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Employee Ownership: What Every Professional Service Provider Ought to Know
By Martin Staubus, Beyster Institute Staff
Employee ownership is an element of business that is becoming widespread. Once confined to a small group of high-tech companies in the nation’s silicon technology centers and a thin sprinkling of ESOPs around the country, companies in more industries and more places are finding that they suffer a competitive disadvantage if they don’t tap into the performance edge that equity sharing can provide.
A challenge for business leaders, however, is that the art and science of employee ownership is not common business knowledge. It isn’t taught in the MBA curricula of the nation’s business schools, and the whole field is studded with arcane technical terms and concepts emanating from the Internal Revenue Code, the FASB, the SEC, and other regulatory entities. In short, businesspeople naturally want to look to professional advisors for help on this type of subject.
For professionals who advise business leaders – accountants, lawyers, bankers, financial advisors and general business consultants – this represents an opportunity to practice their craft (and generate income) by offering accurate, informed guidance. Conversely, professional advisors who remain poorly informed about employee ownership are likely to lose clients who are looking for direction on this topic.
So, without becoming full-fledged experts, what are the basics that professionals should know about employee ownership in order to provide sound guidance and good direction to their clients? For starters, let’s consider why a business would be interested in creating a system for putting equity ownership interests in the hands of employees.
Employee Ownership: Good for the Bottom Line
It’s certainly true that ownership equity can be a valuable tool for recruiting and retaining top talent. The award of significant equity represents a tremendous opportunity for recipients to generate wealth for themselves. At the same time, it provides a relatively low-risk proposition for the original owner(s), since recipients who fail to produce (in terms of generating gains in the market value of the company) will come away with relatively little in final value. Often, it is the only way that a smaller, cash-limited growth company can compete in the marketplace for top quality talent.
That, in turn, suggests another benefit that business leaders will appreciate: the ability to conserve cash by using equity as an element of employee compensation. Businesses that practice employee ownership not only improve cash flow through lower cash wage rates, but save even more because equity-invested employees will actively support frugal practices and expense minimizing. They know this will add to the company’s bottom line and thus to the market value of their equity holdings.
But in the long run, the most compelling reason that business leaders are interested in establishing some form of employee ownership is the extensive compilation of research studies that have consistently found that companies achieve better financial results with employee ownership than without it. Employees who have a stake in the performance of the company show greater concern for the company’s financial results and apply themselves in more productive ways to reach that goal. The icing on the cake is that, not only does the company become more productive, but the job of managing and directing the company becomes easier and more enjoyable since the whole team lines up behind the goal of business results, embracing the things that make “their” company more successful and valuable.
Selecting the Right Tools from the Tool Box
It’s easy enough to conclude in principle that employee ownership can motivate employees and produce gains in company performance. But how do you translate that principle into action? What, exactly, should a company implement?
Professional business advisors should understand that an array of tools and techniques is available to put equity interests in employee hands. Each tool – whether it be stock options, stock purchase programs, ESOPs, synthetic equity units, restricted stock, or any other – has its particular features and limitations that will likely make it suitable for some situations, but not for others. The art of creating an effective employee ownership program involves a process of matching the right tool(s) to the specific situation, as defined by the company’s industry and workforce, the management’s business strategy, and the current owners’ goals and aspirations. A young technology start-up (with young leadership and young employees) and a long-established family-held brick-and-mortar business (with seasoned owners and leaders) can both enhance their performance through employee ownership. But they will almost certainly create programs that use very different tools and techniques to do so.
ESOP: the Supercharged Tool for Ownership Sale/Transfer to Employees
One tool that no business advisor should be ignorant of is the “employee stock ownership plan,” or ESOP. While the ESOP can bring all the performance-boosting benefits that any other equity-sharing tool can, it can also produce some very important additional benefits. The ESOP can serve as a mechanism by which a shareholder can sell stock to the employees as a group (a trust is formed to hold the shares for the employees), with the employees using a company-arranged bank loan to supply the purchase money. The kicker in this is that, where certain conditions are met, the seller can pocket the sales proceeds without paying a penny in income tax – capital gains or otherwise! For you technical tax folks, that arrangement is spelled out in Code section 1042. This is a remarkably attractive way for a shareholder to cash out. Companies that are owned by a small group of major shareholders may find that this is an ideal way to provide liquidity when one of them wants out while the others want to continue to operate the company.
Breathing Life into the Concept: Ownership Culture
Perhaps the most important thing for professional business advisors to understand – and preach to their management clients – is that real success with employee ownership requires much more than simply preparing the necessary legal paperwork and distributing some equity to employees. Keep in mind that the performance improvements that have been seen at employee ownership companies have come about because the employees have adopted new and better attitudes about their company and their work. These healthier attitudes generate more productive behaviors in the employees – behaviors like treating customers more politely; sticking with a task to be sure it is done completely to the last detail; cooperating with colleagues to complete a complex project in the best way rather than engaging in turf battles and angling for personal credit. These new behaviors do not spring instantly and automatically into existence because the employees have received a stock option grant or an award of shares in an ESOP account. Rather, management needs to educate employees about the whole picture – what the employee ownership program is, how it works, and exactly how superior company performance will ultimately put wealth in their pockets. Once a shared understanding of this new opportunity is established, management can encourage a healthy, team-oriented, goal-focused way of operating, with an esprit de corp that celebrates company successes and builds pride on the part of employee-owners in “their” company.
A Final Word
Business leaders are increasingly interested in the idea of employee ownership because of the growing awareness that it helps to generate successful business results (i.e., faster growth and healthier bottom lines). At the same time, it makes a company easier and more fun to manage. For a business owner who is thinking about transitioning out of the owner/leader role, it can be an unbeatable route (via the ESOP) for generating a win-win-win outcome that leaves the company stronger, the employees with the opportunity to own a piece of the business, and the exiting owner with the chance to enjoy the fruits of his career labors without sharing that fruit with the IRS. A professional advisor who makes a client aware of these remarkable advantages will be genuinely appreciated.
©2008 The Beyster Institute and its authors and their entities. All rights reserved.
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