ARTICLE
July 2019

Start Here: For Business Owners

Why do businesses consider employee ownership?

Business owners sell to their employees for four main reasons:

  1. To find a buyer that will pay market value while protecting the legacy and culture of your company, allowing you to exit your business with peace of mind.
  2. To strengthen company performance and workforce engagement.
  3. To protect the workforce, the management team, and the community by keeping the company out of the hands of third parties and private equity.
  4. To provide a robust retirement benefit to your employees at no cost to them, one that is tethered to company performance.

The most common form of employee ownership in the U.S. is the employee stock ownership plan, or ESOP. There are over 6,000 privately held ESOPs in the country, found in every state and a wide range of industries, such as retail, manufacturing, engineering, boutique child education, craft brewing, and waste management services.

ESOPs are:

  • Highly tax-advantaged, both for sellers and for the company itself.
  • Very flexible, allowing you to sell your business all at once at market rate, or take a little bit of equity off the table, continuing to hold majority ownership while achieving partial liquidity.
  • A time-tested business form, supported by both parties in Congress.

Other forms of employee ownership

There are other ways of providing equity to employees besides ESOPs. 

Worker Cooperatives: Worker cooperatives provide a flexible, easy-to-implement path to employee ownership for companies that want to operate with broad-based democratic governance.

Learn more about worker cooperatives from our friends at the Democracy at Work Institute.

Perpetual Trusts: This form of employee ownership is a mainstay in the United Kingdom and has recently emerged in the United States 

Direct Ownership: Corporations, LLCs, benefit corporations, and many other types of companies can create effective employee ownership using other means and structures.

 

Ownership Options When Selling Your Shares Is Not the Goal

Many business owners want to share ownership with employees but are not looking to sell any of their ownership interest, at least for now. There are several options to consider: sharing ownership does not have to mean giving up any of yours.

ESOPs

An ESOP is a kind of retirement plan, related to 401(k) and profit sharing plans. The company creates an ESOP trust and makes tax-deductible contributions to it that are allocated to all employees meeting a basic service requirement based on an equitable formula. In many cases, as in ownership transitions, the ESOP trust uses the company’s contributions to buy shares from the existing owner(s). But when the owners do not intend to sell shares, the company can simply issue and contribute new shares to the plan. It gets a tax deduction, but the ownership interests of the non-ESOP owners are diluted. You can learn more about how ESOPs work in the article How an Employee Stock Ownership Plan (ESOP) Works and our book Understanding ESOPs.

Is an ESOP right for your business?

Start exploring an ESOP sale by signing up for an NCEO membership. As a member, we can connect you with an ESOP company in your state or industry, allowing you to learn from their first-hand experience. Members also receive unlimited access to our live and replay webinars, ready-to-use documents, current and past newsletter issues, our ESOP Q&A with more than 700 questions and answers, discounted pricing, research report summaries, and other exclusive content, and they can call us for advice. 

Sharing Ownership Using Equity Compensation

Creating an ESOP is not the only way to share ownership without selling the original owner's shares. Companies of all sizes, from the Fortune 100 to small LLCs, use stock-based compensation to attract and retain employees, and to align the workforce behind the company’s goals. Equity compensation takes many forms, such as stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, and stock purchase plans. 

These plans allow companies to grant either actual shares or the rights to the economic value of shares. They do not carry the tax benefits of an ESOP, but they can be designed with almost any rules the company chooses, within some limits. If an existing owner of a private company doesn't want to sell shares, the company can issue new shares, much like an ESOP. However, as with an ESOP, this would dilute the ownership of the existing owners.

For more details, see the article Stock Options, Restricted Stock, Phantom Stock, Stock Appreciation Rights (SARs), and Employee Stock Purchase Plans. For more details, we have a number of useful publications. Most notably:

The Decision-Makers Guide to Equity Compensation

Equity Compensation for Limited Liability Corporations

Contact us

Selling your business is a weighty decision with a lot of considerations that are specific to you and your situation. If you have questions about your the next steps on your succession plan, please give us a call at 510-208-1300.