If you’ve spent time learning about employee ownership, then you’ve certainly heard of Employee Stock Ownership Plans, or ESOPs. In fact, ESOPs are so common among employee-owned companies that many people use these terms interchangeably. You might be surprised to learn that, while ESOPs are certainly the most common type of plan used by employee-owned companies, there is actually quite a bit of daylight between the two concepts. Not all ESOPs are employee-owned, and not all employee-owned companies have an ESOP.
This article walks through the differences between “ESOP” and “employee-owned” including:
Given their importance to employee ownership, it makes sense to start with a bit of background information on ESOPs. Since their creation in 1974 as part of the Employee Retirement Income Security Act (ERISA), ESOPs have grown dramatically. According to the National Center for Employee Ownership, there are currently around 6,300 companies with an ESOP. They range in size from dozens of employees to hundreds of thousands and operate in every industry imaginable. The ESOP’s popularity is due to a number of factors, including nearly 50 years of proven success, strong tax benefits, and a fantastic community of advocates and service providers.
By law, ESOPs are extremely inclusive. The basic idea behind an ESOP is that it is a trust that owns a portion or all of a company on behalf of a broad-based group of employees. Shares are usually allocated to eligible employees annually, and the eligibility criteria employees must meet to receive a share allocation are very open. Typically employees need to work 1,000 hours in a year to participate, an average of only 20 hours per week. Additionally, ESOP shares are paid out of company profits and are allocated to employees at no cost. These simple and open criteria drive high levels of participation in the plan and ensure that workers at ESOP companies benefit when their business is successful.
While all ESOPs are broad-based, the percentage of total outstanding stock owned by the ESOP varies dramatically from company to company. There is no minimum, and in practice we’ve seen this range anywhere from a fraction of a percent to 100%. Of course, an ESOP that owns even just a tiny piece of a large and successful company can provide a great benefit to employees, especially since employees are not paying for the shares out of their wages or benefits. However, there is a categorical distinction between a company operating a small ESOP as an employee benefit versus a company where the plan owns a substantial portion of the company, perhaps even 100%. In other words, there is a difference between having an ESOP and being employee-owned.
Further clarity can be gained by looking at a specific example. When downloading the publicly available Form 5500 data from the Department of Labor and filtering for all companies that indicate they have an ESOP, we see the largest such company by number of active participants is Walmart. Their ESOP is probably a nice benefit for some of the company's employees. However, it is not having the same impact on people as the ESOP at 100% employee-owned WinCo Foods, which has made many front line employees into millionaires. That’s why it’s important to remember that having an ESOPs doesn't always mean a company is employee-owned.
While the ESOP model is the most popular and successful structure used by employee-owned companies, it is not the only option. There are a number of alternatives that companies can use to implement significant and broad-based employee ownership, including worker cooperatives, employee ownership trusts (EOTs), employee stock purchase programs, and equity compensation plans like stock options. We describe each in more detail here. Companies can even implement employee ownership through direct share ownership, though often there are advantages to a more formal structure.
Alternative structures play an important role in building an employee-owned economy because not every company is a good fit for an ESOP. The setup and administrative costs of an ESOP can be prohibitive for companies under 40 people. Companies that want to ensure employees have a strong voice in governance might find the worker cooperative to be a better fit. Perhaps the most promising use case for alternative structures is helping smaller companies become employee-owned. For example, in recent years we’ve seen a growing number of EOTs implemented at companies that are too small for an ESOP, an encouraging trend that could greatly expand the employee ownership community.
If not all ESOPs are employee-owned and many employee-owned companies don’t have an ESOP, then it begs the question: What does “employee-owned” mean? Answering this question was priority number one when we started Certified Employee-Owned.
Our vision from the very beginning has been to create national recognition for employee ownership by making it simple and easy for Americans to find and support employee-owned companies. We quickly realized that, while companies leveraging different ownership structures certainly have distinct administrative and legal concerns, everyone in the employee ownership community would benefit from increased visibility and awareness .
With this big-tent vision in mind, we set out to create specific and verifiable criteria to define “employee-owned” that could be applied to any underlying ownership structure. We searched extensively for historical precedent and had over 200 conversations with companies and advocates. Ultimately, we identified financial ownership as a common thread running through legislation and views of advocates from across the space. After accumulating feedback and input, we created a definition of what it means for a company to be employee-owned that focuses on three main concepts:
We have specific practices that we verify under each of these headings, and while we will provide details on both our certification standards and the development process in a future post, it’s important to emphasize that our goal is not to determine who is a “good” or “bad” employee-owned company. There are businesses doing great things with broad-based ownership below our 30% threshold, and there are other companies that would view our standards as too low. It only took about five conversations to realize no definition would ever satisfy everyone, and that’s not the point.
The point is to grow the employee-owned economy. Think about what Organic, Fair Trade, and B Corporation have done in terms of awareness and imagine if we could create that for employee-owned companies. A necessary part of having a certification program is a specific and clear delineation between who does and does not meet the standards. Our standards also allow us to create resources that benefit the entire community, for example our Directory of Employee-Owned Companies, which is an up-to-date list of every company that, to the best of our knowledge, meets the above definition of employee-owned.
Our approach has the potential to change the game for the employee ownership community, including the ESOP space, and that’s why it’s important to understand the difference between “ESOP” and “employee-owned”.