Model State Employee Ownership Legislation

This paper provides model language for state employee ownership options. They include:

Setting up a state employee ownership center
Allowing professional corporations to be owned by ESOPs
Allowing ESOP-owned companies that are majority-owned and/or run by qualifying individuals to qualify for state set-aside programs for women, minorities, and disabled veterans.
Creating a tax credit for feasibility assessments for conversion to employee ownership.

The language here is based on language in proposed or passed state employee ownership center legislation in Texas (proposed) and Massachusetts (passed), New York (the professional services company proposal; passed in Senate as of this writing), and Colorado (the tax credit proposal Colorado passed in 2021). NCEO developed the language on set-asides.

State-Supported Employee Ownership Center

This section provides language for three different options for establishing and funding state employee ownership centers: (1) making them part of a state agency, (2) setting them up in a university, and (3) funding via an RFP for nonprofits to set up the organization.

(a) Establishment of [State] Employee Ownership Center. Not later than 180 days after the date of enactment of this section, the department shall establish a [state university-based center for employee ownership]; [create a [State] Employee Ownership Center for be housed in the Department of XXX]; [issue a request for proposal for finding for a non-profit or consortium of non-profits to establish a [State] Employee Ownership Center].

(b) Duties of Center. The center may:

(1) Raise awareness and provide education and outreach to inform business owners about the benefits of employee ownership successions and the provisions of this Act.

(2) Organize workshops and conferences on employee ownership succession.

(3) Prepare and distribute materials concerning employee ownership succession.

(4) Provide basic information to business owners exploring the possibility of transferring full or partial ownership to employees.

(5) Provide a referral service to help business owners find local legal, financial, and technical advice in connection with employee ownership succession.

(6) Partner with key organizations, such as professional and trade associations, financial institutions, unions, economic development organizations, and nonprofit entities, to promote employee ownership succession.

(7) Issue an annual report on its activities.

(1) Provide access to information regarding government rules and regulations that relate to employee ownership.

(2) Develop, in partnership with appropriate state and local government agencies, proposals for changes, where needed, in policies to promote employee ownership.

(3) Conduct investigations, research, studies, and analyses on the subject of employee ownership.

Companies eligible for assistance under this Act shall include companies with or considering an employee stock ownership plan (ESOP) as defined in Section 4975(e) of the Employee Retirement Income Security Act of 1974 or a worker-owned cooperative, or an Employee Ownership Trust in which at least 50% of the shares are held in perpetuity by the trust and pay dividends to most or all full-time employees.

(d) Funding

The State shall allocate [XXX] dollars for this purpose.

[We suggest that funding be not less than $150,000 to $200,000/year to cover the costs of one full-time and one part-time staff person, plus operating expenses.]

Allowing Professional Corporations to Be Owned by ESOPs

In most states, an ESOP cannot be a majority owner of many professional corporations, including medical offices, accounting firms, law firms, and occasionally other firms, including, most importantly, engineering and architecture. This proposal would allow an ESOP to be a majority owner, provided that the trustee or trustees of the ESOP is or are members of that profession. An exception is made for a transactional trustee hired for the purpose of making sure the purchase of of sale of shares by the ESOP trust from a non-ESOP owner is for not more than fair market value, as required by ERISA. This trustee would not have an ongoing role in making decisions about the shares in the plan.

[The appropriate state code concerning qualified owners of professional corporations] is amended to read as follows: For purposes of this title, a person is an authorized person with respect to: (1) A professional association if the person is a professional individual; [and] (2) a [professional corporation or a] professional limited liability company if the person is a professional individual or professional organization; and (3) a professional corporation if the person is: (a) a professional individual; (b) a professional organization; or (C) an employee stock ownership plan (ESOP) trust, as described in Section 4975(e) of the Employee Retirement Income Security Act of 1974, provided that the trustee(s) of the ESOP is (are) a qualifying professional individual or individuals licensed [under Sec. xxx of the State Code] to provide at least one category of the professional services described in the corporation’s certificate of formation. The employee stock ownership plan trust, however, may have as a trustee an individual or institution not so licensed for the sole purpose of negotiating and/approving of the sale of stock from a non-ESOP owner of the company to the employee ownership trust or the sale of the shares in the trust pursuant to a sale of the company to another buyer.

State Contracting Preferences for ESOP-Owned Companies

When a company that is owned by a qualifying individual or individuals under state set-aside programs for minority, woman, or veteran-owned businesses becomes majority employee-owned by an ESOP, it no longer qualifies for set-aside grants, even though it may still be led by qualifying individuals and/or have a majority of its ownership attributable to such individuals through the ESOP. This discourages many companies from moving to majority ESOP ownership, even though the result often is that people in the target group are often beneficiaries of being an owner through the ESOP.

This proposal provides for two options to address this. First, it provides that a company continues to qualify if its CEO or other top executive officer is a member of the qualifying group and a majority of its board is also a member of the qualifying group. Alternatively, it provides that if the company can provide data showing that a majority of its attributable ownership is held by qualifying individuals, the company will continue to qualify.

SECTION XXX of the Code is amended to read as follows:

CATEGORIZATION OF COMPANIES QUALIFYING FOR STATE MINORITY, WOMAN, OR VETERAN OWNED BUSINESS CONTRACTING PREFERENCES

Option A: Control by qualifying individuals

The comptroller [or other officer in the state with authority on this issue], in cooperation with each state agency reporting under this subchapter, shall categorize each business included in a state contracting preference program under Code Section XXX as owned or owned, operated, and controlled, as applicable, wholly or partly by one or more qualifying individuals to include businesses in which a majority of the common and preferred shares in the company are owned by an employee stock ownership plan as defined under Section 4975(e) of the Employee Retirement Income Security Act of 1974, provided that the chief executive officer of the company and a majority of the board of directors are individuals qualified under the contracting preference programs.

Option B: Majority Ownership by Qualifying Individuals

The comptroller [or other officer in the state with authority on this issue], in cooperation with each state agency reporting under this subchapter, shall categorize each business included in a state contracting preference program report under Code Section XXX as owned and controlled, as applicable, if a majority of the common and preferred shares of the company are owned by individuals qualifying under Code Section XXX [section for set asides]. Such ownership includes ownership by individuals held in their own name(s) plus ownership attributable to qualifying individuals within an employee stock ownership plan as defined under Section 4975(e) of the Employee Retirement Income Security Act of 1974.

Companies seeking to meet this eligibility test must submit to the [contracting agency or other relevant individual] an annual statement indicating the percentage of allocated shares in the trust held by individual qualifying plan participants. The submission must indicate:

Total shares in the company
Shares owned by the ESOP trust
Names of individuals qualifying and the number of shares allocated to their accounts

Falsification of these data shall result in the loss of contracting preferences and a penalty of XX percentage of any contract awarded.

Creating a Tax Credit for Feasibility Assessments for Converting to Employee Ownership

In 2021, Colorado became the first state to create a fund to provide tax credits to help offset the costs of converting to employee ownership. The costs of feasibility assessments for these plans can be a barrier to companies considering them, costs that would not apply to selling the company to another buyer. These costs typically range from about $10,000 to $50,000, depending on the size and complexity of the deal. The Colorado bill allows ESOPs to qualify for a credit equal to 50% of the conversion costs up to $50,000; cooperative and employee ownership trusts can get up to $25,000. The state set aside $10 million per year for the tax credits. ESOPs can qualify for a credit equal to 50% of the conversion costs up to $50,000; cooperative and employee ownership trusts can get up to $25,000.

The language below is based on the Colorado bill and only outlines the key features. The text of the entire bill is available (Colorado House Bill 21-1311, https://leg.colorado.gov/sites/default/files/2021a_1311_signed.pdf)

TAX CREDIT FOR CONVERSION COSTS FOR EMPLOYEE BUSINESS OWNERSHIP

a. (Define agency that is running the program)

b. Employee ownership plan: An employee stock ownership plan (ESOP) as defined by Section 4975(e) of the Internal Revenue Code that will own not less than [define minimum percentage; we suggest 30%] or the company’s total issued shares, a worker-owned cooperative as defined in Section 1042(a) of the Internal Revenue Code, or a permanent trust established by the company to hold not less than [x%] of the shares for the benefit of at least all employees who work at least 1,000 hours in a fiscal year and which pays dividends or an equivalent profit to all employees covered by the trust based on the trust’s percentage of ownership of the sponsoring company.

c. Conversion costs means the costs paid for professional services to determine the feasibility of converting to an employee ownership structure as defined in this Act, and can include, but is not limited to, legal fees, valuation fees, and financial analysis fees.

d. Companies will submit a request to the authorizing agency for approval of expected costs. The agency will provide a response on authorization within 30 days of the request. The [agency] will issue a set of guidelines and develop an application form within 120 days to the enactment of this legislation describing the specific data and other information required for the application.

e. The tax credit will be limited to 50% of up to $100,000 for an ESOP and up to 50% of up to $50,000 for worker cooperatives and employee ownership trusts.

The Colorado bill only applies to successful conversions. This limits the tax impact, but may reduce the number of companies considering these conversions.