Guidance In Building An Ownership Culture
The NCEO offers specific guidance in creating an ownership culture, including the following steps:
- Give employees a financially meaningful ownership stake in the business. It should be enough to be an important part of their financial security.
- Educate employees about how the business generates income and profits and their role in making this happen.
- Train employees in basic business literacy so they understand the data you share with them.
- Build employee involvement and momentum by making the contribution of ideas part of their everyday work through their teams and by providing lots of feedback opportunities.
Creating high-engagement cultures is hard work, but its work that pays off, says Rodgers. We know of very few companies that backed away from these systems once they started them, although systems are often changed.
Benefits For The Company
Companies themselves can also benefit economically from employee ownership.
First, employee-owned companies grow faster than their traditionally-owned counterparts.
A report in Harvard Business Review called this the ESOP effect when they found that, during the five years after companies instituted ESOP plans, their annual employment and sales growth were each more than 5% faster than their competitors.
Companies with employee ownership also tend to see greater productivity, higher profitability, and increased revenue successes that tend to continue over time. A study cited by GEO found that after five years 90% of cooperatives are still in business.
Tax benefits for all parties are another advantage.
During the transition process, companies may be able to use pre-tax money to purchase stock from the owners. The seller can defer their capital gains, and employees can defer taxation on their stock interest until they begin receiving dividends. Many take advantage of tax-free rollovers to an IRA.
NCEO lists these tax benefits for ESOPs:
- Contributions of stock are tax-deductible
- Cash contributions are deductible
- Contributions used to repay a loan the ESOP takes out to buy company shares are tax-deductible
- Sellers in a C corporation can get a tax deferral
- In S corporations, the percentage of ownership held by the ESOP is not subject to income tax at the federal level
- Dividends are tax-deductible
Employee Ownership Is Good For Workers
For workers, employee ownership creates real economic stability. Employee-owners experience financial advantages on four levels:
- Equal or better pay and benefits
- Asset building through profit sharing, retirement savings and shared business ownership
- Enhanced job security and stability
- Well-being and psychological safety
Employee-owners have better job quality outcomes, including training, participation in company decision making and increased access to benefits like paid leave, tuition reimbursement and employer-sponsored childcare.
The case for employee ownership is strengthened by the impact this powerful business model has in addressing economic instability and wealth inequality with low- and middle-wage workers. Prior to the pandemic, as workers lived paycheck-to-paycheck and navigated the challenges of housing, education and childcare costs, 46% of families in the U.S. could not manage a $400 emergency expense. The impacts of the COVID-19 pandemic have only exacerbated this stark economic reality, most of all for workers of color and women who have been disproportionately impacted.
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Earnouts Noncompete Agreements And Consulting Agreements
Many sales of smaller companies contain some kind of earnout provision. Employees buy part of the company directly, with the seller getting the remainder as some percentage of future profit or sales. The company can make these payments, but they are not tax deductible. Depending on how the earnout is structured, it may be taxed as ordinary income, not capital gain.
Noncompete and consulting agreements can also be used to provide compensation to the owner, but the company must be able to justify the cost as reasonable for the value received in order for them to be deductible. Both are taxed to the seller as ordinary income.
What Does Employee Ownership Mean
Employee ownership means no single person, family, or third party is a majority shareholder of company stock. Instead, the company’s stock is allocated among employees through shares .
When first hearing about an ESOP, people may joke and say “Great, now I can fire my boss!” But all jokes aside, this is clearly not how employee-owned companies function. In fact, management roles for an employee-owned company mirror those of most workplace organizations. However, working for an employee-owned company is a positive experience because employees at all levels of the organization have the same ownership opportunities. Its a true team environment.
Fun fact, Airline Hydraulics Corporation has been 100% employee-owned since 2005! Our company’s stock is broken up into shares that become available annually when past employees retire, move on, or when employees who have worked for Airline for ten+ years sell back their stock to further diversify their portfolio.
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Pro: Sellers Are Paid Fair Market Value
The Internal Revenue Service defines FMV as the price a company would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.
An ESOP trustee has a fiduciary responsibility to uphold this standard. FMV is derived through an independent valuation, followed by negotiations between a plans sponsor and an ESOP trustee. The transaction is only consummated if both sides agree on a price. Overall, a company and its shareholders can count on fair compensation for their equity.
New Trend In The Marketplace
From a survey taken by the National Center for Employee Ownership, it was noted that more than about 14 million private companies have taken part in ESOPs. This trend has become a part of almost every industry like the policy research industry and even the supermarkets , with over 8,000 companies today in the US that have retirement plans.
As per their research, an average worker in an ESOP has got the chance to accumulate an estimate of $134,000 in retirement wealth from their stake in the company. In short, the idea of offering employee ownership has become a trend that companies are adopting at a fast pace. This means that companies that have not yet taken up this should consider this idea, as many new ESOP firms are taking the top spots over other closely held private companies.
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Case Study: King Arthur Flour
King Arthur Flour is another popular employee-owned company that has been using the ESOP model since 1996. In 2004, longtime owners Frank and Brinna Sands signed control over to their employees, and in 2007, the company became a certified B Corp.
King Arthurs approach, reported in Forbes, centers around a model of co-leadership in which executive decision-making is shared between four of the companys leaders. That flexibility to innovate isnt something that they would have been able to leverage as a publicly held company.
With employee ownership at its core, the company culture pays off literally. Revenue for the business exceeded $140 million in 2018, a 12% increase from the year before.
Watch the video below to hear why employees find working at King Arthur to be fulfilling.
Working at King Arthur Flour
While employee ownership isnt a panacea for all the issues in the economy, there are a lot of advantages for everyone involved. Thats why moving toward a more inclusive economy starts with building equity in the workplace.
So if youre wondering why employee ownership is good for business, you can think of it from three perspectives Employees, Owners, and Businesses no matter which type of structure you choose
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 , 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. In North Carolina alone, there are approximately 154 such companies. Most are more successful than they were when they were privately-owned.
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Phantom Stock And Stock Appreciation Rights
For many smaller companies, these plans will be the most suitable because they are very simple. Phantom stock pays employees a cash bonus equal to a certain number of shares SARs pay employees a cash bonus on the increase in the value of a certain number of shares. Employees are granted a certain number of phantom stock units or SARs, almost always with vesting requirements. They pay no tax at grant. When the awards vest, then employees do pay tax at ordinary income tax rates, while the company gets a deduction. In effect, phantom stock is the equivalent of restricted stock and SARs the equivalent of non-qualified options, except in that both typically pay out only at vesting and that there is no 83 election available for phantom shares.
Companies can also choose to settle the award in shares. For instance, a company might first set aside enough to pay the taxes on an award, then give the employee a number of shares equal to the remainder.
Esop Companies Grow Faster
Once we had our two samples, we collected data on sales and employment growth. We then compared the growth rates of each ESOP company with its five or more comparison companies, calculating the differences in performance before and after the ESOP was established.
If an ESOP companys growth was consistent and significantly higher than its comparison companies growth, we ascribed this to the ESOP effect. An ESOP company might well have outperformed the comparison companies before it set up its ESOP. We registered an ESOP effect only if the companys performance was even more impressive after it set up its plan.
The results of this analysis proved striking. During the five years before instituting their ESOPs, the 45 companies had, on average, grown moderately faster than the 238 comparison companies: annual employment growth was 1.21% faster, and sales growth, 1.89% faster. During the five years after these companies instituted ESOPs, however, their annual employment growth outstripped that of the comparison companies by 5.05%, while sales growth was 5.4% faster. Moreover, 73% of the ESOP companies in our sample significantly improved their performance after they set up their plans.
Finally, we wondered if there might be other factors involved in setting up an ESOP that might account for improved performancea change in management, perhaps, or an extraordinary use of ESOP tax breaks. We tested for these and other factors and found no relationship.
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What Is Employee Ownership 3 Examples
Before the early 1970s, employee-owned companies were a rarity. Then, in 1974, the Employee Retirement Security Act passed through both chambers of Congress. ERISA created an official definition of employee stock ownership plans and made employee ownership much easier to achieve.
In 1975, there were 1,600 ESOPs in America. By 2018, that number had grown to 6,416. Some employee-owned companies, like Publix, are on Fortune 500s 100 Best Companies to Work For list.
Clearly employee ownership is a tonic for success. But why? Well explore that questionand a few othersin this brief introduction to employee ownership. Lets go.
Employee Ownership: Wall Street Agrees That Ownership Works
Harley Davidson celebrates its 100th anniversary this year. Seen are different areas of the Harley … plant where the motorcycles are assembled.
Corbis via Getty Images
A group of private equity firms, companies , pension funds and nonprofits spearheaded by Pete Stavros a partner at KKR KKR has announced that they are creating an initiative they have titled “Ownership Works” that will work to encourage companies to have their employees especially low-income employees become shareholders. This makes for a happy day as employee ownership is an issue of which I have long been drum banging.
Studies repeatedly have shown the benefits of employee ownership for both workers as well as improving company performance and profits. For example, a Rutgers study found that employees close to retirement and working at a company with an employer ownership plan had more than ten times the median savings of employees nationally . Further, the Rutgers study found that with an employee ownership program employees were more likely to benefit from job training greater job security increased retirement security improved financial skills and improved inequality.
A separate recently released Rutgers study found that employee-owned companies during the COVID-19 pandemic were:
o 3-4 times more likely to retain non-manager and manager employees
o More than three times more likely to retain staff
o Significantly less likely to reduce employees hours or pay.
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What Is An Employee
What does employee owned mean? Well, the National Center for Employee Ownership official definition goes like this:
Employee ownership is a term for any arrangement in which a companys employees own shares in the companys stock.
Workers gain ownership interest in the company, so they benefit directly from company growth. One very obvious side effect of employee ownership is employee satisfactionwhich is what you see on full display when you visit a Publix supermarket.
A Primer On Ownership
The word “ownership” is used in different ways by different people. Legally, ownership of a business is a bundle of rights to reap the benefits of that business and to make decisions about how the business is run. The basic rights in a business are the right to company income, the right to the surplus value of the company if the company is sold, the right to make decisions about how the business should run, and the right to sell all or part of the value of the business.
In non-employee ownership companies, employees receive the right to some of the company’s income through wages, but not other rights. Employee ownership companies involve employees in some or all of the other myriad rights of ownership.
The particular way in which the rights of ownership are assigned to owners in the company depends on its legal structure. A business must be set up in one of three ways: as a sole proprietorship, as a partnership, or as a corporation. In a sole proprietorship, business property, liability, and income are treated as the personal property of a single person. These businesses will have to first establish a partnership or incorporate to share ownership with employees.
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Pro: Tax Benefits For All Stakeholders
Since passage of the Employee Retirement Income Security Act of 1974 , Congress has formally encouraged the establishment of employee-owned companies. With working class wealth creation and middle-market business stability as goals, substantial ESOP tax incentives were included in the landmark legislation and have since been expanded by lawmakers from across the political spectrum.
Esop Benefits For The Selling Owner
For a small business owner, selling a company or preparing for succession can be unpredictable. However, selling the company to an ESOP can provide stability, predictability, and a smoother transition for the company and company leadership. For example, the ESOP provides the selling owner with a buyer ready
to purchase the company at fair market value. In addition, the owner can also sell shares over time to ensure the owner maintains a certain level of control over the business, which also gives vendors and clients confidence in the future of the changing face of the company. Lastly, as an employee-owned company, the owners can take comfort in knowing that the company they built will not be gutted and sold off by a new owner. Dedicated and valued employees will have continued job security and the company can maintain their corporate values instilled by the founders.
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Will Control Be Shared With Employees Or Only Equity Ownership
One of the first decisions to make is whether or not employees will have controlling interest in the company. Does the sort of employee ownership you have in mind involve only equity rights, or will it involve employee control as well? It makes sense to think of there being two basic kinds of employee ownership companies: those with equity benefit plans and those that are employee-controlled.
In a company with an equity benefit plan only, employees receive an equity stake in the company but do not as a group have voting control over the company. Such plans are often set up as a retirement or savings benefit and as a way to let employees in on the equity growth of the company while creating an incentive to stimulate productivity. In such plans, ultimate control remains with either a top manager or an outside owner .
In an employee-controlled company, employees as a group have voting control over the company. Ownership may not even involve significant equity rights, but any outside owners are minority or nonvoting owners. Employee ownership in such a company is a means of sharing control and dividing up corporate income among employees.
List Of The Pros Of Employee Owned Companies
1. It gives an organization the opportunity to rule by consensus instead of through dictation.Goody Clancy started offering an ESOP in the early 1990s because the original owners were ready to move away from the business. There are over 100 employees who belong to the firm, and each one of them is also an owner. They have seven principals who also control a majority of the stock, but no one owns more than 10% of the shares of the firm.
One of the principals in the company, Geoffrey Wooding, told Architect Magazine that the benefit of this structure is an added level of consensus. We govern by consensus, kind of like running Switzerland, he said. There is no titular head. Weve done it this way for a number of years, and it works for us.
2. You can take advantage of several tax and investment benefits.ESOPs provide numerous benefits that are worth considering when comparing an employee-owned company to other structures. Whatever the principal amount is from a loan happens to be offers the potential of being tax-deductible. You can finance this lending option with pre-tax funds to improve your overall gains. When certain requirements are met, those who hold stock can sell it, defer their capital gains taxes indefinitely, and then pay it when it works best for their budget.
If you belong to an S-Corp and have the option for an ESOP, then the recognized earnings from this plan are also usually exempt from regular income taxes.
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