker directed conversions, without the consent of the owners. But it will take a radical shift from the misguided strike to go back to work mentality today. The key is that market valuations work both ways. If a business has no employees its market value immediately collapses to its net asset value. This occurs because without employees there are no future profits, only assets and liabilities.
The conversion process outlined below could work for profitable publicly traded companies. And it will be easier the more the company is “worth” relative to its net asset value (roughly a higher price to book ratio is better). This means highly profitable companies are better candidates and can be converted on the workers terms, not the owners. And as an bonus, profitable businesses have more strategic value than money losing businesses in shrinking industries.
To control their business, the employees would need to organize to simultaneously quit permanently, not strike. Before quitting they would either: 1) Purchase put options on shares of their business 2) Short sell shares of their business 3) Purchase credit default swaps on the debt of their business.
Option 1 of purchasing puts is the best method because options are highly leveraged. Put options grant the right (not the obligation) to sell shares at a certain price. The value of puts increase as the value of a company declines. Highly out of the money puts can be utilized since the final value of the business is known, making the upfront premium cheap. The risk to the workers is limited to the price of the options.
Option 2 of shorting the stock of the company is more risky. Shorting involves borrowing a stock, selling it, and trying to buy it back later at a hopefully lower price. By shorting their stock the workers would make the difference between the market value and net asset value of the business. However, the worker would face unlimited liability in the even the shares rose.
Option 3 of purchasing credit default swaps is probably the most difficult. It may be of use when a company issues (sells) debt but its stock is not publicly traded. It could conceivably be used to convert a large private company with a high credit rating. The risk is limited to the price paid for the credit default swap, but the final value of the swap is difficult to determine since the final value of the debt is unknown. A credit default swap is more of an insurance product than a derivative which pays the face value of a bond in the event of default. In a company with no employees the primary method of generating cash flow from which to pay the bond holders disappears. Since there would no longer be any income generating productive work done, the only way to pay the bondholders is by renting out the assets, or selling them. Selling the assets to make payments to bondholders is unsustainable. And rentals would typically be insufficient to cover bond payments.
The basic idea is to use proceeds from the transactions above to purchase the assets needed to run the business as a worker cooperative, and provide a transition fund for the workers (sort of like a strike fund) until they got up and running. The value of the assets that would need to be acquired is known, and with options 1 and 2 the profit from the collapse of the share price to the net asset value is known as well. There would be a new separate cooperative business so technically this isn’t a conversion. But it would have the same workers producing the same things. Publishing the plan ahead oftime in a small local print only publication would avoid insider trading issues.
This would be a major organizing effort, but one the workers would be in control of. There would be some effort needed to get the customers to support the workers of the business, as opposed to the owners who would try to quickly hire and train new employees. The existing workers would have the advantage of already being trained and proficient, and having worked together. Unlike people, assets are for the most part interchangeable with some exceptions like land and certain intellectual property.
Fundamentally the people doing the work have the power to control production, unless it is conceded. The acceptance of self renting as the structure of work is a concession that can be revoked at any time. The threat of violence for refusing to work has dwindled significantly since the time of slavery. But taking control will require a major shift in the mindset of workers and the labor movement in general.
A few comments on the other side of the transaction. In the crude analysis above the owners are only entitled to the net asset value of the business. To add a bit of sophistication we should also account for the losses the initial owners incurred when the business being converted was started. Take the simplest case of a family business that had the same owners since inception. Their loss in the startup period would grant them some claim to future profits. This means the they might have some claim on profits over the current net asset value. However, without any convention for a suitable range of loss based returns, we can not say what is reasonable or fair. If the business is purchased for the net asset value shortly after the startup period the owners might be shorted, and if it is purchased after a long period of profitability they might be over compensated. But since the concept of a loss based return is new we must currently default to the net asset value for conversions.
The case where ownership has changed hands, perhaps multiple times, is much more complex. Due to ownership changing hands at market value and the payment of dividends, it is unlikely the transaction chain can be unwound. But there is also no reason that owners who did not bear a loss or who acquired shared from a third party and didn’t fund the company directly should receive more than the net asset value.
There is a fundamental problem with the employees of a business paying market values for shares of their business in a conversion. Rented humans (employees) should not be expected to pay for the future profits they will produce any more than a slave should be expected to pay for their freedom. However, in a leveraged Employee Stock Option Plan (ESOP) the employees are not paying for the shares they are acquiring. The shares are being paid for entirely through tax breaks and dilution of the previous owners. ESOPs may not result in full worker ownership and may or may not be democratic, but the employees are getting shares for free. By analogy, a scheme where slaves got a cut of the plantation profits for free might not help abolish slavery, though it would certainly provide a tangible benefit to the slaves involved. One of the drawbacks of ESOPs is that they are often done at the discretion of the owners and management leaving the workers in a secondary role. And in some cases compensations and benefits are reduced in exchange for ownership. Worker reparations are pretty much out of the question in these transactions.
This is not a recommendation to buy, sell, short, or purchase insurance on any security, option, derivative, bond, or contract.