November 18, 2020
If the events of the twenty-first century have made anything clear, it’s that the economy created by doing “business as usual” doesn’t work for everyone.
From the Great Recession and the Occupy Wall Street movement to a global pandemic that’s left countless families struggling to get by, small business owners and their communities are often the ones who experience the effects of the shareholder economy the most.
Perhaps that can explain the rise in popularity and increasing demand for employee ownership in the United States.
As of 2018, the National Center for Employee Ownership (NCEO) reported 10.3 million active participants across 6,000+ companies ranging from construction and manufacturing to finance, retail, and healthcare.
That year, the Harvard Business Review featured worker buyouts as a way of tacking the wealth gap and income inequality. The authors argued that, by transferring ownership to workers, companies can help whole communities raise their standard of living and become personally invested in their success.
Another recent article in Fast Company, aptly titled “The Business of the Future is Ethical, Sustainable, and Employee-Owned,” called for more businesses to embrace employee ownership in order to promote sustainability and take a stand against issues like worker exploitation and environmental degradation.
But what is employee ownership, and why is it becoming a more and more attractive business model to many companies looking to transition?
What is employee ownership and how does it work?
Employee ownership can take many different forms. Worker cooperatives, employee stock ownership plans (ESOPs), and other kinds of broad-based gain-sharing programs (e.g. phantom stock, profit sharing) are all ways to promote inclusivity in the workplace.
The most common form of employee ownership is the ESOP, in which employees become shareholders in the company through a trust that acquires stock and pays out dividends when employees retire or leave the company. Worker co-ops, on the other hand, are democratically owned and governed by the workers themselves, and share profits through annual patronage dividends. EOTrusts are another way ownership can be shared.
While each employee ownership structure has its own distinct set of features, what they all have in common is transferring benefits to workers while providing meaningful engagement with the business and personal investment in its success.
Examples of well-known employee-owned companies in the United States include Eileen Fisher, Equal Exchange, and Colorado’s own Namasté Solar.
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 Arthur’s approach, reported in Forbes, centers around a model of “co-leadership” in which executive decision-making is shared between four of the company’s leaders. That flexibility to innovate isn’t 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.
While employee ownership isn’t a panacea for all the issues in the economy, there are a lot of advantages for everyone involved. That’s why moving toward a more inclusive economy starts with building equity in the workplace.
So if you’re 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…
Benefits for Employees
A main group of people who benefit from employee ownership are, of course, the employees.
In fact, data from the National Center for Employee Ownership’s “Employee Ownership and Economic Well-Being” report shows that, compared to workers in traditional firms, workers in employee owned companies…
- Receive a 33% higher median income from overall wages at all wage levels
- Have a 92% higher median household wealth (controlled for population demographics)
- Enjoy greater access to benefits like flexible work schedules, retirement plans, parental leave, and tuition reimbursement (e.g. 23 percent of employee-owners have access to childcare benefits, compared to 5 percent of non-employee-owners)
- Stay in stable jobs for nearly 2 years longer (5.2 years vs 3.8 years)
Further research on employee ownership shows that employee-owned companies generate 2.5% more jobs per year, while their workers are 20% less likely to be laid off and retire with double the assets.
While some people view co-ops and ESOPs as mere profit sharing or retirement savings plans, they actually give employees a stake in the success of their company. The personal involvement and meaningful work that employee ownership entails can result in greater quality of work and job satisfaction.
Adriana Sanchez, worker-owner at TeamWorks Cooperatives told the Democracy Institute:
“I can say today, after being with the cooperative for about 8 years, that I could not have asked for a better opportunity. TeamWorks has taught me a lot about being a business owner, a team player, and a responsible member of society.”
Similarly, Bartlett & West, an engineering and design firm that became 100% employee-owned in 2009, says that the benefits of employee-ownership extend well beyond its ESOP.
“We have found that what is most valuable about being an employee-owned company is the culture it helps foster,” they write.
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.
(That’s compared to the 60-80% of traditionally-owned firms that fail within their first year.)
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 (and usually the state level as well)
- Dividends are tax-deductible
- Employees pay no tax on the contributions to the ESOP, only the distribution of their accounts, and then at potentially favorable rates
Additionally, attorney Linda Phillips at Jason Wiener, P.C. notes that selling C-corporation stock to a worker cooperative can result in favorable tax treatment under Code Section 1042.
There’s a four-step process to qualify for Section 1042 treatment, including having been a C-corp for at least 3 years, having held the securities for at least 3 years, selling to a worker co-op at least 30% of the total value of outstanding stock, and filing a written statement with the IRS.
Bruce Mayer, CPA also highlights the Subchapter T 20% pass through business deduction, which allows corporate earnings to pass through to the worker-owners of a cooperative without being taxed at the corporate level. If the co-op is making a significant profit, then the deduction can result in significant tax savings.
Benefits for the Selling Owner
For a small business owner, selling a company or preparing for succession can be unpredictable – and many businesses close without finding a buyer.
Selling the company to employees can provide more stability, predictability, and a smoother transition for the company and its leadership — providing the seller with a ready buyer that will carry on the company, preserving jobs, company culture and mission, and remaining open for business in the community.
That’s why the Vermont Employee Ownership Center lists employee ownership conversions as one of the best exit strategies for current business owners, and it’s why state employee ownership centers around the country, including RMEOC, focus resources and energy on helping businesses to become employee owned.
Similarly, M&A advisory firm rarebrain lists five major benefits a selling owner receives from transitioning — particularly to an ESOP, though they are shared by co-ops as well when other criteria (e.g. C Corp status) are met:
- Taxes deferrals can increase cash flow and give the company a competitive edge.
- A “built-in buyer” offers a win-win situation in which you can control your exit while your employees quickly share in the company’s success.
- An independent appraiser allows owners to sell their business to its employees at full fair market value while sidestepping the complications of a third party buyer.
- Tax-deductible loans allow employee-owned businesses to borrow at a lower rate in order to refinance debt, reinvest in the company, acquire another business, and more.
- Company sustainability due to workers’ personally vested interest in the company’s success ensures that both the business and the owner’s legacy continues far beyond the sale.
Converting to employee ownership offers both tangible and intangible benefits to everyone from the workers and selling owners to the company itself.
But the benefits don’t stop internally.
Worker ownership is better for the environment, better for local communities, and a model for progress toward addressing social issues like racial and gender disparity in the workplace.
Ensuring equity at every level of your organization isn’t just a good business strategy — it’s how we can continue to build an economy that works for everyone.
Interested in learning more about how employee ownership can benefit your business while creating a more inclusive economy?
Check out the resources listed below and sign up for our monthly newsletter to get industry news, featured stories, and resources to help your business thrive sent directly to your inbox.
- Employee Ownership by the Numbers (NCEO)
- Colorado Employee Ownership Office (OEDIT)
- Employee Ownership Resource Center (Fifty By Fifty)
- Ensuring Your Legacy (ICA Group)