Erie Chamber Blog
Sunday March 15,  2020

Are you a business owner without a succession plan (and no children in the family business)? Or are you a start-up founder interested in an alternative business structure? ESOPs and Worker Co-Ops may be the way to go.

ESOP stands for employee stock ownership or employee share ownership is when a company's employees own shares in that company. Below are some frequently asked questions to better understand the ins and outs of this organizational structure. 

Why don’t more people do this?
Based on a joint research white paper published by the National Center for Employee Ownership (NCEO) and the Employee S-Corp Association (ESCA) the overwhelming reason is “lack of awareness” by selling shareholders. This is why the PaCEO was formed, to raise awareness. In 2017 research showed that less than 3% of sellers considered (or even heard of) ESOPs when selling their business.

When company owners think about selling, they typically reach out to their trusted advisors (Attorneys, Financial Advisors, Banks, CPAs). Unfortunately, most advisors in this industry are poorly educated or misunderstand Employee Ownership. If they don’t know about it, they can’t invite their clients to investigate.

In an ESOP transaction, the US Department of Labor requires a 3rd party valuation to determine Fair Market Value (FMV), which then becomes the sale price. It is possible for a seller to get a sale price higher than FMV if, for example, the buyer wishes to eliminate employee departments or move the company offshore. But in these circumstances, the business does not realize the gains from being tax-free.

Can I retain control of the business after I sell?
Absolutely. In an ESOP transaction, the organizational structure remains. There is a Board of Directors, who hires a CEO, who hires the management team. In many cases, the selling shareholder stays on as CEO for as long as they wish.

How are shares of an ESOP company divided?
The selling shareholder has a great deal of leverage in determining how the ESOP works through the creation of the Plan Document. The Plan Document determines how shares are allocated (Pro-rata on salary? Even-Stephen? Seniority? Or some combination of factors?). The owners also decide how and when shares are paid out. The DoL requires, at a minimum, at retirement-aged, and no more than 5 years after an employee departs a company.

Does every employee participate?
Yes, every full-time employee (30 hours/week) must be given the option to participate. But the Plan Document may also specify a vesting period.

How much does this cost?
All transactions (ESOPs or other sales) are expensive. All transactions require lawyers, financial managers, and valuation groups. In an ESOP, you also need a Trustee to represent the employees. And it all depends on the size of the business. Typically, costs for an ESOP transaction can be as much as 10% more costly than a non-ESOP transaction. But it depends on the complexity and size of the company.

Worker Co-ops

Does the business run “democratically”?
Many Co-Ops include a democratic organizational structure, but it is not a requirement. This means that certain decisions are made by all employees (one person one vote). But typically there is a business organization that does not require everyone to vote on everything (buying pencils, e.g.).

But a business may also have a traditional management structure, with a company leader (president) and other employees filling other roles. Not everyone wants the responsibility of decision-making. However, in a true Worker Co-Op, the employees own the company equally.

What if new employees come onboard?
There are a variety of ways this can occur. New employees may need to clear a vesting period prior to being awarded ownership. Typically they also need to “pay” for their ownership through payroll deductions or some other method. Unlike ESOPs, there can also be two classes of employees – owners and non-owners. But this brings its own set of challenges.

How is a Co-Op funded?
Typically there is a multi-tiered funding model that purchases the business from the owner, on behalf of the employees. The funding model could include any combination of:

  • A partial seller note (the owner acts as the bank, paid through company profits over time)
  • Loans from commercial lenders (Banks)
  • Grants from nonprofit organizations with a mission for employee ownership
  • Impact Investing organization funding
  • Government support

Are there tax advantages for Co-Ops?
Unfortunately, at this time there is not. But there are financial supports available from the SBA (Small Business Administration), and there are numerous bills (State and Federal) seeking to create financial support and tax relief for Co-Ops, as they create jobs and support local communities.

How big can a Co-Op be?
Co-Ops can be large or small. Some have 3 employees, some have hundreds.

What are Next-Steps after learning about employee ownership?
The Pennsylvania Center for Employee Ownership (www.OwnershipPennsylvania.org) can walk any interested party through the process, and provide a broad list of experienced and vetted professionals who can assist in the next steps. We always recommend that you meet with a company that is currently employee-owned, who has gone through the process and can share their experience.

Once that is complete, the interested party chooses a company to conduct a brief professional assessment on whether the company is a good fit for employee ownership. Generally, there is no cost for this. If it makes sense, then the next step would be a professional Feasibility Study that takes a deep look at the financials and projects the picture of costs and profits over a 5-year period.

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