What is an Employee-Owned Company and How Do They Work?

An employee-owned company is simply one in which the workforce holds a significant, or even majority, stake in the business’s ownership. This business model is very different from the traditional employer-employee dynamic, and aims to put significantly more power in the hands of employees. Rather than workers and contributors, employees have a serious vested interest in the company’s success.

The core philosophy behind employee ownership is about shared prosperity and empowering employees to feel truly committed to the business and its success. The goal is long-term sustainability and viability for the business, not necessarily short-term profits for external shareholders.

Here, we explore several forms of employee ownership, highlighting common models such as Employee Stock Ownership Plans (ESOPs) and worker cooperatives.

Employee Ownership Models

Employee ownership isn’t a single, uniform structure. There are a few different employee ownership models, each with its own mechanisms and aims.

Employee Stock Ownership Plans (ESOPs)

An ESOP is a qualified retirement plan, similar to a 401(k), that’s designed to invest primarily in the stock of the sponsoring employer company. Essentially, the company established a trust the holds company shares for its employees. The company can contribute shares directly to the trust or cash, which the trust then uses to purchase company stock. The shares are allocated to individual employee accounts within the trust, typically vesting over a period of time that the employees are with the company. When an employee leaves the company or retires, their vested shares are typically bought back by the company or ESOP, with the value distributed to that employee.

ESOPs are a useful employee retention tool and a good supplement to a retirement package, but they don’t offer employees full voting control over the direction of the company.

Benefits:

• Tax advantages: For the company, ESOP contributions are often tax-deductible. S-corps that are 100% ESOP-owned can effectively become federal income tax-exempt. For employees, their ESOP accounts grow tax-deferred, making them a great retirement savings vehicle.
• Liquidity: ESOPs make it easier for owners to sell shares and potentially defer capital gains taxes while transferring ownership, which supports easy succession planning.
• Retention: The vesting component incentivizes employees to stay with the company

Drawbacks:

• Complexity: ESOPs require specialized legal and financial expertise to establish and administer.
• Cost: Setting up an ESOP can be very expensive given the expertise required.
• Not truly employee-owned: Employees benefit from ESOPs, but they don’t usually have direct voting control over the company’s operations because the shares are held in a trust.

Worker Cooperatives

Worker cooperatives are businesses that are owned and democratically controlled by their workers. Like the name suggests, cooperatives often prioritize social and community benefits in addition to financial success.

In cooperatives, each worker typically has one vote, regardless of their investment or position. Profits are typically shared equally, or based on the labor contribution rather than capital investment. All workers participate directly in the decision-making processes, from daily operations to strategic planning.

Cooperatives are common on college campuses, but they’re an increasingly preferred model on farms and restaurants.

Benefits:

• Equity: Cooperatives foster a high degree of democratic control and equitable profit sharing, which makes everybody feel more committed to the cause.
• Collaboration: The sense of collective responsibility often contributes to a more collaborative and inclusive workplace culture.

Drawbacks:

• Growth limits: Raising external capital tends to be challenging for worker cooperatives due to their non-traditional ownership structure.
• Speed: Democratic decision-making processes can be slower due to the need for broader consensus.

Direct Stock Ownership/Employee Ownership Trusts (EOTs)

Two final employee ownership models are related to ownership trusts. Direct stock ownership involves employees directly purchasing or being granted shares in the company. An employee ownership trust (EOT) is a relatively newer model in which a trust holds a significant portion (or all) of the company’s shares on behalf of the employees. The trust acts as a long-term guardian of the company’s employee-owned status, providing indirect ownership and helping to maintain the company’s independence and values.

Benefits:

• Ownership: In either case, trusts provide actual ownership and contributive power to the company’s future to employees, unlike an ESOP.
• Retention: Trusts provide an avenue for profit-sharing, which can incentivize employees to stay on longer.

Drawbacks:

• Fewer tax advantages: Trusts may not offer the same tax benefits as an ESOP.

Advantages of Employee-Owned Companies

Regardless of the specific model, employee-owned companies may have broad-reaching advantages over traditionally structured businesses. These may include:

• Increased employee engagement and productivity: When employees have a direct financial interest in the company’s performance, it’s not surprising they’d be more motivated. A “working for collective success” mindset can empower employees to do their best work because they feel a deep sense of ownership and responsibility to the company and to their coworkers.
• Improved longevity: Employee-owned companies tend to have lower employee turnover rates and greater stability than traditional companies. The ownership structure encourages a focus on sustainable growth and long-term value creation rather than short-term gains, which can make employees feel more valued, more important, and more likely to stay. (Which translates to lower recruitment costs and stronger institutional knowledge.)
• Enhanced corporate culture: Employee ownership naturally fosters a more collaborative and inclusive environment. Employee-owned companies also often operate with greater transparency, building trust within the workforce and creating a stronger sense of community and shared purpose. It’s more likely that people will actually like coming to work.
• Tax benefits: In some cases, businesses and employees alike can reap tax benefits. ESOPs provide significant tax deductions for the company’s contributions, while employees get a tax-deferred retirement benefit. Business owners who are looking to exit can also sell to an ESOP to defer the capital gains taxes on their sale.

Impact on Stakeholders

Employee ownership has an impact on a broad range of stakeholders, beyond just employees and the company. Of course, the financial benefits, retirement savings, job security, and sense of purpose that come with employee ownership are all outstanding advantages for employees. The company may benefit from a collaborative, inclusive environment that incentivizes retention and the tax advantages of an ESOP.

However, some other stakeholders may also experience an impact:

• Customers: Highly engaged and motivated employee-owners are often invested in providing better customer service and supporting better customer experiences.
• Local community: Employee-owned companies tend to have deeper roots in their local communities and are more invested in giving back.
• Former owners: Business owners looking to retire or transition out of the company may benefit from selling to an ESOP or facilitating a worker cooperative conversion.