In today’s current labor market, it is paramount for companies to differentiate themselves to attract top talent. One way is to give employees a “piece of the pie” by offering employee ownership. Many studies have shown that offering ownership to employees increases employee satisfaction and productivity, and employee-owned businesses tend to grow faster and are more profitable than non-employee-owned businesses.
A company can offer employee ownership in myriad ways. Below are three of the more prevalent methods.
An Employee Stock Ownership Plan (ESOP) is a retirement plan whereby shares of company stock are contributed to participant accounts annually, typically based on employee compensation. When a participant leaves the company, his shares are redeemed and either retired or recycled back into active participants’ accounts.
An ESOP can be a tax-effective exit strategy for business owners as well since the tax on the sale of company stock to the ESOP could be deferred by the owner if structured properly.
It’s also important to note that an ESOP cannot be offered exclusively to one class of employees and must be available to all employees not already covered under a collective bargaining agreement. The company will also be required to fund eventual redemptions; therefore, it’s important for the company to monitor participant accounts as well as planned retirements and redemptions in order to properly manage the share repurchase obligation.
Stock options offer more flexibility than a traditional ESOP, are cheaper to administer, and are not perpetual like an ESOP; however, they do offer fewer tax advantages. Unlike an ESOP, stock options can be offered to select individuals within an organization. The options can be offered to the employee at a discount, typically have a vesting period, and can be exercised in the form of actual company stock or cash equivalent. Stock options are typically not an exit planning strategy for owners like an ESOP would be. A company typically has a pool of shares designated strictly for stock options.
Stock Appreciation Rights
Of the three options discussed, stock appreciation rights (SARs) offer the most flexibility for the company but are likely the least attractive from an employee’s perspective. SARs are awarded to employees at a base share value, and over time as the company’s share price increases, employees are compensated based on the appreciation of the share price over the base value. SARs are often paid in cash and not actual company stock, resulting in zero dilution of ownership’s shares.
Make no mistake, SARs can still be extremely lucrative to the employee and incentivize them to grow the business over time. But SARs typically lack the tangible ownership of the other two options. Although employees are being compensated based on the growth and profitability of the business, they have no real ownership stake that they can sell at retirement.
There are many other ways to offer employee ownership, including cooperatives, profit-sharing plans, and employee stock purchase plans. When deciding which employee ownership strategy is the best fit for your business, think first about what is motivating you to explore employee ownership and what you’re trying to achieve. For instance, are you using it as an exit strategy, as a way to attract and retain top talent and key management positions, or as a method to improve company culture and organically grow the business? The answer should help guide you in the right direction for your business.
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