How Does Employee Ownership Work?

There are a number of different ways to share ownership with employees. Which option is right for your business depends on the goals of the business owners, the type of the business, and the company’s mission and values. Depending on which structure is used for the transition, there are many potential tax incentives for the selling owner(s) and the business.

In the United States, the two most common ways to share a significant ownership interest with employees are through worker cooperatives and employee stock ownership plans (ESOPs).

Worker Cooperatives

As values-driven companies, worker cooperatives live at the intersection of business and social impact. Workers own and control the business democratically, adhering to the governance principle of one-worker-one-vote.

Worker cooperatives in the United States are most commonly incorporated as cooperative corporations, a business entity available in approximately half of the states. Some states have statutes specific to worker cooperatives, like in Massachusetts, while others have more general cooperative statutes, including producer cooperatives (like Organic Valley), consumer cooperatives (like REI), and other cooperative forms.

Although the cooperative corporation is the most common entity type for worker cooperatives, many cooperatives incorporate under more common business forms, such as a limited liability company (LLC) or C corporation. Unlike cooperative corporations, these other entity types do not have cooperative principles woven into the fabric of the model. To ensure cooperative principles are followed, these businesses include them in their governing documents. The LLC form may also lack certain cooperative structures, such as internal capital accounts for members. Worker cooperatives are not highly regulated at the federal level. However, worker cooperatives using any business entity type can follow certain IRS guidelines in order to gain tax advantages at the federal level.

Employee Stock Ownership Plans (ESOPs)

An employee stock ownership plan, or ESOP, is a type of employee benefit plan (like a 401(k) or profit sharing plan) that can be used to transfer partial or full ownership of a company to employees. With an ESOP, shares are not held directly by employees, but through an ESOP trust, which is administered on employees’ behalf. Federal law governs many aspects of how the plan is administered, including allocation, vesting, distribution, and more.

ESOPs have significant tax benefits. Under the plan, employees must have voting rights on certain major issues such as dissolution or sale of company assets but are not required by law to vote for the board or have other governance or management rights. Almost all ESOPs are completely company funded; employees do not pay to participate in the ownership plan. ESOPs are the most popular form of broad-based employee ownership in the United States, with almost 7,000 ESOPs covering approximately 13.5 million employees.  For more information about ESOPs, see the National Center for Employee Ownership.

Other Options

Employee ownership can be structured in a variety of ways, falling into two basic categories: (1) direct ownership of shares by employees and (2) ownership by employees through a trust. Worker cooperatives are an example of direct share ownership, whereas ESOPs are an example of trust-based ownership. Although most employee-owned companies use either the worker cooperative structure or an ESOP because of the tax benefits and current infrastructure around those two forms, many businesses have used other ownership structures that fit their particular needs. For example, Graybar Electric, an electrical equipment wholesale company, created its own stock purchase plan to share a majority of stock with employees.