Employee Ownership as a Search Fund Advantage, Turner Wyatt of Small Capital

 Turner Wyatt is the founder and CEO of Small Capital, an investment firm backing self-funded searchers who want to bake employee ownership into their acquisitions from day one. A lifelong social entrepreneur (food security, food waste/climate, and founding the Upcycled Food Association), Turner describes his pivot into ETA as a direct response to what he sees as the other defining challenge of this century: income inequality. His core thesis is simple: if ETA is reshaping ownership in America, it’s a missed opportunity if employees remain locked out of wealth creation, and it’s also a missed opportunity for business performance. 

Transcript

00:00:00 Nick LALL: Welcome to search funded the Entrepreneurship through Acquisition podcast. I'm your host, Nick law, and I'm here today with Turner. Wyatt Turner is the founder and CEO of Small Capital. He is a lifelong entrepreneur, and he's done a lot of really interesting stuff, I think, almost all of which has had a societal purpose or some other mission that's guided his work. He's done some really interesting things in food security He's put his own beer. He sold vans and negotiated a van for himself, bringing them over from Japan, which I thought was a pretty interesting story. but the topic of this podcast is mostly going to be on Small Capital, which is his latest venture. He's been working on it for about three years now. It's a firm that invests in self-funded searchers who are making use of the employee ownership model, which is really central to his thesis. They believe that businesses do better when employees have a stake in them. There are social reasons for this. There are business reasons for this, and I'm going to try to cover as many of those as I can on this podcast. But before we get into all that, Turner, I'd just love to learn a little bit more about you. Um, maybe you could just tell us a little bit about what you were doing, um, before this, how you got interested in employee ownership and knew that it was the area that you wanted to work in?

00:01:05 Turner WYATT: Sure. Yeah. As you pointed out, I've kind of had a wandering path, but basically I've been a social entrepreneur since college, which means that I'm an entrepreneur, starting businesses, organizations, but consistently with some kind of social or environmental impact, some kind of mission. And so when I first got out of college, I started a handful of food security organizations working on food waste, health equity, food access, that kind of thing. And I got really interested in food waste as a climate solution. food waste is a leading contributor to greenhouse gas emissions and climate change. And, was in the climate space for a while and ended up starting Upcycled Food Association, which is a big network of businesses globally that use otherwise wasted food to create new food ingredients or new ingredients generally. and so nothing I've said so far has anything to do with ETA or employee ownership, which demonstrates that there was a real pivot in my in my path. And about three years ago, I was leaving my post as CEO of Upcycled Food Association. And along the way I had, I learned a lot about climate change and the work that's being done there to address climate change. And along the way, I kind of became interested in what I see as the other biggest issue of our century. That's income inequality. And, I live here in rural Colorado, ski town, lots of tourism. And you talk to any business owner. And the first thing they'll say is, it's so hard to run a business here because none of my employees can afford to live here. And I think you're in New York, probably all of your listeners, wherever they are, are dealing with some kind of affordability issue in their community. And it's true. Workers in many of the workers that your listeners will inherit when they acquire a small business are not making enough to be good employees, let alone have a high quality of life for themselves. and there's this great tool. Employee ownership, which has been shown time and time again, across many research studies over decades to increase wealth of working class workers at small businesses and big businesses. but employee ownership, unlike lower middle market M&A, unlike ETA, is not skyrocketing. It's stagnated. and that's despite policy advancements, that's despite a lot of new actors and capital coming in and philanthropy coming into the space. And so we were kind of just scratching our head like, why? In a time when income inequality is terrible, affordability is terrible. ETA and lower middle market M&A, all M&A generally is growing. Why don't we see employee ownership growing in parallel with that curve. And what could we do to make those two curves parallel. and around that time I got a research fellowship from a foundation called Walking Software to basically research this question for, for a year, like, how do we make small businesses work better for workers? And, decided that I wanted to focus on building something that was specifically focused on scaling employee ownership to be as fast as possible. You know, there's lots of employee ownership stuff happening out there, like people working on conversions and lawyers and technical assistance providers and some investment funds. but they just aren't keeping pace with the level of activity that we're seeing in ETA. And so we said, okay, what if we designed an employee ownership capital product that that took advantage of the fact that ETA is exploding and built employee ownership into the DNA of ETA deals, so that once the small businesses acquired, it becomes a part of this solution not only to address income inequality, but turns out to enhance the performance of the business itself as well.

00:05:23 Nick LALL: Yeah, absolutely. I mean, I think it's pretty well agreed upon and known by everyone at this point that some of the biggest issues that we are facing as a society are that there's consolidation of wealth and power to fewer and fewer people. There are also just the people who are doing well on the type of economy we have are those who own assets, which unfortunately are not a lot of the type of people who would be the employees of the type of firms that entrepreneurs are acquiring. But maybe you could talk a little bit more about why it actually also is a good business decision, why employee ownership has proven to be good for businesses in general, and why it may be particularly good for entrepreneurs in search fund acquisition businesses especially.

00:06:08 Turner WYATT: Yeah. Well, first, you're absolutely right. There is a consolidation of wealth and power. And I think that's one of the coolest things about the growth of search funds is it's this opportunity for a reset on that, you know, thank God for the SBA seven alone giving, relatively inexperienced people the ability to buy a business and own something and to build wealth that way. and unfortunately, even if we did that and all of the small businesses in America were bought up by, SBA backed individuals, who were going to own the business themselves and continue the legacy of the prior owner and continue providing great services for their communities on a, family owned, operated basis. There would still be this inequality of wealth between that new owner and the employees, which is a shame that we would kind of squander that opportunity to create wealth opportunities for more people. But it's also a shame in terms of the performance of the business. Employee owned businesses are better and doesn't really matter what way you slice it. They're more profitable, for one thing, and they grow faster. They're more productive. They've better retention. They have a six times greater likelihood of surviving for forty years. And so for the people who are attracted to ETA because of its ostensible lower risk relative to starting a venture, one of the best ways to enhance that even further would be to implement employee ownership at the business, to just improve the longevity and the productivity and the profitability of the business even more. And where do these performance benefits from employee ownership actually come from? Well, if you work at a small business, you're probably making a salary or hourly wage, which fundamentally is a disincentive to work hard. You know, you show up, you get a paycheck, you show up another hour, you get another a bigger paycheck. You know, you show up another pay period, you get a paycheck. That's not an incentive to perform. that's an incentive to show up. But businesses don't make money on the basis of people showing up to work. They make money on the basis of adding value to customers. Solving problems for customers and being efficient at at the rate at which they do those things relative to the cost of their inputs. And business owners know this very acutely. The way that a business owner thinks is if I if this business makes more money, I will make more money. That's the way a business owner thinks. And that's fundamentally different from someone who says, if I show up another hour, I get a little bit bigger of a paycheck. And so really, the at the core of the improvements that we see in employee owned businesses relative to non employee owned businesses, it's a financial incentive for employees to perform. And it's not just a financial incentive. You do have to pair that financial incentive with some kind of culture change because you know bonuses are great. But bonuses by themselves don't fundamentally change the incentive structure of your employees. You can have a bonus at the end of the year, and still have employees that aren't super motivated or bought into the mission, or, acting in a way where they're internalizing, if this business makes more money, I'm going to make more money. but if you pair and on the other hand, just culture change on its own doesn't accomplish it either, because that just turns into kind of BS, HR team building stuff that no one likes. It's just like, let's all work together and make this a great place to work. But it's like, show me the money. Why would I do that? and so if you pair these two things and this is, this is been borne out in the research as well. So if you pair a culture of ownership with the financial incentive structure of ownership, that's where the magic happens. And that's where you start to see employees really internalize their, their wealth creation with the performance of the business and aligning those two things. and it can create really positive results at businesses.

00:11:02 Nick LALL: Yeah. I mean, I think there's plenty of research out there that the more autonomy you give employees ownership, they do perform better. And so if you give them actual ownership in the business, I'm sure that's probably the best way, you can do that. Maybe you could talk a little bit more about small capitals approach and how you actually help the To eat. Entrepreneurs enable employee ownership and culture change.

00:11:24 Turner WYATT: Sure. So small capital is an equity investor, and we provide equity to searchers who want to buy a business. And the typical profile is, someone comes to us and they might not know anything about employee ownership. but they need equity to fund their acquisition. And so we say, great, we'll give you the equity. But instead of, you sitting back and collecting a pref and a step up, and waiting for an exit or waiting for dividends, we will we're making a bet on the employees. We will add value. Not by being like your operations management consultant, activist, investor that's going to, advise you necessarily on the best way to run this business. It's likely that you and even more likely that the employees are the best people to make those decisions. And if we can motivate those employees to work harder and better, that's one of the most important fundamental value adds that you can implement in a business. And that's what we add. So our written into the DNA of our investment structure is a redeemable equity paradigm, where our equity that we originally purchased in the business over time converts to employee ownership equity that's held by an employee ownership entity and then provides profit share, commensurate to some, trust document or co-op agreement out to employees. and until once we've, hit our target return, then we're out of the business entirely. And, you have your levered equity from whatever debt you're bringing to the table as the searcher and the portion of the business that we originally funded, with our equity capital is now employee owned.

00:13:15 Nick LALL: Yeah, that's really cool. I think that it makes sense that it aligns incentives there. And, it's not just like exactly that you're being philanthropic. It's, there's a business reason for it on both sides. how did you go about raising your fund, like, were did you go to institutions, philanthropy? How did you get your funds and what was that process like?

00:13:39 Turner WYATT: Rlps are mainly individuals, and it's people who care about small business, people who want to get exposure to small businesses. we're based in Colorado. Most of our investors are in Colorado because they're kind of I think the way that they're thinking is, okay, I could make a return investing in a bunch of businesses that I don't care about or, aren't aligned with my values. Or it can make a return. Investing in the small businesses that I adore and that are in my community and that I actually patronize myself. and I think that element of, aligning investor values with the just the ethos of small business and how important small businesses are to our economy, our society is one thing. And then employee ownership is just kind of a cherry on top for some. They're interested in employee ownership for the impact they want to see. Workers have more wealth in America. for others, it's they understand that there's a value add from employee ownership. And so we're de-risking our investments by implementing a incentive paradigm that increases business chances of success.

00:14:58 Nick LALL: Yeah, that's that's super interesting. And I think that's what's cool about this space, is that you see a lot of people like that who, they they can make returns in a lot of different ways. But there is something about small businesses, especially if you're focusing on the community that they're in. it's not that, spoke to the issues that we have with our system earlier, and it's just the way things are in the system. It's not that the people who, have the money in the system want it to be that way, necessarily. It's just the way things are. And I think this is a great example of that. I was wondering if you could maybe discuss employee ownership in, other models, whether that's like an Esop or a startup option pool. How does that compare to what you guys are hoping to do with ETA and, ways it could be different or better?

00:15:48 Turner WYATT: Yeah. So one of the biggest barriers to employee ownership that we see is just education. Not very many people know how it works. there's not a ton of success stories. And that's the problem is we need to see employee ownership scale so that it can have the impact that it would have on business and society and people, but also so that there can be more success stories. So we can see how this actually works. If you Google how to sell my business to my employees, you're probably going to find a couple things. First off, the bat number one is really hard and expensive. You have to take submarket exit terms. and you're probably going to hear Esop, Esop, Esop, employee stock option program, and and Esops are great. I love Esops, I think they're genius. They work really well. But it's a it's governed by ERISA. And so there's a ton of red tape, great tax benefits as a result of being, an official ERISA product. but it's really expensive to set up and maintain. it's not unheard of for an Esop to cost a couple hundred K at least to set up, and then a lot every year to maintain, you have to get a third party valuation every year. So it doesn't jive well with small businesses where half of Americans work, and which represent ninety percent plus of the number of small businesses in our country. And so one of the reasons that we were attracted to ETA as a strategy, as a market to deploy our employee ownership thesis, was that it represents kind of the long tail of small businesses in the US. You know, these great profitable, ancient small businesses that have just been churning off cash flow for decades, and who are just too small to be able to afford an Esop. Luckily, there's other formats of employee ownership, that are gaining traction. Some have been around forever, and are kind of resurging right now. Others are a little bit newer and are also gaining attention. and so those are the formats that we tend to focus on, just not because they're, any better or worse necessarily, but because they're essentially in the price point that's available to these great profitable small businesses that want employee ownership and that could benefit from employee ownership, but they're just too small to to afford an Esop. so I can talk about each of those a little bit more if you want.

00:18:22 Nick LALL: Sure. Yeah.

00:18:24 Turner WYATT: So one of the best, most flexible forms of employee ownership, in my opinion, is the employee ownership trust, which is a perpetual purpose trust entity that owns shares of the operating company on behalf of trustees and trustees are essentially current employees. And so let's say, you're a searcher and you get a investment from small capital. That's twenty percent of your acquisition. we're going to go through a redemption process where we, essentially sell those shares to an employee ownership trust. And then from that point on, twenty percent of post debt free cash flow is going to get distributed out to trustees, current employees as profit share. and so that one kind of begs the question of like, what's the difference between this and just profit share? And the answer to that is it's the culture change. The actual employee ownership trust vehicle gives a container where employee ownership culture can be really healthy. You can give bonuses, you can give profit share. But you're not going to access those benefits of increased motivation, morale, productivity, profit. Unless that incentive is paired with really great culture where people see themselves as owners. You're not an owner of a business just because you get a bonus. But if you're a trustee in this business entity that owns shares of the operating company for whom you work, that is a much more powerful incentive. Aligning container where employees can make make profit, share on top of their wages, and contribute to really, really positive culture that's going to benefit the business in other ways too, not just financial. and so an employee ownership trust, people are attracted to that because it's super flexible. You can set up an employee ownership trust just about any way you want. you can have people invest at different schedules. It can be pro-rata across your workforce or be, you know, disproportionate to people with greater seniority. It's super flexible. It's a fraction of the cost of an Esop to set up. and they're just really handy tool because it's kind of the, in some ways it's kind of like the most generic, simple tool to just set up a profit share oriented employee ownership format at your business. another one is a co-op worker co-op, which kind of has a bad rap in my opinion. People see them as like overly democratic or socialist, and that's just not the case. You can set up a co-op to be really flexible, to work within most business types. and with a co-op, it essentially serves as the same function as an employee ownership trust in that it's a vehicle that either is the business entity, is the operating company entity itself, and provides profit share out to employees. Or you can have a co-op that is a holding company of the operating company, similar to an EOT and provides profit share out that way. There is an enhanced sense of democratic leadership at a at a co-op. but again, the reputation is that it's like overly democratic, and it really doesn't have to be that way. and so educating folks on, on that is another part of the work that we strive to do. Like co-ops are great. There's some great tax benefits of of operating or selling to a co-op. and it you can set it up to essentially be a really flexible tool that does engage employees in a really authentic, beneficial way and provides profit share out to them. Co-ops are also a fraction of the cost of an Esop to set up and come with most of the tax benefits.

00:22:08 Nick LALL: Yeah, I would imagine also that these are probably really helpful for the searchers when they're talking to the sellers, because I think that the sellers, obviously they want to maximize the amount that they can sell the business for. But second to that, it's almost always taking care of their team. And so if you can tell them the other team's going to have equity going forward, you're clearly a guy who's not going to just flip the business quickly and, do things that a lot of the sellers are less comfortable with.

00:22:34 Turner WYATT: Oh, yeah. Here is something that I ask lots of searchers to think about is in light of the reality that we all know of after sale price, it's legacy. It's how much how well are you going to take care of my business that I've poured my heart and soul into for decades? How well are you going to take care of my team, my community, my customers? What are you going to say to the seller to win the Loi that separates you from the other offers that they're getting, the other searchers that they're talking to? And what I've observed is that most searchers really rely on the same few lip service bullet points of like, I'm not going to sell in five years, I'm not going to fire anyone. I'm going to be a team player. I'm going to maintain good relationships with your your customers and your suppliers. And my reaction to that is always like, well, of course you're going to do those things. You have to do those things if you're going to successfully run this business and that doesn't separate you from your competitors in acquiring this company at all. If you come to the seller and you say, hey, I'm going to buy this business and I'm going to make it employee owned, chances are employee ownership is something that they have already thought about, and they've done that Google search and they've found the results of like it's hard and expensive and Usopp is the only way. And so if you're giving them a really practical way that you can demonstrate that is on the very cap table of the business post acquisition for how you are going to do those things that support their legacy into the future. That is a huge advantage for you in winning and winning looks at these businesses because very few other people will say that. and meanwhile, searchers are thinking to themselves, we talked to a lot of searchers and many of them say, oh, I was thinking about doing an option pool, or I was thinking about doing some kind of employee ownership. But in the future. And to that, we kind of say, well, in the future, you're going to be mired by the complexities of running this business. The best time to do it would be now, when you're actually capitalizing the acquisition versus in the future, when you essentially have to dilute yourself in order to make room on the cap table for the employees. So if you can capitalize the acquisition of part of the business for the employees at the same time that you're acquiring the business. it's a much better, more efficient use of capital. and again, just gives the seller a very practical example of how you intend to support their legacy, besides the lip service that they're going to hear from everyone.

00:25:26 Nick LALL: Yeah, it definitely makes it much more tangible. I guess next question would just be how do you evaluate searchers or deals? Like, do you have any, framework? Do you also look for businesses that have social impacts, or do you feel like you're making enough impact just doing employee ownership for any small business?

00:25:42 Turner WYATT: We don't have any kind of impact. criteria for the, businesses necessarily. Like you said, we we think that the best impact a small business can make is to take really great care of its employees and its community. and an employee owned business is better for the community, too, because it's going to stick around. It's going to be a stable employer for more people. It's going to provide better wages. And so that's the best impact that a small business can have. personally, would I be more attracted to a solar company versus an oil and gas company? Sure. but fundamentally where we want to make impact is on the, the providing greater wealth opportunities for employees. we are looking for many of the same qualities in business that most searchers are enduring profitability. small, we tend to look, you know, on the smaller end, generally sub ten million revenue, at least ten years old or so and profitable. everything else is kind of downstream of those First. First look, criteria.

00:26:57 Nick LALL: Definitely makes sense. you've also spoken about how you want to make small capital the most scalable employee ownership platform in the world. I guess maybe you could talk a little bit more about that. how what what gave you the conviction, the conviction that this could scale? And then also, what does it look like once it does scale? Like what's the ultimate goal?

00:27:17 Turner WYATT: Yeah, I think I mentioned before that the employee ownership ecosystem right now is filled with a lot of really smart people, and a lot of people are investing in it. A lot of philanthropists are looking here as a way to deploy their capital to create impact. and as someone who's been in the nonprofit world for a long time, fled and started and fundraised for nonprofits, it unfortunately kind of has right now, it's operating at the pace of nonprofits. we're seeing, like a lot of research and a lot of advocacy, but we're not seeing a lot of deals. I'm not seeing a lot of actual employee ownership deals, conversions, businesses that are converting to employee ownership, which is the real. That's what we want, right? I mean, we can do all the advocacy and research that we can dream up, but ultimately we want to see businesses that were not employee owned become employee owned. Pretty simple. And so instead of focusing on areas of the market where you kind of have to cultivate from scratch new investment opportunities and bring them through a sort of bespoke conversion process with lots of consultants and, and lawyers and technical assistance providers. What if we just provided a capital product that there was already a lot of demand for in a growing market, and made it look and feel and smell a lot like the capital product that searchers are already in need of, but designed it in a way that created employee ownership. And so I think the the reason that we think ETA is so congruent with our mission of scaling employee ownership to the greatest degree is because of the pace, because, we've all heard the silver tsunami statistics, like there's millions of businesses that are going to undergo leadership transition, ownership transition in the coming decade. each one of those is an opportunity for new employee ownership. And if we just create a capital product that most of those deals need anyway, that creates employee ownership. That's a really efficient way of getting the outcome of of more employee owned businesses. For us, we don't really think about, there's a lot of folks in the space that think about like, well, what portion of the business is is owned by the employees. And that's kind of the success metric for us. It's like, you know, we're not competing against one hundred percent. We're competing against zero percent because ninety nine point nine nine businesses are right now ninety nine point nine nine percent of businesses right now are not employee owned and are not going to become employee owned when they sell. And so the status quo is that there's no employee ownership. And so even if we can create a small portion of employee ownership, if we do that at a lot of businesses, the net impact is going to be a lot higher than if we do one hundred percent employee ownership at a small number of companies, our impact metrics generally tends to be more aligned with how much wealth are we creating for people? That's what this is ultimately about. And so rather than focusing on how what percentage of the business ends up as employee owned, one of our early qualifying criteria is can we believe that at base case this is going to increase income for employees by at least ten percent. So it's not about the percentage of the business that's owned by employees. It's about how much is it actually marginally increasing their income as employees, which has the obvious impact metrics. But it also is like, if the incentive aligned, the performance incentive aligned portion of their income increases, then that just strengthens the incentive. if you're a sales guy and ninety percent of your wages are coming from commissions, that's more motivating than if ten percent of your wages are coming from commissions. so it has that dual benefit. And, we hope to have some great tools that will help to measure the impact of what happens to these businesses and the employees over time as, employee ownership strengthens and takes hold. To demonstrate, here's the kind of wealth that we're creating for individual people.

00:31:39 Nick LALL: I think from our last call, you said you're closing on your first deal now. Maybe you could talk about how that process has been. Any surprises? why you chose this one?

00:31:49 Turner WYATT: Yeah. So the first deal that we're working on right now, is actually not in the ETA space. We have. So I don't know if this is going to be interesting to include or not. half of what we do is, is focused on ETA. The other half is focused on helping business owners sell to their employees, either partial or full buyouts. So we talked to a lot of business owners about chips off the table deals or cap table cleanup deals or, you have part of the business, you want to move into employee ownership or you have a great management team there, and you want to move the whole thing into employee ownership and exit. those are possible too. And it's a little bit more actionable for us right now, as you know, to source those deals because, searchers are kind of on their own timeline. And so we have great relationships with many searchers, across Colorado and the US. and our goal has really been to build relationships with them early on in their search so that they can decide, is this something that I want to do? Is this something that I would even want to build my cap table around, or orient my fundraise around or orient my search around? do I believe in the power of employee ownership to strengthen and de-risk my acquisition? and so, yeah, we're we're building our network of searchers, that are will hopefully eventually come back to us and ask for capital for their acquisitions. And and we would move forward with them in the near term. We're, we're focused on investing directly with small businesses in our community working directly with sellers?

00:33:23 Nick LALL: Sure. anything else that I didn't cover that you wanted to talk about or.

00:33:30 Turner WYATT: Honestly, those are great questions. I think we I think we hit it. All right. Yeah.

00:33:34 Nick LALL: I guess maybe one just one last question. how can people reach you? What what kind of people would you want to connect with?

00:33:44 Turner WYATT: I think we want to connect with the searcher who wants to do something more meaningful, more creative, more community based with their search. And that tends to align with the searchers who are not obsessed with the deal, but obsessed with the business. That makes sense. we are all networking in the ETA space, and there's definitely a brand of searchers out there who their their finish line is getting the deal done right? But of course. And what you hear on all the podcasts is like, that's the starting line, right? You be obsessed with the business, or better yet, be obsessed with the problem that the business is solving, not with getting the deal done. And those are the people who we want to connect with, and in particular, those who want, those who see the value in activating their employees not as a bonus program, but as a fundamental advantage both to their acquisition and to their success running the business into the future.

00:34:53 Nick LALL: Amazing. Thank you so much, Charles. Really cool what you're working on and wish you the best of luck.

00:34:58 Turner WYATT: My pleasure. My pleasure. Yeah. Thanks, Nicholas.