Many business owners and advisors are familiar with Employee Stock Ownership Plans or ESOPs. They are a good tool for business owners looking to cash out some or all of their equity in the business. ESOPs provide significant tax breaks for the seller AND the business, as well as definite productivity and profitability benefits to the company moving forward. Another advantage of employee ownership is that, when done right, the extra incentive of ownership can drive the employees and the company to new heights of productivity and profitability.
However, there can be some roadblocks for smaller small businesses. Two of the major ones are the cost of setting up the plan, and the cost of maintaining the plan. Generally speaking, both of these can be prohibitive for companies with fewer than 20 employees and less than $1 million in sales. More on the basics of an ESOP can be found here.
The good news is that there is another alternative for smaller companies: an employee-owned cooperative.
Selling to a worker-owned cooperative provides a similar benefit to the selling owner, what is commonly known as the 1042 Rollover. The 1042 rollover is so named for the section of the Internal Revenue Code (section 1042) that permits owners of closely held businesses who sell 30% or more of the stock in their company to their employees through an Employee stock Ownership Plan (ESOP) or a worker-owned cooperative to shelter the capital gains from taxes by rolling the proceeds of the sale over into other qualified domestic securities within 12 months of the sale. This is the primary benefit for the selling small business owner.
The other major “selling” point is that the setup costs, as well as the ongoing costs, are much lower than with an ESOP.
There are some differences between the two structures (for example what business issues are voted on by the employee owners, and how ownership shares are voted) that need to be taken into consideration. But generally speaking the hurdles are very manageable.