Closely held firms often face a twin dilemma:
1) As private companies, they don’t have publicly traded shares to use to motivate key employees the way public companies do.
2) In addition, they face a governance challenge if the second, third, or fourth generation of the founder is unable or unwilling to run the business.
More and more, such companies are looking into selling the business to its workers either in the form of an ESOP (employee stock owned plan) or in similar worker-owned arrangements. It isn’t the answer for everyone, but increasingly, owners with fewer options see this as a way of rewarding employees while cashing out of their business.
Most founders who want to empower their employees do it by selling their stock to an ESOP, which operates like a retirement trust fund and is regulated by the IRS and the Department of Labor. The number of worker-owned businesses in the U.S. is growing robustly, around 6% per year, and these businesses now account for about 12% of the private sector workforce.
13.9 million workers participate in an ESOP
1.8 million workers have a stock bonus or profit-sharing plan
9 million employees are compensated with stock options
11 million have access to a stock purchase plan
Source: The National Center for Employee Ownership (NCOE)
Johnsonville Sausage’s shared compensation system
Johnsonville, a sausage maker that started as a small family-owned butcher shop in Sheboygan, Wisconsin in 1945, has developed into a global brand and the #1 national brand of sausage—and it’s a brand that still behaves like a local butcher. To this day, the same family, started by CEO Ralph Stayer’s grandfather, owns the business, but building the business is in the hands of the employee members, including coming up with the new advertising creative, answering questions on the Sausage Support Center Hotline and tailgating with SEC fans with actual working wearable grills.
Stayer’s vision of putting members first also includes sharing profits and investing back into the business and community. “First, we eliminated the annual across-the-board raise and substituted a pay-for-responsibility system, “ Stayer wrote in HBR. As people took on new duties—budgeting, for instance, or training—they earned additional base income. Where the old system rewarded people for hanging around, regardless of what they contributed, the new one encouraged people to seek responsibility.”
Second, we instituted what we called a “company performance share,” a fixed percentage of pretax profits to be divided every six months among our employees. We based individual shares on a performance-appraisal system designed and administered by a volunteer team of line production workers from various departments.” Although not technically employee-owned, the sausage maker exhibits a high degree of worker participation through the company’s shared compensation scheme.
Burns & McDonnell grows after becoming an ESOP
Kansas City-based engineering firm Burns & McDonnell became an ESOP in 1986 when its parent company needed to divest businesses to pay down debt. The result has been astounding.
The company has gone from 600 to 5,500 people and from $40 million in annual revenue to $2.6 billion. It is the 23rd largest employee-owned company in the U.S. CEO Greg Graves believes the move sparked a culture of entrepreneurialism that enabled the company to go the next level and make Burns & McDonnell an attractive place to work. Graves’ efforts earned Burns & McDonnell a continued rising seat on Fortune’s 100 Best Companies to Work For List, now ranked at no. 16. Employee turnover, which had been around 20%, has dropped to 5%.
“The first year we submitted to Fortune’s Best Companies to Work For List, we landed in the 50s,” says Graves, who then studied the top 10 companies with a goal of rising to the top. “Each year we would introduce a variety of new services or benefits to our employees-owners. It could be something as simple as on-site dry cleaning or farmers markets to larger investments, like an in-house medical center. This year, we’re introducing an on-site child care center and pharmacy.”
In most partnerships, a highly competitive process determines who gets elected to be managing partner. The successful candidate is one who can build support among the “rank and file” of other partners and win their support. But once elected, the managing partner has substantial autonomy and independent decision-making power, often much more autonomy than his or her counterpart in a typical worker-owned business. This helps when the partnership needs to make tough decisions. For example, it might be necessary to shut a part of the practice that is losing money, and that means layoffs. Some argue that a purely consensus-based decision process would find it extremely difficult to make the right call.
Graves admits that employee-ownership isn’t for everyone, but if the leadership has the full faith of the employees, decision-making can be quicker and buy-in can be more secure.
The upside to ESOPs
- Provides an exit strategy for owners. In almost every small business, the owner or owners will eventually want to leave. Selling the business to employees can be a way to provide continuity and preserve the culture of the business.
- Attracts and retains good employees. Many small businesses have trouble attracting and retaining good employees.
- Preserves jobs and local ownership. Employee ownership is a proven means of preserving local ownership of companies and the jobs they support, fairly sharing equity, boosting productivity, and improving the quality of work life.
- Improve performance. Several reliable studies indicate that, on average, employee-owned firms perform substantially better than non-employee-owned firms when ownership is combined with employee participation in decisions affecting their work.
- Like profit-sharing plans, ESOPs are useless when companies involved go under. Furthermore, the system favors long-term employees, making it less attractive for newcomers to get in on the plan. As a company issues more shares, the percentage of shares of existing owners are diluted, putting pressure on executives to come up with new incentives to balance that dilution.