Are you looking for a way to foster a stronger sense of team spirit among your employees? Are you nearing retirement and wondering about your exit plan? Do you have a family-owned company and no family members interested in picking up the reins when you’re ready to hand them over?

Any or all of those situations — and perhaps a few others — might offer a reason to consider a novel approach to restructuring your business: turning it over to your employees.

As a concept, employee ownership goes back decades. Legislation passed in the 1970s created tax incentives to encourage it, and an estimated 7,000 companies have some form of employee ownership, according to the National Center for Employee Ownership (www.nceo.org), based in Oakland, California. But it’s still unknown to many.

Employee ownership may be ready for a second look, however. Tucked into the national defense bill President Donald Trump signed in August 2018 are provisions making it easier for small businesses to establish certain kinds of employee ownership arrangements.

Company owners who decide to convert their businesses to employee ownership do so for several reasons. “The primary motives are, first, to take care of the workforce,” says Loren Rodgers, executive director of the NCEO. Ownership gives employees an opportunity to reap greater rewards if the business is someday sold to another company.

Employee-owned companies also find that the workforce benefits even if the business never changes hands, he says. “They can continue to grow, with everybody pulling in the same direction.”

Variations

The most common form of employee ownership is called an employee stock ownership plan. Federal tax laws create incentives for employers to create ESOPs, allowing capital gains taxes to be deferred when the plan is established.

ESOPs tend to favor larger businesses established as C-corporations or S-corporations. Rodgers estimates that a company has to have at least 30 employees before the benefits offset the costs of establishing an ESOP in the first place.

The good news is that ESOPs aren’t the only form of employee ownership.

Smaller businesses are most often structured as limited liability corporations. And for LLCs, Rodgers notes a couple ways to set up some form of employee ownership plan.

And while they lack the tax incentives that promote ESOPs, these plans can produce the other advantages that many employers find with employee ownership — a means of sharing the rewards of success with their workers and, as a consequence, a more unified and productive workforce.

Capital interests

Unlike S- or C-corporations, LLCs don’t issue stock. They can’t offer ESOPs, and they can’t offer other forms of stock-based compensation — such as stock options, restricted stock or conventional shares, according to the NCEO.

But they can still give employees an equity stake in the company in the form of “member interests,” Rodgers says.

These member interests take two forms. One is called “capital interests.” Rodgers compares capital interests in an LLC to a stock option grant in an S- or C-corporation. An employee is awarded part ownership in the LLC in the form of capital interests. Over time, as the value of the capital interests goes up (assuming the company is successful and grows), it’s similar to holding stock that rises in value.

In essence, the capital interests form of ownership is a retirement benefit, with the value realized only when the employee leaves or retires and sells back the interests in the company.

Sharing profits

Rodgers says most LLCs opt for the other form of employee ownership, however, called “profit interests.”

As with capital interests, employees who are issued profit interests will share in the increase in the equity value of the interests over time. And as with capital interests, they won’t actually benefit from that increased value until they leave or retire and sell the interests back to the company.

But profit interests also enable employees to get a distribution of profits from the LLC over the course of their employment — similar to a profit sharing program, but directly because they own part of the business. The profit distribution is taxed as ordinary income.

A business opting for one of these plans has a choice about how to treat the initial award of interests to employees. Some may have employees purchase the interests, but most don’t, Rodgers says. Instead, the interests are awarded as a form of compensation.

Businesses usually buy back the interests when employees leave or retire at a price that reflects the gain in value of the company over time.

Since they are a form of compensation, an employee would typically pay tax on the value of the interests at the time they are awarded. Upon leaving or retiring, the employee would sell the capital interest, paying a capital gains tax assuming that the interests are sold at a higher price than they were worth at the time of the original award.

Businesses with these sorts of plans typically have a vesting schedule that spreads out the total units of interests an employee receives over a couple of years or more. That provides an incentive for employees to stay longer, Rodgers explains.

Other options

Still another approach employers can take that is not quite the same as employee ownership is called a “phantom plan.” That is the equivalent of stock appreciation rights in the company, and the awards are taxed like a profit sharing bonus, Rodgers says. The difference is “There’s no legal ownership; it’s purely contractual.”

Unlike conventional profit sharing systems, however, phantom plan formulas take into account the growth in the equity value of the company.

Getting information

These arrangements can be complex, so getting thorough information about the options is important. Any business owner looking to make such a dramatic change must also get appropriate advice from a professional who knows the ins and outs of your specific business and circumstances.

Rodgers suggests companies interested in employee ownership first research the subject to become as familiar as possible with the process and details. The NCEO publishes its own guide to the subject, Equity Compensation for Limited Liability Companies, which includes sample plan documents in Microsoft Word formats.

Legal advice is essential, but Rodgers still suggests learning as much as you can before selecting a lawyer. And when you do retain an attorney, choose one who works with and understands the laws relating to LLCs.

Perhaps by now you’re feeling a little intimidated by the whole idea and ready to say, “Why bother?” That’s understandable, but this isn’t entirely uncharted territory.

Many businesses that have opted for employee ownership report a genuine payoff, and so do their employees, Rodgers observes. An offshoot of the NCEO, www.ownershipeconomy.org, spotlights research showing employee ownership’s benefits across the board.

Employee ownership helps align the interests of the company and its employees, spurring motivation and productivity. It gives people a reason to stay, and in a tight labor market, it can give them “a reason to join the company in the first place,” Rodgers says.

“A lot of our member companies find that it’s just a lot more fun to work in a company where everybody feels like they’re members of the same team. There’s a conceptual shift in what it means to be an employee-owner as opposed to just an employee.”