How founders can advance employee ownership
As founders, we have incredible power to generate billions (or trillions!) of wealth for employee-owners.
Employee ownership is not new. Industrial giants from the 20th century like Kodak and General Electric offered stock to their employees. Nearly every software engineering or product management role includes equity as part of the compensation package. My belief is that every company in every sector should offer equity to every employee.
Why should you advance employee ownership?
Let’s stay with why you should consider broad-based (which means for all employees, not just a few key executives) employee ownership.
- Recruitment and retention
Especially in services businesses, recruiting is a constant struggle. The business is its people, and many jobs, like those in senior care, demand emotional labor for mediocre pay. From 2014–2017, turnover at ESOPs (companies with an employee share ownership plan) was 10.8 percent, compared to 27.1 percent at non-ESOPS, according to National Center for Employee Ownership statistics. According to a study by Rutgers, majority ESOP Firms drastically outperform other firms at retaining jobs at a 4 to 1 rate.
There are obvious caveats to this. Employees aren’t loyal to a company simply because its employee-owned; they are motivated by how that ownership materially affects their lives and the lives of their families. Does ownership create a culture of respect and generous benefits? Is the end-of-year dividend check the amount of an hour of work (probably not that motivating) or a month of work (now we’re talking!). If the company sells, is the ownership stake enough to buy a house or pay for college or book a family trip to Disney? (all real examples of how employees spent their checks after KKR-backed CHI Overhead Doors exited). The absolute dollar amount of what ownership means for each employees matters, so smaller companies will need to allocate a larger percentage of ownership for the equity to be motivating.
Also, ownership can’t be viewed as a replacement for a wage increase or end-of-year bonus. It needs to be additive to, not a replacement for, cash compensation.
2. Performance
Employees are on the ground and see obvious ways to earn more and reduce costs. This wisdom is behind kaizen, which means continuous improvement, which is a core principal of Toyota’s manufacturing system. Any employee on the assembly line has the ability to suggest changes or raise red flags. Ownership introduces an incentive to use those observations to realize improvements. If I’m getting a fixed salary, why bother to mention cost-saving improvements? If I’m getting a share of profits, I’ll chime in. Why would employees take an “ownership mindset” of something they have no financial ownership of?
Ben Affleck and Matt Damon’s new production company, Artists Equity, will share profits with not only directors, producers and actors but also crew members such as cinematographers, editors and costume designers. When speaking with The Hollywood Reporter, Affleck shared, “I was talking to [cinematographer] Bob Richardson. He’s a genius. And I said, ‘Bob, what if I gave you a million bucks to save me five [million]? Could you do it?” And he goes, “Fuck, I’ll save you 10.’”
However, no one wakes up knowing what equity is. How concepts like dividends and exits translate to personal income are not intuitive and need to be explained. If you just say, “Hey! You’re an owner!” you’re probably not going to see any performance improvements. If you say, “Hey! You own 1% of the company. If we make a $5 million profit, you get $50,000. If we make a $10 million profit, you get $100,000,” that hits.
3. It’s the right thing to do
I’ve also found it kind of crazy that some guy who writes a check ten years ago will receive massive financial upside in the company, yet the people showing up for work every day just receive their agreed-upon, fixed wage. With a mindset of abundance, we can include all employees in the financial upside of the company that they build.
How do you advance employee ownership?
Cue calling your lawyers and accountants to get real advice on this, but here are some ideas:
- Double the employee pool
Most companies have some sort of norm around creating an option pool, usually for senior employees. In venture-backed startups, it’s 10 percent. In search funds, it’s five percent. Take the industry norm and double it. Yes, you and your investors will get a little diluted, but this expanded pie will allow for many to own the company, not just a few, unlocking all those juicy recruitment, retention, and performance benefits that stem from broad-based employee ownership.
2. Exit to employees
When owners are looking to sell their business, they look to private equity, similar companies, or the stock market. But what if more owners sold to their employees?
A common first response to this idea is, “Sounds great, but my employees don’t have that kind of money.” When business owners sell to employees, they do not sell to individual employees, but rather to an ESOP or other legal structure representing employees. The ESOP gets the capital to purchase the company from the business owner either through the company’s existing profits or from a bank loan. Sellers who sell to ESOPs even have tax benefits, including not recognizing long-term capital gains from the sale with regard to federal income taxes if you sell at least 30 percent of the company to an ESOP. There are plenty of ESOP advisors, such as Verit Advisors, who can help structure and finance an exit to employees.
Even a minority sale to employees can reap massive benefits. In 2010, Clif Bar sold 20 percent of the company’s employee-owned stock to an ESOP. When the company sold to Mondelez International in 2022, that 20 percent translated to $580 million for employee-owners.
The headline here is that you don’t have to be a saint to advance employee ownership. In expanding the employee pool and considering employees as your company’s buyer, you can transfer inconceivable wealth in the hands of people doing the honest work.
