Many companies promote and publicize the fact that they’re employee-owned, and for good reason: an employee stock ownership plan (ESOP) isn’t just an ownership model. It’s a qualified retirement benefit for employees that gives them an ownership stake in the company.
But an ESOP isn’t the only model for employee-owned businesses. Other employee ownership options aren’t qualified retirement plans with the same tax advantages that an ESOP can offer — yet, they are still important and often useful ways for employees to acquire an ownership stake in the company they work for.
It’s important to understand that “ownership stake” doesn’t always mean employees exercise control over a company. For example, most ESOPs place voting rights in the hands of a designated ESOP trustee. Worker cooperatives, on the other hand, extend democratic control to employee-owners.
So what does employee-owned mean? And what are some of the benefits of employee ownership? The answer depends on several factors.
Multiple Paths to Employee Ownership
There are numerous ways a business can offer ownership stakes to employees. When most people think of owning a company, they envision a controlling ownership, as is achieved in the cases of partnerships and direct buyouts. When employees directly buy out a selling business owner, that kind of ownership transition usually involves a relatively small group of employees — often members of management — with agreed-upon objectives and closely aligned goals.
But other employee-ownership models exist too, and while they don’t all extend voting rights to employee-owners, they can confer a number of impactful benefits both to employees and to the business as a whole. So the meaning of employee ownership can vary quite a lot from one employee-owned company to the next. Following are some of the most common ownership structures and vehicles.
A worker co-op is a democratic business model that gives equal ownership rights to employees. Employees purchase either shares of stock or a membership share, usually after a probationary period of employment. When employees leave the business, they sell their share(s) in it.
Business owners who choose to sell to a worker cooperative may be exempt from capital gains taxes if gains are reinvested in U.S. securities. Specific regulations and tax benefits apply to worker co-ops.
Employee Stock Ownership Plans
An ESOP is a qualified retirement plan that holds company stock in trust and allocates shares to employees. Employees don’t invest their own money in company shares, and when a vested employee separates from service, the company buys the ESOP shares back from the departing employee.
This video offers a simple explanation of how an ESOP works:
Equity Compensation Plans
Many employers use company stock as a form of compensation. Stock options, employee stock purchase plans (ESPPs), and stock appreciation rights (SARs) all fall within this category of ownership. Each has its own pros and cons, structural requirements, and tax implications.
Employee Ownership Trusts (EOTs)
Like an ESOP, in an EOT a trust owns the part or all of the company to provide indirect ownership to employees, and the best interest of employees is a concern of the trust. But unlike an ESOP, an EOT is not a retirement plan. Employee-owners don’t accumulate shares during their employment, so there’s no repurchase of shares when they separate from service. Rather, an EOT is a profit-sharing ownership trust, and profits are shared annually with employee-owners.
EOTs can be relatively simple to establish and administer, and can incorporate some more democratic control principles similar to worker cooperatives. They can also articulate company values and culture within EOT documents. But they don’t include the attractive tax advantages of an ESOP.
The Value of Employee Ownership
When it comes to running a business, there’s business value — and there are business values, and certain types of employee ownership can have an impact on both.
I’d be remiss if I didn’t point out that a 100% ESOP-owned S corporation is not subject to federal income tax (or state income tax in most states). That major tax advantage positions those ESOP companies well for growth.
But if you asked workers what an employee-owned company means to them, you should expect an answer that goes well beyond tax benefits. Studies have shown that ESOPs perform better than comparable non-ESOP companies, and in fact ESOPs provided greater financial security, higher wages, and better job retention during the pandemic.
One key factor that makes employee-owned companies stand out is the concept of ownership mentality. ESOPs place a high value on teamwork and shared success, and when employees know they have a stake in the company and that their work performance can affect that value, they have a shared, concrete motivation to succeed (and stay). That motivation can be powerful, transformative, and long-term — impacting productivity, profitability, and recruiting and retention. In fact, ESOP companies reported quit rates two times lower than national rates.
Employee-owners also have a unique opportunity to build greater retirement wealth: Millennial workers at ESOP-owned S corps had median ESOP balances of more than $22,000 and non-ESOP balances of more than $11,000. That compares with the median U.S. millennial retirement account balance: $0.
Certainly, no single ownership structure fits every business, but employee ownership options like ESOPs can be a flexible alternative to other exit strategies, and their benefits to employees can leave a legacy of wealth-building long after the sale. Learn more about how employee ownership can impact company culture when you download our free guide, What to Expect After the Transition to an ESOP Company. Click the link below to get your copy now.