EMPLOYEE OWNERSHIP 101
You might not have considered all the options.
More than 50% of small business owners do not have a plan for what will happen to their businesses when they are ready to retire. Planning ahead is key to a smooth transition. Business owners have many options, including passing on their business to family members, selling to management team members, selling to an outside purchaser (such as a competitor, vendor, or supplier), selling to an investor, or selling to employees. There are proven ways to sell to employees that can benefit business owners, employees, and the community.
There are thousands of successful, thriving, employee-owned businesses across the US. Most are more successful than they were when they were privately-owned.
Employee Ownership could be the right solution
In addition to providing a tax-preferred exit strategy for selling shareholders, employee ownership has many other benefits, including:
- Preserving jobs and community impacts – keeping jobs in the communities where they are rather than moving or losing them.
- Helping companies attract and retain good employees – Employee-owned firms with engaged cultures have higher retention rates.
- Creating new tax benefits for the employee owned business – Some employee owned firms, such as 100% ESOP S Corps, are tax exempt.
- Improving company performance - Studies have shown that employee owned firms tend to out-perform comparable companies, while exhibiting more resilience during economic downturns.
- Improving wages and benefits – Employee-owned companies also tend to have higher wages and better benefits.
- Enabling employees to build wealth over time – Once the selling shareholder and associated loans are paid off, a portion of annual profits are allocated to employee retirement accounts.
Employee Stock Ownership Plans (ESOPs)
The most common form of employee ownership in the United States is the Employee Stock Ownership Plan (ESOP). Nationally, there are more than 6,500 active ESOPs today, representing more than 14 million employee owners. ESOPs are retirement plans, somewhat like 401(k)s, except the invested dollars all go into the company where the employees work. And importantly, like a 401(k), an ESOP can be tax-advantaged - if the company is an S Corp, whatever portion of the company is owned by the ESOP (if it is 30% or greater) pays no federal or state corporate income tax. So a 100% ESOP-owned S Corp is generally tax-exempt. If the company is a C Corp at the time of sale, the selling shareholder can defer capital gains taxes indefinitely if they sell at least 30% of the company’s shares to an ESOP.
If your company has 20 or more employees, low debt, and is consistently profitable, an ESOP may be a great option for you. Otherwise, another employee ownership structure may be better. Does this sound complicated? You can read all about ESOPs on the National Center for Employee Ownership and ESOP Association websites and there are many experts available to help.
More about ESOPs:
While ESOPs are the most common kind of employee owned company in the U.S., the most common form across the world is the worker cooperative. These are companies that are governed democratically, with employees voting for the board of directors. Each employee owner receives one and only one voting share. There are more than 465 worker cooperatives in the U.S. Worker co-ops can be a great option for smaller companies or those that want to prioritize workplace democracy. You can read more about worker cooperatives at the Democracy at Work Institute website.
More about Worker Cooperatives:
https://www.electricviolinshop.com/blog/evs-featured-by-unc-tv/ (Story of Electric Violin Shop)
https://www.youtube.com/watch?v=joiFRVqy00Y (Story of A Child’s Place)
Employee Ownership Trusts
A new form of employee ownership, popular in the United Kingdom and just beginning to catch on in the U.S., is the Employee Ownership Trust (EOT). These companies are owned by a trust, established by the selling owner, with the requirement that all profits above those needed for reinvestment in the business go to the employees. Employees are only beneficiaries of the trust during the time they are employed. Some businesses choose a perpetual form of the trust (depending on state law) to ensure that their business will remain employee owned in perpetuity. EOTs lack the tax benefits of ESOPs but are also significantly less expensive to create and administer.
More about Employee Ownership Trusts