The 2022 WORK Act (Worker Ownership, Readiness, and Knowledge Act) required the Department of Labor (DOL) to create a new program to fund state employee ownership centers and to create guidelines for how valuations should be done in ESOP companies. These are two very different functions. The first is focused on outreach and education with the goal of encouraging, where appropriate, employee ownership and employee involvement in work-level decisions. Employee ownership is not defined in the language of the bill but presumably includes ESOPs, worker cooperatives, employee ownership trusts (EOTs), and broad-based equity grants. The language and legislative history of the Act make it clear that the purpose of the program is not to encourage more plans aimed at narrow groups of employees. Under this part of the Act, the DOL will administer a grant program to state-level organizations to do outreach and education.

The second part of the Act focuses on valuation guidelines for ESOPs. Proper valuation techniques, as well as elements of deal structure that affect the fairness of valuations (warrants, seller note rates, control provisions, etc.), have all been subject to uncertain standards based on often conflicting case law as well as on DOL process agreements with certain trustees. Developing clear and reasonable standards could help reduce litigation and make sure that ESOPs are compliant with the spirit and letter of ERISA while not discouraging ESOPs in a way clearly contrary to Congressional intent.

These are two very different functions, and we believe they should be overseen by different offices in the DOL. Developing valuation guidelines is clearly a regulatory function best carried out by EBSA. It would not make sense, however, for EBSA to oversee the grant-making program. The sponsors of the WORK Act clearly intend the law to help spread employee ownership. We believe (and we believe the sponsors would agree) that this does not simply mean trying to create more employee ownership but rather educating employees, business owners, leaders, and professionals about what employee ownership is, when it is appropriate, and what makes it work well—or not. Part of that is to provide outreach and education on open-book-management and employee involvement in decisions at the work level, a practice that research has shown improves the performance of these plans significantly. The outreach is not just for ESOPs, however. Indeed, some of the existing state programs have had a heavy focus on worker cooperatives and other forms of employee ownership that are more appropriate than ESOPs for very small companies.

The new structure for the WORK Act will have EBSA run the Employee Ownership Initiative office and have the Employment and Training Division administer the grants, assuming Congress provides an appropriation. We believe this can be a very workable approach. This paper represents the NCEO’s suggestions on how the DOL might best proceed.

Outreach and Education

The law requires the DOL, effective FY 2025, to create an “Employee Ownership Initiative to promote employee ownership and employee participation in business decision-making.” The program is to be funded at $4 million in fiscal year 2025 (which starts in October 2024), gradually increasing to $16 million by fiscal year 2029. To continue after that, Congress would need to create a new appropriation for the program. The funds can go to existing state programs or to create new ones. States can contract out the work to qualified organizations or create the program in-house. If a state does not apply, nonprofits can apply in the following fiscal year.

The DOL’s primary role here is to make grants, not to itself create substantial educational material (that material already abundantly exists), to assess the effectiveness of the program, and to publish information on what it learns about effectiveness. The Employee Ownership Initiative Office, however, will play an important role in providing information that states and the Employment and Training Administration, as well as others interested in employee ownership, will find useful.

The law requires that program funds would be used for:

“(A) providing education and outreach to inform employees and employers about the possibilities and benefits of employee ownership and business ownership succession planning, including providing information about financial education, employee teams, open-book management, and other tools that enable employees to share ideas and information about how their businesses can succeed;

“(B) providing technical assistance to assist employee efforts to become business owners, to enable employers and employees to explore and assess the feasibility of transferring full or partial ownership to employees, and to encourage employees and employers to start new employee-owned businesses;

“(C) training employees and employers with respect to methods of employee participation in open-book management, work teams, committees, and other approaches for seeking greater employee input; and

“(D) training other entities to apply for funding under this subsection, to establish new programs, and to carry out program activities.”

The bill directs the DOL to perform its function in carrying out the employee ownership Initiative by making state-level grants, acting as a clearinghouse on techniques employed by new and existing programs and existing state-level programs, and funding projects for information gathering on those techniques by groups outside the DOL (and disseminating that information).

Funds also can be used to help pay for feasibility studies; provide materials for outreach and training; create a data bank on where to find legal, financial, and technical advice in connection with business ownership; and create networks of employee-owned companies.

States can “sponsor and submit an application . . . on behalf of any local entity consisting of a unit of State or local government, State-supported institution of higher education, or nonprofit organization,” as well as submit an application on their own behalf. If a state fails to support or establish such a program in a given fiscal year, then in subsequent fiscal years, such local governmental, educational, or nonprofit entities can apply for grants on their own initiative.

There are already a number of state programs that perform these functions. Three—Colorado,  Massachusetts, and Washington (to start in 2024)—are state-funded. Two others, Ohio and Vermont, have received government funds in the past. The Employee Ownership Expansion Network (EOX) includes state programs that are privately funded and focus on ESOPs. A few of these (Pennsylvania, Minnesota, Missouri, and North Carolina) have full-time staff; others are more at a development stage. Texas, Washington, and New York are among the states considering setting up state programs; California passed a  law in 2022 setting one up in 2023 (it is not yet operational).

Because the Act does not define employee ownership, an early task will be to do that. Most practitioners in this field believe that includes ESOPs, worker cooperatives, EOTs where the trust holds at least 50% of the shares for the benefit of the majority of employees, and equity grant programs made to at least half the workforce. The Act is also ambiguous about what worker participation means. Extensive research on employee ownership shows that companies that share financial and work-level metrics with employees, include them in decisions about how their jobs are done, and give them opportunities for input into decisions beyond their own jobs outperform comparable companies. Employee involvement in board-level or management decisions does not correlate with performance, however, nor do employee surveys indicate it is a significant priority for employees. These kinds of systems cannot be mandated, in part because they vary so much depending on the company and in part because if management is not on board, they become little more than formalities. The DOL office can, however, use the research findings to help evaluate whether state programs have effective approaches to education on these issues.

The administration of the grants would be separate and under the Employment Training Administration. The DOL needs to decide what role EBSA will play in this process. Grant administration will involve a few central tasks in administering the grants, as described below. In developing these tasks, the DOL should work with the many local and national employee ownership organizations to develop specific guidelines and possibly create an advisory council including people from these groups.

Evaluation of Applicant

We see the DOL looking for at least the following elements in a grant application for non-state organization applications:

  • Does the applicant have experience with ESOPs, worker cooperatives, and/or employee ownership trusts? If not, does the applicant have agreements with individuals and organizations who have that experience that can share it?
  • What resources does the applicant currently have available for potential employee ownership company owners, employees, board members, and advisors? What resources does the applicant plan to have available? This should include website development as well as materials developed by the applicant or other organizations that have agreed to make them available.
  • How will the applicant do outreach to potential employee ownership company owners, board members, and advisors? 
  • A budget for activities.
  • Does the applicant have a preference for certain forms of employee ownership? The application might ask the applicant to describe the pro and cons of each of the three approaches as a way to see if there is a bias.
  • What agreements does the applicant have in place with other organizations in this field to share resources, cosponsor events, etc.?
  • Does the applicant have an advisory board from companies, providers, and other experts?
  • Does the applicant have a plan for adding additional financial resources beyond the grant?
  • Does the applicant have a sustainability plan post-grant?

States will not have this in-house expertise. Instead, we believe the DOL should look for a specific plan about how the state will ensure it develops in-house expertise or plans to work with those who do, how they will use the money, and how they will coordinate with other state agencies to make sure that resources in these programs are available.

Whoever the applicant is, if the plan is an ESOP, the DOL should require education about current best practices for governance and valuation based on DOL process agreements with ESOP trustees.

Program Essentials

The DOL should require the following elements in any program:

  • Materials and presentations should provide a description of how the various employee ownership plans work and compare on an objective basis.
  • Materials and presentations should include discussions of best practices on employee engagement strategies (open-book management, work teams and other high-involvement practices, etc.), valuation (based on DOL process agreement guidance), governance (at least one outside board member; independent trustee for any transactions with a non-ESOP owner), and sustainability (planning for repurchase).
  • There should be training programs available provided by the applicant or organizations it has vetted on creating and operating a plan, financing a plan, governance, and employee engagement practices.
  • There should be a strategy to work with intermediary organizations, such as city development offices, business and labor organizations, and academia to help outreach efforts.

Evaluation of Program Effectiveness

Awardees should submit metrics on program effectiveness each year, including but not limited to the number of events and participants, the number of people viewing the website, the number of people requesting information, and the number of new plans. Awardees should also provide data on governance and engagement programs at any new companies resulting from the program.

Assessments on ongoing grants should look at the number of new plans created by the program, the scope and effectiveness of outreach, whether new plans follow best practices as described above, plans for sustainability, and the scope and effectiveness of alliances with other organizations.

The office should publish its finding on the effectiveness of these programs and work with academics and researchers at the NCEO and other groups to develop data on this issue.

Valuation Guidelines

The responsibility here is easier to describe, albeit no doubt difficult to complete. Courts have come to varying conclusions about such issues as how much to pay for control, how to assess deal structure elements such as warrants and seller note rates, what makes for a misleading forecast, when trustees (including outside trues) are conflicted, debt impact, executive compensation, and what financial models to use to mimic financial buyers. The DOL has put out guidance on some of these matters in its process agreements, but they apply only to the affected trustees, and there is disagreement in the valuation community about whether they all apply in each case as well as some of the specifics. There is also no agreement on just how common bad valuations are, although the exceptionally low default rate on ESOP acquisition loans (two per thousand per year based on over 1,700 transactions we at the NCEO studied for the period 2009–2013) suggests the valuations at least are not so bad that the debt taken on is not sustainable.

To develop the new guidelines, we suggest EBSA and the three national ESOP organizations (the NCEO, the ESOP Association, and Employee-Owned S Corporations of America) nominate people for an advisory council. While EBSA would have the final say, we suggest that people recommended by these groups represent 50% of the panel. We urge that at least two panel members be trustees, lawyers, or appraisers with expertise in ESOPs.

A key issue in developing these guidelines is what ESOPs are supposed to do. The legislative history is compelling that the goal is to broaden ownership. ESOPs, however, are part of ERISA, whose goal is to improve retirement security. These can conflict. Would, for instance, a plan that pays 10% more than what is deemed fair value, but that increases the amount of annual contributions to a retirement plan significantly, be in conflict with ERISA or consistent with the purposes of ESOPs? Standards need to help resolve this issue.