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The Many Forms of Employee Ownership: ESOPs, Co-Ops, Profit-Sharing Plans, and Equity Compensation Plans

Posted by Marc S. Schechter | Sep 24, 2018 | 0 Comments

Contributing Author: Gwenllian Kern-Allely, Law Clerk

Employee ownership has many forms. The most common in the U.S. is the employee stock ownership plan (ESOP).  Cooperatives (co-ops) and other profit-sharing plans also exist as a way for employees to benefit from the company's profits during their employment with the company. However, each form of profit sharing has different benefits. This post will give a brief description of popular types of employee ownership plans. To note, there are a number of equity compensation plans available, and this post will by no means cover all of them.

ESOP

An ESOP is a retirement plan providing benefits for both employees and employers alike. First created in 1974 under the Employee Retirement Income Security Act (ERISA), the ESOP is a qualified retirement trust that does not require any contributions from the employees. As a qualified plan, an ESOP must conform to federal rules to ensure that participation does not favor some members over others. The stock of the company is held in trust and is allocated to employees. The employees do not purchase or invest any of their own money into their shares of the company and are paid the full value of their stock when they leave the company. ESOPs have various tax benefits associated with them. The repayment of the ESOP trust loan is tax deductible, and the employees do not pay tax until they receive their shares. A selling shareholder may be able to defer or completely avoid income tax on their sale of shares to an ESOP. Some states have enacted additional pro-ESOP legislation that provides assistance in creating the ESOP or can provide a tax benefit to owners that sell their shares to the ESOP.

Worker Co-Op

A co-op, or worker co-op, is an employee ownership plan where each worker has an equal share of the business. The workers all have equal votes in the governance of the business, creating a democratic business model. The length of time or rate of pay of an employee has no effect on their voting rights. The Board of Directors is typically elected by the workers, and the business follows the bylaws of the worker cooperative.  Most co-ops follow the Seven Cooperative Principles created by the International Cooperative Alliance in 1994.[1] Due to their ability to create most any structure, worker cooperatives have great flexibility in determining how to run their business. 

Worker Collective

Similar to co-ops, a worker collective is an employee ownership plan that is managed without hierarchy among the members. In a collective, all workers are equal and participate directly in the governance of the company. People may be delegated or delegate to committees to make some decisions on behalf of the company.

Profit-Sharing Plans

In a general profit-sharing plan, the company contributes a portion of its income into a pool that allocates the shares to eligible employees. As the name suggestions, the employees only receive a portion of the profits when the company turns a profit. The profits can be dispersed either in stock or cash form. Depending on whether the plan is styled as a cash or deferred plan, the employee may receive the profits at the time the profits are determined (cash) or are deferred to an account that is distributed at a later time (deferred). Cash profit-sharing plans require an official plan document and a trust for the plan's assets. Deferred profit-sharing plans are regulated under ERISA.

Equity Compensation Plans

The primary forms of equity compensation plans are stock option plans and stock purchase plans. Stock option plans present the employee with the right to buy shares of the company at a certain price at a specified period of time. The option must vest before the employee can purchase the stock. A stock purchase plan differs from stock options because it allows the employee to buy the stock from the company right away, with the caveat that the company can repurchase any unvested shares at the initial purchase price. In a stock option plan, all employees granted an option must have the same rights and privileges.

While each plan offers various monetary benefits to the employees, they all have the same goal: foster employee ownership in the company. Studies have shown that employee-owned companies incentivize employees to work harder and give employees the satisfaction of working “for themselves.” Each plan provides different amounts of responsibility and financial benefits along the road which makes it important for businesses to choose the right plan for their unique enterprises.

[1] The Seven Cooperative Principles are (1) open and voluntary membership, (2) democratic member control, (3) member economic participation, (4) autonomy and independence, (5) education, training, and reform, (6) co-operation among cooperatives, and (7) concern for community.

About the Author

Marc S. Schechter

Marc Schechter specializes in the areas of employee benefits, ERISA, and business matters.

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