Employee ownership programs come in many forms, including stock options, profit sharing, and worker cooperatives. But by far the most common form of employee ownership in the U.S. is the Employee Stock Ownership Plan, also known as an ESOP.
ESOPs started springing up in the 1970s, after the passage of the Employee Retirement Income Security Act of 1974 (ERISA), as an alternative exit strategy for owners and a retirement benefit for workers.
ESOPs act as qualified retirement plans that invest primarily in employee securities and allow qualified employees to share in company stock ownership. ESOPs have many benefits including tax treatment, company culture, and retirement benefits.
In this article, we answer common questions about employee stock ownership plans, including how do ESOPs work? How many ESOPs are there in the US? Do ESOP companies perform better? And many more.
How Do ESOPs Work?
An ESOP is essentially a trust fund for employees where the company contributes cash in the form of company shares. Contributions to the plan are tax-deductible, and employees pay no tax on their earnings until they cash in their stock upon their exit or upon retirement, provided they have met the ESOP vesting requirements.
In terms of taxation, provided that a C-Corporation has 30% or more of its stock owned by an ESOP, they can defer taxation on capital gains by reinvesting in securities of other qualified companies. If it is an S-Corporation, income is not taxed federally or by the state.
How Many ESOPs Are There?
According to the National Center for Employee Ownership (NCEO), as of 2021, there are about 6,600 ESOPs covering more than 14 million participants.
How Much Corporate Equity do Employees Hold?
In addition to the 14 million ESOP participants, 9 million employees participate in stock option or equity plans, 5 million participate in 401(k) plans primarily invested in employer stock, and 11 million employees buy shares through employee stock purchase plans. The NCEO estimates that employees control about 8% of corporate equity.
How are ESOPs Used?
Many ESOPs, roughly two-thirds, are used to purchase the shares of a departing owner of a profitable private company. Most of the remaining ESOPs are primarily used as an employee retirement benefit or a means to borrow money in a tax-advantageous way. Less than 10% of ESOP plans are in public companies.
Do ESOP companies perform better than Non-ESOP companies?
A Rutgers study found that ESOP companies grow 2.4% faster than non-ESOP companies. And while participation plans alone have little impact on company performance, a combination of employee ownership and workplace participation programs show substantial gains in performance. For example, an NCEO study found that ESOP companies that practice participative management grow 8-11% faster than they would without an ESOP.
Do ESOP employees fare better financially?
A Washington State study on ESOPs found that participants made 5-12% more in wages and had almost 3x the retirement assets as workers in comparable non-ESOP companies. Based on government filings a few years ago, ESOP participants receive ~$4,500 per year in company contributions with an average account balance of $55,800. 56% of ESOP companies also have at least one additional retirement plan for employees. Conversely, only 44% of comparable non-ESOP companies have any retirement plan, many of which are funded entirely by employees.
As you can see, employee stock ownership plans can be a great benefit to employees and can help contribute to positive outcomes for the company. We hope that this article shed some light on how ESOPs work and what impact they can have on companies and employees.