Employee Ownership

For Employee Ownership Initiative

Types of Employee Ownership

Employee ownership gives workers a financial stake in their company. The chart below lays out three types of broad-based employee ownership.

 Employee stock ownership plan (ESOP)Worker cooperativeEmployee ownership trust (EOT)
What is it?An ESOP is a federally regulated retirement benefit plan that can own part or all of a company. The plan takes the form of a trust that holds company shares on behalf of participants and beneficiaries, i.e. current and retired employees. A worker cooperative is a business owned and controlled by the people who work at the business. Employee-owners purchase a membership share, which entitles them to profit sharing and participation in governance.An employee ownership trust is a form of perpetual purpose trust that can own all or part of a business. The trust holds shares on behalf of employees and ensures that the company prioritizes employee benefit as part of its core purpose.
How do employees become owners?Eligible employees become owners automatically when they pass a threshold of total hours worked (a common standard is 1000 hours in a year). The plan documents define which groups of employees are eligible.Employees who complete a candidacy period are voted in as cooperative members and buy a membership share. The buy-in amount varies, but it is usually set at an accessible level and payable in installments.Employees are automatically beneficiaries of the trust while they work at the company. As collective beneficiaries, they have no individual share allocations. Employees make no cash investment and are not entitled to a payout when they leave.
What do employees contribute and how do they benefit financially?Workers earn their ESOP shares as part of their compensation package. Shares are allocated to their ESOP accounts each year based on a formula laid out in the plan documents. Employees receive benefits when they retire or, in some cases, when they leave the company.Employee-owners share the profits and losses on the basis of “patronage.” The patronage formula is usually based on hours worked but may take other factors into account. Patronage dividends can be paid after any profitable year in cash, in an individual retained earnings account, or both.State trust law is flexible and may not proscribe how profits are allocated in companies owned by EOTs. But most EOTs have language in their trust documents saying that most or all of the profits (other than those needed for reinvestment in the business) go to the employees.
How is the company governed?The ESOP trust is the legal shareholder, and its trustee generally votes the shares. Typically, the trustee is chosen by the company’s (plan sponsor’s) board and, in turn, appoints board members. ERISA does not specify participant voting rights, but the plan and trust documents may. Participants vote on major corporate actions such as mergers or liquidation.Employee-owners elect the company’s board of directors and occupy the majority of board seats. Co-ops can also have outside board members. Most governance decisions are made by the board, with employee-owners voting on foundational issues such as mergers or dissolution and others named in the bylaws.The trust is the legal shareholder. The EOT is very flexible, so employees may have no governance rights, total control, or something in between, depending on how it is set up. 
What are the main governing documents and laws?

ESOP plan document

Trust agreement

Federal law (ERISA)

Your ESOP documents

Articles of Incorporation

Bylaws

State law (co-op or LLC statutes)

Trust agreement

State law (trust law)

Learn more about the various types of employee ownership.

  • What to know when your client is considering employee ownership Journal of Accountancy.

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  • Key feature: ESOPs are qualified retirement plans subject to regulation by the IRS and the U.S. Department of Labor under the Employee Retirement Income Security Act of 1974 (ERISA). ESOP plan fiduciaries must administer the plan properly, and solely in the interests of the plan and its participants, including current and former employees, and beneficiaries.
  • A closer look: ESOPs can carry added risk when workers rely on one company for both their paycheck and their retirement savings. As a best practice, many companies with ESOPs also sponsor 401(k) plans with an employer match to help employees build diversified retirement portfolios. Federal law also requires ESOPs to allow participants over age 50 to convert their ESOP shares into diversified investments. ESOPs can choose to allow this at a younger age as well.
  • Learn more:
    • ESOP participants can find out more about the information they are entitled to here.
    • ESOP plan sponsors and service providers can read EBSA’s guidance on ESOP valuations here.
  • Key feature: Worker cooperatives follow the same principles as other types of cooperatives, including farmer co-ops, credit unions, and rural electric cooperatives. They operate on a one member, one-vote basis, which distinguishes them from investor-owned companies that typically follow a one-share, one-vote model.  
  • A closer look: Worker cooperatives are democratically governed, but their management practices can vary. Many worker cooperatives use a traditional management structure, with a senior executive responsible for day-to-day operations and accountable to a board of directors. Others choose alternative approaches to management. In many cases, established businesses that transition to worker cooperatives carry their management practices forward into the co-op.
  • Learn more:
    • Visit these organizations’ websites for detailed information: USDA Cooperative Services, and University of Wisconsin Center for Cooperatives.

    • Read about how the Small Business Administration and many partner organizations supported Ward Lumber’s cooperative transition in this article.

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  • Key feature: EOTs are designed to do two things: (1) codify a commitment to employees as beneficiaries and primary stakeholders in the business and (2) prevent a sale of the business to outside buyers.
  • A closer look: EOTs have a long history in Europe but are relatively new in the United States. Few states have laws governing them, so common practices and guidelines are still emerging. EOTs are very flexible and inexpensive to set up, but they are not federally regulated. As such, they do not qualify for the tax benefits available to many ESOPs and worker cooperatives.
     

FAQs for Employers Considering Employee Ownership

Employee ownership can:

  • Give workers a share of the profits they create.
  • Support a more engaged and productive workforce.
  • Help with hiring, retention, and succession planning.

Congress established tax benefits for ESOPs and worker cooperatives in some cases, but tax savings alone are not a reason to choose employee ownership. If employee ownership supports your workers and aligns with your business goals, the tax benefits are a bonus.

Learn more: If you want to see what employee ownership could look like at your company, explore the different forms of broad-based employee ownership here.

Getting the price right is a critical part of a successful employee ownership transition. Under ERISA, an ESOP can pay no more than fair market value for company shares. This requirement helps ensure that workers receive retirement benefits that they have been promised. If the price is set too high, participants’ benefits may be reduced, and the company may take on too much debt.

No specific law defines the price at which a worker cooperative or EOT can purchase a business, but the principle of “no more than fair market value” makes sense here as well.

Learn more: Read about a prudent process for ESOP valuations.

It depends on your priorities and on the size of your company.

  • ESOPs are the most complex and offer the greatest tax benefits, but they cost more to set up and maintain. Because of this, a company with fewer employees and with smaller operating profit might be a better fit for an employee ownership trust or a cooperative.
  • Cooperatives use a one person, one vote system, and employee-owners elect the board.
  • Employee ownership trusts support long-term or permanent employee ownership.
  • Bottom line: Think about your needs around governance, employee participation, tax considerations, and long-term priorities and discuss them with experienced advisors. Each type of employee ownership can be designed to blend these priorities in different ways.

The best way to know whether employee ownership is a good fit for your business is to undertake a detailed feasibility study with the help of qualified advisors. You may also want to compare a sale to your employees with other succession planning options.

For most employee ownership transitions, you should follow these five steps.

  1. Learn the basics of employee ownership and decide whether to seriously consider it for your company. Contact the Division of Employee Ownership for help.
  2. Conduct a feasibility study by working with a professional to complete a detailed financial analysis, evaluate how the company would be managed after the transition, identify who would take on key leadership roles, and confirm which type of employee ownership you want to pursue.
  3. Structure employee ownership for your company and determine the sale price. This step is complex and involves people from inside the company as well as external advisors. It typically takes three months to one year.
  4. Finance and close the sale. Most employee ownership transitions use a mix of seller financing and outside loans from banks or community development financial institutions. Once the financing is secured and documents are signed, the sale closes.
  5. Provide ongoing support. Continue educating and engaging employees. Employee ownership’s benefits depend on sound management and worker participation. You can learn more about open-book management and other ways to engage your workforce here.

You will typically need both a lead transition consultant and several technical advisors.

A lead transition consultant acts much like a general contractor and can:

Guide the employee ownership design process Facilitate stakeholder engagement and communications Support deal structuring and sale negotiations Coordinate the work of technical advisors
  • Provide training after the transition

    • Technical advisors typically include:

    One or more lawyers A CPA A financial analyst
  • A business appraiser or valuation advisor

    • For ESOPs, an appraisal, also called a valuation, is required to determine the company’s fair market value. An independent trustee should represent employees’ interests throughout the transaction.

    When hiring a valuation advisor in connection with a purchase or sale transaction, trustees must ensure that the valuation advisor is independent from other parties involved in the transaction and professionally qualified for the role. Before negotiating or entering into any transaction based on the valuation advisor’s advice, trustees need to (1) ensure that the advisor received complete, accurate, and current information necessary to value the employer securities; (2) obtain a full and timely written analysis from the valuation advisor supporting their conclusions; and (3) carefully determine that reliance on the valuation advisor's advice is reasonable and in the participants’ best interest. The Department of Labor has entered into a number of process agreements with ESOP trustees providing more detail regarding these duties.

    Best practice: Chose service providers whose style and approach fit your needs and interview several candidates before hiring them. Read EBSA’s Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan.

    Employee ownership is not new—it has deep roots in American history. Many people are unfamiliar with employee ownership because employee-ownership companies represent less than 1% of all U.S. businesses, and popular culture tends to separate workers from owners.