March 5, 2020 Last updated March 16th, 2020 912 Reads share

Sharing Business Ownership with Employees

Image Credit: DepositPhotos

CBS Sunday morning recently did an expose on Bob’s Red Mill, producer of myriad stone-ground grains. He started the business in his 50’s after reading an inspiring book. This owner, now 93 years old, has built a business worth over $100 million, and he has begun to share ownership with his employees. This is clearly not a strategy for all owners, and it has its own set of unique advantages and disadvantages.  However, it can provide a solution for owners interested in quality outcomes like smooth operational transfers, consistent procedures, desire for sustainability and more. 

The first tax measures were enacted in the mid-1970s. According to Harvard Business Review, in the past fifty years, the number of ESOP’s has grown ~ 500% (to more than 8,000) while employees owning stock have jumped from ~250,000 to more than 8 million.

More locally, there has been growing support from the government to encourage employee ownership. Reagan supported it in the 1980s as a fitting path that would lead to better, long-term growth, and our current democratic presidential candidates support it now as a path to increase the wealth of working people who contribute to a company’s success. Some states now offer financial support to offset the cost of legal fees to make the transition, and others provide tax write-offs for companies who make the shift to an employee-owned structure.

Even with the increased focus by government leaders, it is unlikely that legislation will force commercial businesses to share profits or ownership with employees. However, there are many reasons to consider employee ownership.

Why Would I Consider Including Employees as Owners?

Choosing to sell or gift some or all of a company deserves serious consideration. For those who decide to make the change, these are the most likely reasons to pursue an ownership change:

  • Monetary Incentive. As mentioned, in some locales, there are tax benefits, but there is also reduced capital gains when the time comes to sell the company. And if shares are sold to employees, rather than gifted, it could provide an influx of cash to the business for capital investment. But take note:
  • Succession Planning. Perhaps you are ready to retire and want to see the business carry on after your departure. Since nearly 85% of businesses have no succession plan in place, a large chunk of them will close their doors when an owner retires. By transferring ownership to the employees before death or retirement, the business continues.
  • Community Benefit. Employee ownership can maintain local jobs and services when the original owner is no longer around, thereby making it easier for a community. If you simply sell a business, there is no guarantee of the future viability of the company, the employees, your supplier, and the local community.
  • Employee Retention. Organizations with well-established team-based services like design companies can use employee ownership models as an incentive to keep a well-honed group together. As a retention tool with short or long-term benefits, employees who own a piece of the pie will stay longer and work more collaboratively because they have a vested interest in success.
  • Altruism. Sometimes, it just feels good. Owners, like Bob Mill, may decide that those who most contributed to a business’s success should be the ones rewarded for the hard work getting there. These employees often end up with more cash for college, home-buying, or other investments like retirement.

What Does Employee Ownership Look Like?

Employee ownership can mean everything from cooperatives to stock options. And there are unlimited ways to design ownership, but most fall into three categories—direct, indirect, or a hybrid of the two. Direct ownership involves some sort of tax-advantaged share plan. Indirect employee ownership holds shared collectively in an employee’s trust. And then a hybrid of the two is an option, too—anything within reason can be negotiated that fits your needs and desires.

In the US, the employee trust option is the most common when sharing ownership with many employees. As an employee stock ownership plan, (ESOP), employees can participate or not, usually buying stock. These purchases provide some liquidity to the seller/previous owner, and the purchased stock remains titled to the employee even if they leave the company. This asset can then be sold as part of a retirement plan.

Another option is to pocket dividends from the shares while an employee, but not retain ownership rights if an employee leaves the company. While less common in the US, this would effectively incentivize people to contribute toward profits and also encourage employees to stay with a good company.  In fact, there are “phantom” ownership structures that mimic ownership but do not include all the restrictions and responsibilities. In these ownership-like structures, holders of phantom interest receive cash flows when an event (like a sale or distribution or dividend) occurs. In this way, they feel like owners, even if they do not hold traditional equity.

No matter the details, ESOP’s are heavily regulated trusts that offer significant tax advantages for businesses that create them. The regulations, however, establish the trust based on the employee numbers. Joining the trust as a new hire means waiting until someone else retires and leaves.

Challenges of Employee Ownership

When you decide to create an employee-owned model, it will restrict stock ownership in a trust and limit additional investors. If you need an injection of new capital at a later day, there will be limits on the rights you can give to any potential capital investor.

Even with the best of intentions, employee-owned businesses have challenges. Since employees have a voice in the direction of a company, it can be cumbersome and slow to make large business decisions. Building consensus takes time, and the larger the organization of employee-owners, the longer it can take.

Changing to an employee-owned company is costly and complicated. Even if your state offers financial assistance to make the shift, it might not be what makes the most sense for you as the original owner. You might avoid capital gains tax, for example, but the company’s value will be lower when you finally do sell your portion and step away.

And then, if you are dedicated to employee ownership for altruistic reasons or to ensure continuity in your community, be prepared to work harder than if you simply sold the company to a single buyer. It takes patience and a willingness to stay involved with the organization to ensure the transition keeps the organization on stable footing after your departure.

Finally, altruism and continuity are goals that do not produce a financial buyer.  Additionally, it is likely that capital is not as available to an employee group as it is to other buyers.  ESOP’s can get capitalized, but it is a more complicated transaction than a “simple” sale of the business, producing downward pressure on value and on the ultimate sale price of the business.

Is It Still a Good Idea?

Employee ownership can be very beneficial to companies, communities, and owners. Communities retain jobs and valuable commerce while re-distributing and building wealth for employees. The theory is that workers demonstrate greater commitment to the company’s success through improved service and quality.

That makes it good for business and for the employees. And, of course, it gives retiring entrepreneurs another way to pass on their company success. For Bob’s Red Mill, employee ownership was empowering and forward-thinking enough to make it on CBS’s premier weekly show. His model is designed to reward his employees and transition the business smoothly once he’s gone. Maybe it would work for you, too.

business partners – DepositPhotos

Jon Forknell

Jon Forknell

Read Full Bio