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 employee-owned company, 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:
- Quick Background on ESOPs
- Not all ESOPs are Employee-Owned
- Many Employee-Owned Companies Don’t Have an ESOP
- Defining “Employee-Owned”
- Stronger Together Through Certification
Quick Background on ESOPs
ESOPs have grown dramatically since their creation in 1974 as part of the Employee Retirement Income Security Act (ERISA). According to the Department of Labor, 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 company stock 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 open criteria drive high participation and ensure that workers at ESOP companies benefit when their employer is successful.
Not all ESOPs are Employee-Owned
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.
But there is a categorical distinction between a company operating a small broad-based, share-ownership plan as a benefit and a company where the employees own a substantial portion of the stock, 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. In the publicly available Form 5500 data, the largest company indicating they have an ESOP is Walmart. To be sure, that ESOP must be a nice benefit for some of the company's employees. However, it probably is not having the same impact as the ESOP at 100% employee-owned WinCo Foods, which has made many front line employees into millionaires. WinCo is just one of many inspiring stories of employee-owners building life-changing wealth. That’s why it’s important to remember that having an ESOPs doesn't always mean a company is employee-owned.
Many Employee-Owned Companies Don’t Have an ESOP
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 alternative ways to implement significant and broad-based employee ownership, including Worker Cooperatives, Employee Ownership Trusts (EOTs), Employee Stock Purchase Plans (ESPPs), and equity compensation plans like stock options. Companies can even implement employee ownership through direct share ownership, though there are often benefits to using 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. Some selling owners want more flexibility. Others might want to ensure employees have a strong voice in governance. But perhaps the most promising use case for alternative structures is helping smaller companies become employee-owned. The setup and administrative costs of an ESOP can be prohibitive for companies under 40 people. In recent years we’ve seen a growing number of small companies using EOTs, direct share ownership, and even stock options. This encouraging trend could greatly expand the employee ownership community.
Defining “Employee-Owned”
If not all ESOPs are employee-owned and many employee-owned companies don’t have an ESOP, then it begs the question: How do you define employee-owned? Answering this question was priority number one when we started Certified Employee-Owned.
Our vision from the very beginning has been to use certification to accelerate the creation of an employee-owned economy. Programs like Great Place to Work and Fair Trade show that certification builds support by amplifying the voice of the movement. We quickly realized that, while companies with different employee ownership structures have distinct administrative and legal concerns, they would all benefit from the visibility created by certification.
With this big-tent vision in mind, we set out to create a definition of “employee-owned” that could be applied to any ownership structure. We searched extensively for historical precedent and had over 250 conversations with companies and advocates.
Ultimately, we identified financial ownership as the common thread running through legislation and views of advocates from across the space. With that in mind, we focused our definition on three concepts:
- Ownership: At least 30% of the company must be owned by employees (excluding founders)
- Access: Reasonable access to ownership must be open to every employee
- Concentration: Ownership among employees cannot be too concentrated
Stronger Together Through Certification
It’s important to emphasize that the point of this definition is not to determine who is a “good” or “bad” company. Ultimately we are focused on what certification can accomplish for the employee ownership community and a necessary part of any certification program is a specific and clear delineation between who does and does not meet the standards.
Setting a standard people know and trust has intrinsic value, but it also enables the creation of shared resources. Our Directory of Employee-Owned Companies is an up-to-date list of every company we know of that, to the best of our knowledge, meets the above definition of employee-owned. The directory create a simple way for people to find employee-owned companies, but it’s only possible with a clear definition of employee-owned.
Our certification mark is the strongest way for a company to communicate that they meet high standards of significant and broad-based employee ownership. Over one hundred Members are using the mark on their websites and major companies like WinCo Foods and Litehouse are using the mark on widely circulated products and packaging. The foundation of this branding initiative is the trust created by third-party certification.
Certification is changing the game for the entire employee ownership community, including ESOPs, and that’s why it’s important to understand the difference between “ESOP” and “employee-owned”.
This article was originally posted 2/16/22 and was updated on 3/28/2023.
