The Success of Employee Ownership: Learnings from the U.S.

Background of Employee Ownership

Employee ownership had been around in the United States since 1921 due to a change in the tax code allowing employees to buy stock in a company through a stock bonus plan.    However, the concept of the Employee Stock Ownership Plan (ESOP) wasn’t truly conceived until Peninsula Newspapers sold the company to the employees in 1956. The owners wanted the employees to inherit the ownership of the newspaper as they saw other local newspapers being swallowed up by larger entities. A San Francisco attorney, Louis Kelso, devised the plan.

When a sweeping piece of legislation, called the Employee Retirement Income Security Act was passed in 1974, ESOPs began their growth across the country. Currently, in the U.S., there are over 6,000 companies owned in this arrangement affecting almost 15 million people.

From the perspective of a former ESOP CFO and CEO, and a founder of a U.S. ESOP boutique consulting firm, Stokastique, Lisa Hague makes the case for why companies in the United Kingdom should consider an ESOP (EO in the UK) business model in order to reap greater financial stability and happier employees.

Benefits to Employees

There are many benefits to employees, some of which are financial and others which are more emotional.

On the soft side, employees are now working for themselves versus a single owner, the public or other types of ownership. There have been a number of academic studies that showed that employee owned businesses perform better in the long term than other forms of ownership. In addition, wealth inequality is attacked since the wealth of the ownership of the company is now spread among all employees. It is a way for capitalism to create wealth for employees. The employees have skin in the game.

The financial benefits are very strong. As stock is allocated, each employee owns more shares and they have beneficial ownership of the company through the stock. If the company is successful the wealth of the employee grows over time. The longer a person works for the company, the more shares they earn, so it breeds a loyalty to the company. The tax deferred nature of the growth is of much benefit to the person. It is not uncommon that a person who has worked in an ESOP to have over 50% of their wealth tied to the stock of the company.

This proportion of wealth also carries risk as the person’s wealth is tied to one stock. It is important for the employee to diversify their portfolio by saving their own dollars and spreading those investments among other companies. A number of studies show that the average ESOP balance is more than $100,000 US dollars.

Plan Operation

ESOPs operate as defined contribution plans. In the United States, it is very similar to a 401(k) plan or in the United Kingdom, a Group Personal Pension plan – except the largest investment is in the stock of the company. ESOPs have typical tax advantages including that contributions are tax deductible, the earnings are tax deferred and taxes are not paid until the account is withdrawn.

The plan, similar to a scheme, is a written document that provides all the terms of the plan. The plan has an eligibility requirement detailing the age and service requirements to join the ESOP. Annually, the company makes contributions on behalf of the employee as the employee does not contribute to the plan. In general, the contribution is a level percentage of payroll, say “10% of pay”.  Each employee has their own account detailing the value of the account. In addition, the plan defines the vesting (when the participant owns the shares, generally before six years) and when the participant can withdraw the account. This happens upon termination, as the employer buys the shares back and provides cash as the distribution as shares do not leave the plan and follow the employee.

The shares are valued annually by an independent appraiser that is hired by a trustee. The trustee’s role is very important as the shares are deposited in the trust and the trustee is fiduciarily responsible for all the accounts. The trustee’s main obligation is to the shareholder and their return.

When a participant severs employment, the plan defines when the participant my receive the funds. It is not uncommon that the payments may be spread over a time period such as five years.   It is also a practice that participants my be able to receive the payment in one lump sum.  The plan document details the actual terms.

Success Stories

One recent success story in the US involves Vermont Information Processing.  The company was 100% owned by the employees and sold to a private equity backed enterprise for over $1,000,000,000. Over 300 employees out of 600 were millionaires. It is an example of how wealth is spread among all the employees.

My story was similar.  Nyhart, founded in 1943, became an ESOP in the 1970’s because the 3^rd generation of the family was not able to run the company and the former owner wanted to give the company to the employees.  The ESOP continued and created a very team oriented culture as the employee acted like owners.  For example, it was not uncommon that employees would do simple things like ensuring the lights were turned off at the end of the day to save money. Over time, the employees retirement plan wealth was very concentrated in the ESOP vs the 401k plan.  It was not uncommon that a persons wealth was 80% in the ESOP. Under my leadership the company was acquired and many staff employees had account balances greater than $1M, spreading the wealth to all employees not just a few.

Conclusion

The United States has had a long history of supporting employee ownership to its employees.  While the ownership structure is a minority of companies, it has proven beneficial in providing employees a strong retirement. It therefore is a model that would lend itself well to being further scaled in the UK, offering wider benefits to employees.

Join a webinar on the 15th April at 2-3pm and listen to Russell Brown CEO of Shaw Healthcare explain how Shaw Healthcare’s transition to employee ownership (EO) during the pandemic has driven better care outcomes, increased retention, and business performance, and how EO empowers employees, enhances wellbeing, and supports innovation.

A new White Paper by Care England and the Employee Ownership Association highlights the benefits of employee ownership in the care sector. Explore how EO can help to ensure the future of care in the full report.