What is an Employee Owned and Operated Company (ESOP)?

The basic company structure usually puts owners at the top of the hierarchy while constituents line up below them. However, there is another organizational scheme that allows constituents to run the trade. We call companies of such nature “employee-owned and operated.”

Employee Owned Companies

An employee-owned company is a type of organization where employees have some ownership of the business.

However, companies can’t just claim employee ownership as they wish; in order to be considered employee-owned, they also need to observe some elements.

Certified EO attributes the following standards to employee-owned companies:

  1. Employees should have significant ownership of the business. Significant means at least 30% of the company.
  2. All employees should have reasonable access to the program.
  3. Concentration of ownership should be limited.

Types of Employee Owned Companies

In the U.S., there are currently over 4,000 employee-owned companies today. They can be as small as just a few employees to more than 180,000 people with revenues ranging between $1 million to more than $20 billion.

However, there are many more types of employee-owned companies. Some companies are employee-owned from its establishment while others acquire the status through conversion.

In this list, we can see how they vary from one another.

1. Worker Cooperative

Owned and managed by its employees, a company allows workers to directly participate in governing the company. Employees therefore take pride in electing its board of directors by virtue of one-person/one-vote.

2. Perpetual Trust

Based on the U.K.’s John Lewis Partnership, this type of employee ownership is new in the U.S. Perpetual trust holds company stocks for the advantage of the employee. But while employees receive a share of the profit, they don’t necessarily obtain equity stake in the company.

3. Direct Share Ownership

Among all employee-owned company types, this is the most flexible. Under direct share ownership, employees hold shares to the company at reduced and tax-efficient rates.

4. Employee Stock Ownership Plan

Most employee-owned companies in the U.S. commonly follow this structure. In this article, we’ll focus a little bit more on employee stock ownership plans, its advantages, and what it means for a company and its employees.

Employee Stock Ownership Plan (ESOP)

An employee stock ownership plan or is a form of employee-benefit plan that somehow resembles a profit-sharing plan. This allows an organization to grant employees shares of company stocks in individual accounts.

Essentially, employees become shareholders of the company as compensation for working in that entity.

Employee stock ownership plans came into fruition in the early 1970s, but we felt its impact more so in the 1980s and 1990s. When it was created alongside the passage of the Employee Retirement Income Security Act of 1974, people recognized it as an employee benefit scheme.

As of 2018, approximately 7,000 employee stock ownership plans have grown in existence and covered around 14 million workers.

Most employee-owned companies have them, but not all companies with employee stock ownership plans are employee-owned. On the other hand, there are many public companies who implement the plans as part of their retirement benefits, but don’t really have significant employee ownership.

Whichever it is, we’re sure about one thing: employee stock ownership plans provide many advantages to both the company, its owner, and its employees.

Motivations Behind Employee-Owned Companies

Now why would a company want to convert to being employee-owned?

There are many reasons for this, but the three main ones have to do with company succession, employee benefits, and taxes.

1. The company owner wishes to move on

It may be easy for people to assume that companies use an employee stock ownership plan to rescue dwindling businesses. But far from it, it instead allows owners of successfully held companies to retire quietly.

To illustrate, we’ll have the case of a CEO who wishes to retire but has no succession plan. Selling their company elsewhere might usher unwelcome changes into the company, so they decide to sell the business to their employees.

Through employee stock ownership plans, the company owner can now have a ready market for their shares. In this case, companies can either buy out an owner’s shares or use the plan to borrow money to buy the shares.

This then is an excellent option for CEOs as they get to exit at their own pace while preserving the company that they’ve built.

2. The company receives tax benefits

Companies are clamoring for employee stock ownership plans specifically because they include a unique provision when it comes to borrowing money.

Under employee stock ownership plans, both principal and interest are deductible: a company borrows cash to buy company shares while providing tax-deductible contributions to repay that loan.

More than that, business owners can also defer or avoid capital-gain taxes under this program.

3. Employees receive additional benefits

Employee stock ownership plans aim to reward and motivate employees, which makes it more of an employee contribution than expense.

For starters, employees get a stake in the company’s success. Suppose anything happens to the employee, their account receives stock shares. This makes the plan an additional source of income in addition to ensuring job stability.

Another thing: public companies often use employee stock ownership plans alongside employee savings plans. This means that the company will match employee savings with employee stocks. Compared to matching employee savings with cash, this system offers a higher matching level.

Is It Right For You?

To determine whether being employee-owned is the best for a company, we recommend business owners to envision their company with this type of plan. Would it fare well enough on its own when transferred to a different ownership?

Competitors or private equities are always on the lookout for companies who are about to transition leaderships. While these are also viable options, company owners must be prepared for the possible changes that this would entail.

Such changes may not necessarily align with the company’s original visions. Worse, the company may not be ready for it at all.

To assuage these woes, many companies opt for an employee stock ownership plan as it allows them to transition their business to people who already know about it the most.

Pros

Reports show that employee-owned companies have higher levels of employee engagement than regular companies. In turn, this high employee engagement rate produces equally higher growth in sales, employment, and productivity.

Because of the benefits that being employee-owned entails, employees discover a bigger purpose in building up the business. As such, employee-owned companies experience low turnover rates.

For owners, an employee stock ownership plan is a way to stay involved in the company, as well as an opportunity to be financially secure in the business for a few more years.

Cons

If business owners would instead like to make a quick sale or distance themselves from the business, then employee ownership wouldn’t be the best solution. After all, outside buyers can purchase the company at a price higher than it takes to set up an employee stock ownership plan.

Keep in mind as well that establishing employee stock ownership plans takes time and would most likely be expensive. For small businesses alone, it usually costs around $20,000 to $30,000 annually.

As such, owners who keep to themselves when it comes to making decisions for the company, calling directions, and distributing financial information would likely find employee ownership overwhelming.

Before setting up employee stock ownership plans, we recommend company owners to consult with pertinent advisors to determine whether it’s the right move for their business.