Introduction to the Model Employee Ownership Act

by Christopher Michael

Originally published with the Center on Wisconsin Strategy

The Employee Ownership Act (EOA) builds on the lessons learned from four decades of federal experience in promoting employee ownership to extend its benefits through state policy. The Act provides greater ease and flexibility in transitioning conventional business enterprises to employee-owned ones, and encourages growth of both employee stock ownership plan (ESOP) companies and worker cooperatives. It also supplements existing ESOP law by creating two new forms of employee ownership that are much easier and cheaper to establish and maintain.

Employee ownership is already an important part of the American economy, with 14 million workers and 7,000 companies, including brand names such as Publix Supermarkets (180K employees, $32B in annual revenue), Gore-Tex (10K employees, $3B in annual revenue), and Burns & McDonnell (5K employees, $2.5B in annual revenue).[1] At a time of intense political polarization, increasing employee ownership remains transpartisan in support.[2] Recent polling of American adults on the question “Do you support or oppose the concept of companies being owned by their employees, so that all the workers at a company share in its success?” showed the following results.[3]

 
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Employee ownership is not only popular, however. It is also good for the economy. There is wide scholarly consensus that, as compared to conventional corporations, employee-owned firms:

  • achieve higher productivity with increased sales;[4]

  • enjoy lower turnover and greater longevity;[5][6]

  • offer better employment opportunities;[7]

  • retain jobs in-state and avoid relocating out-of-state;[8]

  • sustain the state tax base through employee and corporate income tax;[9] and

  • save costs on unemployment insurance and other state benefit programs.[10][11] 

The standard mechanism for creating employee-owned companies is the ESOP. The ESOP structure, established under federal law in 1974, proved to be a tremendous success. However, while the number of employee-owners and aggregate wealth ($1.3 trillion) of ESOPs grows, the raw number of ESOP companies hovers between 8,000 and 10,000.[12][13][14] Over the last dozen years, the number of ESOPs dipped slightly below 8,000.[15] Advocates expect a turnaround if Congress extends the ESOP capital gains deferral to S corporations.[16][17] However, veteran ESOP advisors understand that additional problems remain.

The lack of business awareness about the attractions and possibility of employee ownership succession is a longstanding challenge. But even those who pursue the option face hassles and costs sufficient to dim, for many, their initial enthusiasm.[18] Selling owners often do not have the necessary support in the form of loan financing.[19] Even with capital to put the deal in place, however, the legal creation of an ESOP often costs upward of $150,000,[20][21] And there are ongoing annual costs for its administration that range from $15,000 to $30,000.[22] For smaller businesses, especially, these direct costs can be prohibitive. For many owners and estate planners, the complexity and time costs of installing an ESOP are also limiting factors.[23] In addition, for many selling owners, ESOP tax incentives are inapplicable or of little use. Their underutilization by business suggests the need for more straightforward incentives.[24] Finally, ESOP companies might decide to terminate their plan and recall employees’ shares. In fact, 3% to 4% of all ESOPs terminate each year.[25] This rate is due, in part, to federal law that requires ESOP trustees to sell employees’ shares if presented with an attractive offer from an outside buyer.[26] Alternatively, an ESOP company might simply “freeze” their plan. Current employees keep their shares, but the company does not issue shares to new employees, which results in the ESOP winding down over time.

The EOA leverages existing federal supports for employee ownership while addressing these familiar difficulties. First and foremost, the EOA provides incentives for two new types of employee ownership plans: employee ownership trusts (EOT) and direct share ownership plans (DSOP). These programs are vastly simpler to explain to business owners and employees than ESOPs. They are significantly less expensive to create at $8,000 to $30,000 per plan. And their ongoing costs are negligible to zero. No company is too small for an EOT or DSOP. By incentivizing and supporting these plans, the EOA provides for immediate benefits to all company employees. The EOT, in particular, offers a mechanism for perpetual employee ownership that would not be subject to termination, freezing, or the federal rules that sometimes require ESOP trustees to sell employees’ stock. In addition, the EOA provides clear-cut tax benefits that would be applicable to all business owners, as well as loans and loan guarantees in support of sellers and banks. To improve public and especially business understanding of employee ownership successions, the EOA also creates a state university-based center for employee ownership.

Moreover, the EOA goes beyond the above to include other sensible policies, such as providing preferential treatment of employee-owned businesses in government contracting; and leveraging employee ownership structures to increase charitable contributions. In combination, these policies constitute a comprehensive program of state support for the transition of healthy businesses to employee ownership, as well as promotion of existing employee-owned firms.[27]

The EOA is revenue-neutral to slightly positive. Employer savings on unemployment insurance and increased revenue from existing taxes on employee income, corporate income, and sales (all a function of the number of jobs and businesses retained in-state) should offset the cost of tax exclusions and a university-based center under the Act.[28] The loan and loan guarantee elements of the Act and its support for “best value” procurement are intrinsically revenue-neutral or positive.[29]

References

[1] National Center for Employee Ownership. 2016. “The Employee Ownership 100: America’s Largest Majority Employee-Owned Companies.” http://www.nceo.org/articles/employee-ownership-100 (Accessed December 11, 2016). 

[2] Republican National Convention. 2016. Republican Platform 2016, p. 8. https://prod-cdn-static.gop.com/static/home/data/platform.pdf (Accessed December 11, 2016).

[3] Employee-Owned S Corporations of America. 2016. “Sixty-Eight Percent of Americans Support Employee Ownership and a Shared Stake in Success.” http://esca.us/2016/07/press-release-sixty-eight-percent-of-americans-support-employee-ownership-and-a-shared-stake-in-success (Accessed December 10, 2016).

[4] Blasi, Joseph, Douglas Kruse, and Dan Weltmann. 2013. “Firm Survival and Performance in Privately Held ESOP Companies" in Sharing Ownership, Profits, and Decision-Making in the 21st Century (Advances in the Economic Analysis of Participatory & Labor-Managed Firms, Volume 14), p. 113-20. Bingley, UK: Emerald Group Publishing.

[5] Kruse, Douglas, Joseph Blasi, and Richard Freeman. 2012. “Does Linking Worker Pay to Firm Performance Help the Best Firms Do Better?,” p. 12-13. Cambridge, MA: National Bureau of Economic Research. http://www.nber.org/papers/w17745.pdf (Accessed September 9, 2016).

[6] Blasi et al. 2013. “Firm Survival and Performance,” p. 114-19.

[7] Kardas, Peter, Adria Scharf, and Jim Keogh. 1998. “Wealth and Income Consequences of Employee Ownership: A Comparative Study from Washington State.” Journal of Employee Ownership Law and Finance 10(4): 3-52.

[8] Blasi et al. 2013. “Firm Survival and Performance,” p. 114-19.

[9] Blasi, Joseph. 2016. “Proposed Legislation on Gross Income Tax Exclusion for Capital Gains on Sales of Certain Employer Securities: Estimation of Offsetting Benefits,” p. 1-3. Working paper.

[10] Rosen, Corey. 2015. “The Impact of Employee Ownership and ESOPs on Layoffs and the Costs of Unemployment to the Federal Government,” p. 7-10. Oakland: National Center for Employee Ownership. https://www.nceo.org/assets/pdf/articles/Employee-Ownership-and-Unemployment-2015.pdf (Accessed September 9, 2016).

[11] Kurtulus, Fidan Ana, and Douglas Kruse. 2015. “An Empirical Analysis of the Relationship Between Employee Ownership and Employment Stability During the Last Two Recessions in the US: 1999-2010.” Forthcoming.

[12] National Center for Employee Ownership. 2016. “ESOPs by the Numbers.” https://www.nceo.org/articles/esops-by-the-numbers (Accessed December 10, 2016).

[13] Rosen, Corey, and Michael Quarrey. 1987. “How Well Is Employee Ownership Working?” Harvard Business Review (September). https://hbr.org/1987/09/how-well-is-employee-ownership-working (Accessed December 11, 2016).

[14] Liu, Caitlin. 1996. “For Employee-Owners of Avis, a Bittersweet Deal.” New York Times, July 14. http://www.nytimes.com/1996/07/14/business/earning-it-for-employee-owners-of-avis-a-bittersweet-deal.html.

[15] National Center for Employee Ownership. 2016. “ESOPs by the Numbers.” https://www.nceo.org/articles/esops-by-the-numbers (Accessed December 10, 2016).

[16] U.S. Congress. 2016. H.R.2096 - Promotion and Expansion of Private Employee Ownership Act of 2015. https://www.congress.gov/bill/114th-congress/house-bill/2096 (Accessed December 11, 2016).

[17] U.S. Congress. 2016. S.1212 - Promotion and Expansion of Private Employee Ownership Act of 2015. https://www.congress.gov/bill/114th-congress/senate-bill/1212 (Accessed December 11, 2016).

[18] Dagher, Veronica. 2013. “Owners Look to ESOPs to Cash Out.” Wall Street Journal, April 29. http://www.wsj.com/articles/SB10001424127887324235104578241241194685714.

[19] Ibid.

[20] National Center for Employee Ownership. 2016. “Trends in Transaction Design and Management.” Employee Ownership Report 36(1): 10-11. http://www.nceo.org.

[21] Patrick, Josh. 2013. “The Questions to Ask Before Adopting an ESOP.” New York Times, July 11. http://boss.blogs.nytimes.com/2013/07/11/the-questions-to-ask-before-adopting-an-esop/?_r=0.

[22] Rosen, Corey. n.d. “Twelve Bogus Reasons Not to Do an ESOP (and Seven Good Ones).” https://www.nceo.org/articles/reasons-esop (Accessed December 11, 2016).

[23] Wells Fargo. 2016. A Look at the Good, the Bad, and the Ugly of an Employee Stock Ownership Plan. https://www08.wellsfargomedia.com/assets/pdf/commercial/retirement-employee-benefits/perspectives/good-bad-ugly-esop.pdf (Accessed December 11, 2016).

[24] Rodgers, Loren. Employee Ownership Update (January 4, 2016). https://www.nceo.org/employee-ownership-update/2016-01-04.

[25] National Center for Employee Ownership. “Freezing or Terminating an ESOP.” https://www.nceo.org/articles/freezing-terminating-esop (Accessed December 11, 2016).

[26] Brozen, Neil. 2016. “Responding to Unsolicited Offers to Purchase ESOP Companies: Issues for Plan Fiduciaries” in Responding to Acquisition Offers in ESOP Companies, 2nd ed., p. 17-18.

[27] National Center for Employee Ownership and Employee-Owned S Corporations of America. 2016. Economic Growth Through Employee Ownership, p. 3. http://esca.us/wp-content/uploads/2016/08/Economic_Growth_Through_EO_revised.pdf (Accessed December 11, 2016).

[28] Blasi, Joseph. 2016. “Proposed Legislation,” p. 1-3.

[29] Griffith, John, and Richard Caperton. 2012. “Managing Taxpayer Risk: The Federal Government Responsibly Prices and Manages Risk When Issuing Loans and Loan Guarantees,” p. 1-2, 7-8. Washington, D.C.: Center for American Progress. https://cdn.americanprogress.org/wp-content/uploads/issues/2012/05/pdf/federal_credit_brief.pdf (Accessed September 10, 2016).