Employee owned

What Is Employee Owned?

"Employee owned" describes a business structure where employees, rather than external shareholders or a single owner, hold all or a significant portion of the company's equity. This model falls under the broader financial category of Business Structures within corporate finance. In an employee-owned company, the employees are simultaneously workers and shareholders, aligning their interests with the long-term success and profitability of the organization. This alignment can influence various aspects of a company, including its corporate governance, operational decisions, and distribution of profit sharing.

History and Origin

The concept of employee ownership is not a recent development, with roots tracing back centuries. Benjamin Franklin, for instance, implemented a form of employee ownership in his printing business in 1733, allowing journeymen to purchase and own print shops using earned profits. In the mid-19th century, prominent American companies like Procter & Gamble began setting aside company stock for employees upon retirement, granting them an ownership stake based on their contributions.²⁸, ²⁹

A significant turning point in the modern era occurred with the work of American economist and attorney Louis Kelso. In the 1950s, Kelso conceived of the modern Employee Stock Ownership Plan (ESOP), advocating for a system where capital investment could be more broadly distributed among workers.²⁵, ²⁶, ²⁷ His efforts, alongside those of Senator Russell Long of Louisiana, culminated in the Employee Retirement Income Security Act (ERISA) of 1974, which formally established ESOPs in U.S. law as a retirement plan and provided substantial tax incentives to encourage their formation.²³, ²⁴

Key Takeaways

Employee ownership signifies a business model where employees hold a controlling or significant interest in the company's equity.
This structure aims to align employee and company interests, potentially leading to increased productivity and stability.
The most common form of employee ownership in the U.S. is the Employee Stock Ownership Plan (ESOP).
Benefits can include enhanced employee engagement, potential tax benefits for the company and employees, and a viable succession planning strategy for retiring owners.
Challenges can involve complex regulations, the need for significant capital, and potential concentration of employee wealth in a single asset.

Interpreting Employee Ownership

Interpreting an employee-owned structure involves understanding its implications for both the business and its workforce. From a business perspective, employee ownership often leads to a more engaged and motivated workforce, as employees directly benefit from the company's success. This can translate into higher productivity, improved quality, and lower turnover rates.²¹, ²² The ownership stake often instills a sense of shared responsibility and a greater commitment to the organization's long-term health. Employees, acting as stakeholders, are more likely to make decisions that benefit the collective. The structure also impacts how decisions are made, potentially fostering a more collaborative environment where employees have a greater say in operational matters, although the degree of participation varies greatly among employee-owned firms. The concept of fiduciary duty is also paramount, particularly for those overseeing the employee ownership plan, ensuring it operates in the best interest of the employee participants.

Hypothetical Example

Consider "GreenLeaf Gardens," a successful private company specializing in organic landscaping. The founder, nearing retirement, wants to sell the business but wishes to preserve its culture and reward her loyal employees. Instead of selling to a larger corporation, she decides to transition GreenLeaf Gardens to an employee-owned model through an ESOP.

Here's how it might unfold:

Valuation: An independent appraisal determines the fair market value of GreenLeaf Gardens.
ESOP Creation: The company establishes an ESOP trust, which borrows money to purchase the founder's shares.
Share Allocation: Over time, the company makes tax-deductible contributions to the ESOP, which are used to repay the loan. As the loan is repaid, shares are released from a suspense account and allocated to individual employee accounts within the ESOP, based on factors like salary or length of service.
Employee Benefits: Employees gain an ownership stake without directly purchasing shares, building retirement wealth. As the company thrives, the value of their shares increases, providing a direct financial incentive for their hard work and dedication.
New Leadership: While the founder retires, the management team, now also employee-owners, continues to run the company, preserving its mission and employee-centric approach. The employees, through their ESOP accounts, collectively become the new owners of GreenLeaf Gardens, sharing in its future dividends and growth.

Practical Applications

Employee ownership finds practical applications across various sectors and for diverse business objectives. One primary application is as a robust succession planning tool for retiring business owners. Instead of seeking an external buyer, owners can sell their shares to an employee trust, providing a smooth transition, preserving company culture, and rewarding long-term employees.²⁰

Beyond succession, employee ownership is utilized for its potential to boost employee morale and productivity. Studies suggest that employee-owned companies often exhibit lower voluntary quit rates and higher employee retention compared to their non-employee-owned counterparts, indicating a strong workplace culture and increased job satisfaction.¹⁸, ¹⁹ For instance, a survey by the National Center for Employee Ownership (NCEO) found that employee-owners reported significantly greater retirement security, with median ESOP account balances often exceeding general retirement savings.¹⁶, ¹⁷ This model can also offer substantial tax benefits to the selling owner, the company, and the employees, depending on the specific structure, such as an ESOP.¹⁵ Additionally, it serves as a strategy for wealth distribution, enabling a broader segment of the workforce to participate in the economic gains of a business.¹⁴

Limitations and Criticisms

Despite its advantages, employee ownership is not without limitations and criticisms. One significant concern is the potential for a lack of diversification in an employee's personal financial portfolio. When a substantial portion of an employee's retirement savings or wealth is tied up in the stock of a single company—their employer—they face concentrated risk. If the company performs poorly or fails, employees could lose both their job and their retirement nest egg.

Th¹², ¹³e complexity and cost associated with establishing and maintaining employee ownership plans, particularly ESOPs, can also be a barrier, especially for small and medium-sized businesses. These structures often require extensive legal, financial, and valuation expertise. The¹¹re are also regulatory complexities; the Internal Revenue Service (IRS) has issued warnings regarding compliance risks and "aggressive tax schemes" associated with certain ESOP transactions, emphasizing the need for strict adherence to tax laws.

Fu⁹, ¹⁰rthermore, the implementation of employee ownership does not automatically guarantee increased productivity or employee engagement. These outcomes often depend on complementary factors such as participatory management, open-book management, and a culture that truly empowers employees with decision-making opportunities. Without proper communication and employee education regarding the plan and their vesting rights, the perceived benefits of ownership might not materialize.

##⁷, ⁸ Employee owned vs. Employee Stock Ownership Plan (ESOP)

The terms "employee owned" and "Employee Stock Ownership Plan (ESOP)" are often used interchangeably, but it's important to understand their distinct meanings. "Employee owned" is a broad term describing any business where employees collectively hold ownership stakes. This can include various structures like worker cooperatives, direct stock ownership programs, or even informal agreements. It refers to the fundamental concept that employees have an ownership interest in the company they work for.

An ESOP, on the other hand, is a specific type of qualified defined contribution retirement plan, regulated by the IRS and Department of Labor. It is the most common and legally formalized method of achieving broad-based employee ownership in the United States. While all ESOP-owned companies are by definition employee-owned, not all employee-owned companies are structured as ESOPs. ESOPs offer specific tax benefits and adhere to strict rules regarding how shares are allocated, vested, and distributed to employees. The primary confusion arises because ESOPs are the dominant mechanism for achieving significant employee ownership in the U.S. corporate landscape.

FAQs

How do employees acquire ownership in an employee-owned company?

Employees typically acquire ownership through various mechanisms, most commonly through an Employee Stock Ownership Plan (ESOP). In an ESOP, the company establishes a trust that holds company shares for the benefit of its employees. Employees do not typically purchase shares directly with their own money; rather, shares are allocated to their accounts over time, often through company contributions or a loan repaid by the company. Other methods include direct share purchases, stock options, or membership in a worker cooperative.

Do employee-owned companies pay out dividends?

Whether an employee-owned company pays out dividends depends on its specific structure and financial performance. If the company is structured such that it issues dividends to its shareholders (including employee-owners through their ownership stake), then yes, employees would receive them. In an ESOP, for instance, shares are held in a trust, and cash dividends paid to the trust might be passed through to employee accounts or used to repay the ESOP loan.

What are the benefits for employees in an employee-owned business?

Employees in an employee-owned business can experience several benefits. These include building wealth through their ownership stake, which can supplement or form a significant part of their retirement savings. The⁵, ⁶y may also benefit from increased job security, as employee-owned firms tend to have lower layoff rates. Add³, ⁴itionally, a culture of shared ownership can lead to greater employee retention, improved morale, and a stronger sense of purpose and engagement in their work.

Are all employee-owned companies the same?

No, employee-owned companies can differ significantly in their legal structure, the percentage of ownership held by employees, and their corporate governance practices. While ESOPs are a prevalent form in the U.S., other models include worker cooperatives, where employees are members with voting rights, and direct ownership plans, where employees directly purchase or are granted company shares. The degree of employee involvement in decision-making also varies, from purely financial ownership to full participatory management.

How does employee ownership impact company performance?

Research suggests that employee ownership can have a positive impact on company performance. Studies indicate that employee-owned companies often show higher productivity, greater profitability, and improved financial resilience compared to traditionally structured firms. Thi¹, ²s is often attributed to enhanced employee motivation, lower turnover, and a more engaged workforce that is directly invested in the company's success. However, these benefits are often amplified when ownership is combined with a culture of employee participation and transparency.