October is Employee Ownership Month and according to the National Center of Employee Ownership (NCEO), this month is dedicated to the celebration of the “undeniable benefits that employee ownership provides to employees, companies, local communities, and the nation.”
As leaders in the Exit Planning space, we felt a responsibility to touch on this subject as employee ownership is a piece in the larger picture that is Exit Planning. Employee ownership has piqued the interest of many business owners, and it is worth exploring and gaining a clear understanding of how it serves as one exit path that an owner could choose.
As is true with any exit path that is chosen, calling upon experts is crucial in implementing a successful business transfer. There are a variety of unique benefits and challenges that come with an employee ownership transition. Partnering with employee ownership experts can help you best identify candidates, determine the feasibility for your business owner clients, and monitor the changing market.
The Employee Ownership Market
As the modern-day business landscape is ever-changing, many are unaware of what piece employee ownership has in the pie when it comes to types of business models in the U.S.
As detailed by NCEO in an article based on 2019 data, there are over 14 million U.S.participants on ESOPs, with just over 10 million that are actively employed and covered by ESOPs. A majority of privately-held ESOPs are S corporations, represented largely by service and manufacturing organizations.
Another statistic that shows market growth for employee ownership is that according to the NCEO, an average of 250 new ESOPs have been created each year since 2014. However, the total number of active ESOPs has been on a slight decline in recent years.
Lastly, in a recent BEI webinar presentation, representatives from Project Equity reported on a dramatic shift in the business landscape and exit ath preferences due to generational changes of baby boomer business owners nearing retirement.
Check out the statistics Project Equity shared, plus their take on employee ownership by watching the webinar recording!
The Employee Ownership Options
Each employee ownership path has its own complexities and the following list is not an exhaustive, technical discussion on every aspect of each path. However, it is helpful for business owners to know that the market for employee ownership is expanding and there are options (beyond ESOPs) that might be suited for their exit goals. The following list describes the popular options as they relate to the primary uses and types of companies that could consider these paths.
- Employee Stock Ownership Plan (ESOP)
The form of employee ownership most people have some familiarity with is Employee Stock Ownership Plans (ESOPs), as it is the most common form of employee ownership in the United States. ESOPs are appealing as an exit path due to the substantial tax benefits that exist for the companies and employees.
This model is best suited for companies with owners looking to do a partial or complete ownership transition, and have the significant funds to begin the ESOP. The NCEO estimates a cost between $100,000 - $300,000 to begin, with ongoing costs starting at $20,000 - $30,000 per year.
In order to establish an ESOP, companies must be C corporations, S corporations, or LLCs taxed as a C or S corporation. Primary uses include broad-based incentives and rewards to the workforce, and establishing new ownership at the time of the owner’s transition.
- Equity Compensation Plans / Equity Grants
Equity Grants are often used by newer companies looking to grow, or by large private companies. Primary uses include providing incentives and rewards to selected workers and conserving cash in startup companies.
With this model, companies choose which employees are included and how much equity is awarded to the eligible employees. This limits governing capabilities of employees and requires there be a realistic way for the awards to become liquid at time of transition.
- Employee Ownership Trusts (EOT)
Employee Ownership Trusts (EOT) have been prominent in the United Kingdom for quite some time, and are recently becoming more popular in the U.S.
Companies with this model of employee ownership are owned by a trust that is established by the selling owner. It is required that at the point of sale, all profits above those needed for reinvestment in the business go to the employees.
The NCEO suggests the best candidates for EOTs are those that are “looking to do a transition that will give legal protection for preserving legacy, community benefit, or social and environmental goals.” The key difference between EOTs and ESOPs, according to the Employee Ownership Expansion Network, is that EOTs have fewer tax benefits and are significantly less expensive to create and carry through.
- Worker-Owned Cooperatives
A worker cooperative is a company that is governed democratically as employees elect a board of directors and each maintains one vote. Worker co-ops are good options for smaller companies, those that prioritize workplace democracy, and those with a social mission.
Co-ops typically don’t allocate equity and instead, hold it collectively and employees pay dividends based on hours worked. This eliminates fiduciary issues and the need for business valuation at the point of sale.
For a more detailed breakdown of some of the variances in the types of employee ownership models, tax details, cost and allocation information, check out the chart provided in the following NCEO landing page: Employee Ownership for Closely Held (Private) Companies: ESOPs, Equity Grants, Trusts, and Worker Cooperatives | NCEO
The Exit Planner’s Role in Employee Ownership
Employee ownership paths, especially ESOPs, require a working knowledge of several specialty areas - ERISA rules and fiduciary, banking, securities, tax and M&A law. Therefore, many advisors stray away from promoting this type of exit path. Knowing this, it is wise to recruit expertise to join your team of advisors for advice and feasibility consulting.
Another key component as an Exit Planning Advisor is to define your client’s values-based goals. As is in each case of determining which exit path is best suited for your client, many owners struggle not only with choosing the path, but with finding someone who can help them based on their post-exit lifestyle needs.
Significant planning and analysis go into employee ownership transitions, including:
- Completing a feasibility study
- Hiring the team of advisors
- Determining the structure of the transaction
- Designing the employee benefit aspects of the plan
- Conducting the stock valuation
Perhaps you won’t have all the answers when it comes to employee ownership, but there are a variety of educational opportunities out there and a growing interest in these paths that it is worth exploring.
Lastly, the reality is that an employee ownership model might not be the right fit for your business owner client. If it turns out their business is not feasible or other stipulations of the options don’t align with their values-based exit goals, there are a variety of other exit paths that could be pursued.
So, What’s Next?
- Learn more on employee ownership practices from resources such as NCEO, EO Expansion Network, Executive Financial Services, & Project Equity, to name a few.
- Evaluate your client portfolio for potential employee ownership candidates.
- Partner with employee ownership experts to support your clients through the process. Contact us today to schedule a meeting to discuss how BEI can help!
Learn more about employee ownership, particularly ESOPs, from BEI strategic partner, Executive Financial Services (ESOP Coach).