ESOP vs. Worker Cooperative: What's the Difference?

WHAT’S THE DIFFERENCE BETWEEN AN E.S.O.P. AND A WORKER COOPERATIVE?

Here’s the key information you need to understand about each of them, adapted with permission from information originally published by the Cooperative Development Institute.

Worker-Owned Cooperatives

A worker cooperative is an employee-owned business in which each member or worker-owner has one equal share of the business. This also means that every worker-owner has one equal vote in the co-op, no matter their pay or seniority.

Of course, different worker co-ops have different structures. Some are more hierarchical and have managers, an elected board of directors, and sometimes an elected board president. However, at the end of the day these leaders are accountable to the full membership. And in fact a manager or co-op president only has one vote and one share in the business, like any other worker-owner. While the board makes major strategic decisions and management has operational authority, both are ultimately empowered by and responsible to the full membership.

Worker co-ops that are more collectivized and horizontal in their structure, with no internal hierarchy, are often very small enterprises, with a few notable exceptions. Tasks and decisions may be delegated to individuals or groups, but the “board,” the top governing body, is made up of all the worker-owners.

In addition, in the worker co-op world there’s a thing known as the “patronage dividend.” Basically, this is a member’s share of the business’s profits at the end of each year. According to co-op principles, it is allocated based on “patronage,” which, in a worker co-op, means hours worked. Sometimes the formula takes into account additional factors such as relative pay. But because the worker-owners each have the same membership share no single person can receive a higher return on their investment from owning more of the company.

ESOPs

An ESOP has a completely different ownership structure. In this case a separate entity, a trust, acquires some portion — sometimes all — of a company’s stock, and holds it for the benefit of employees. The company generally appoints the trustees who administer the plan, which is largely a retirement or separation benefit. Employees’ accounts within the trust accumulate shares of the company based on various formulas, usually salaries as well as the pace of the company paying back bank loans for the purchase of company stock. The value of the shares at any given time depends on an annual independent valuation of the company. Typically, employees receive the cash value of the shares in their account upon leaving the company.

ESOPs are not cooperatives — there is no direct ownership by workers of company stock — and there is no requirement for democratic governance. Employee shares do not generally confer voting rights (except in very specific rare circumstances). That said, a growing number of ESOPs own 100 percent of their company’s stock, and that does change the nature
of the enterprise. ESOP companies that invest in workforce education and have participatory structures enjoy productivity gains compared to non-participatory, non-employee-owned companies.

A COMPARISON OF EMPLOYEE OWNERSHIP MODELS 

 

Worker Co-op

ESOP

Key Benefits

·    Flexible tax benefits

·    Deepest employee/ community impact

·    Best structure for mission preservation

·    Good structure for mission preservation

·    Significant tax benefits


·    Easier to find financing

 

 Key Challenges

·    Will likely need multiple sources to finance the transaction

·    Considerable employee training requirements

·    Needs employee buy-in

·     High initial and ongoing costs

·     Less flexible

·     Larger audit risk from the Department of Labor

Tax Benefits

·    Capital gains tax deferral for transition

·    Ongoing: Deductibility of profits allocated to employees

·    Capital gains tax deferral (C Corp ESOPs)

·    Exemption from federal corporate income tax (S Corp ESOPs) 


·    Ongoing: Deductibility of contributions to the plan 


 

 Cost

·    Initial transaction: $20,000 to $50,000

·    Initial transaction: $60,000 to $250,000

·    Ongoing: $15,000 –$40,000/year

 

Minimum Requirements

·    Profitable company

·    Early and ongoing investment in employee training

·    Willingness of owners to give eventual control of board to employees

·    Willingness of employees to step up as worker-owners 


 

·   Profitable company

·   At least 20–25 employees


·   At least $500,000 in payroll

·   Currently a C or S Corp (or can convert to one)

 

Timeline

·     6 months to a year for the initial transition, up to 3 years to transition leadership

·    6 months to over a year

 

 

 

This article appeared in Issue 9 | September/October 2016

We’re going local in Issue 9, taking a deep look at what it takes to create thriving communities, where some attempts fall short, and how conscious business can and does help. We have interviews and advice from top CEOs, including George Siemon of billion-dollar farmers’ co-op Organic Valley; Robyn Sue Fisher, who built a 200-employee ice cream business out of a Radio Flyer wagon; and Reeves Clippard of A&R Solar, one of Seattle’s fastest-growing companies. We also investigate the dark side of the sharing economy, offer a complete guide to the new equity crowdfunding law, and present the case for employee ownership. Plus: how to be a better listener, key business lessons for makers, Detroit’s leading innovators, and more!

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