ESOP: Employee ownership of companies on the rise

A decade ago, John Schock of Pasadena, Md., reached his mid-50s and a crossroads. He could fund his retirement by selling off his financial-services firm to another company. But he wanted to assure the future of FMS, the firm he'd founded in 1974.

"If there isn't a solid succession plan for key management and staff, then a company can fail after the founder leaves," Mr. Schock says.

So he took the unconventional route: He sold FMS to his workers, all 35 of them, by creating a tax-advantaged Employee Stock Ownership Plan. They got 30 percent of the company in 2000 and the rest last year. "We picked the ESOP option because over time it does create more of an entrepreneurial environment than the employer-employee environment," says Schock, who remains the CEO.

It's a pattern that could ripple throughout the economy as baby boomer business owners near retirement. Since 1975, the number of employee-owned companies in the United States has grown from 1,600 to more than 11,000; they now represent about 12 percent of the private-sector workforce. Some proponents think they'll grow even more this decade.

"I predict significant growth in the number of ESOPs in the next five to 10 years" as retiring business owners learn about the benefits, says Corey Rosen, executive director of the National Center for Employee Ownership (NCEO), a nonprofit group based in Oakland, Calif.

One of the hallmarks of employee-owned companies is profitability. Even in 2009, one of the most difficult years for businesses since the 1930s, 66 percent of ESOPs either grew or stayed the same, according to an NCEO survey of 200 firms.

Aqua Hotels and Resorts, a hotel management company in Hawaii, added five new properties this year, despite a 20 percent downturn in the Hawaiian tourist industry. Barclay Products, a Gurnee, Ill., manufacturer of bathroom fixtures, has bought three other companies since its ownership was transferred to employees 12 years ago. Davey Tree, a national tree service based in Kent, Ohio, became 100 percent employee-owned in 1979 and went from $60 million in annual revenues to $550 million in 2009, as it acquired several other companies.

Power of owner-workers

The ESOP firms' secret? Motivated employee-owners with a stake in the business.

"Our employees are very conscientious about how they serve our customers, how they take care of our equipment, and how they make decisions every day," says Sandra Reid of Davey Tree.

It's a theme that emerges again and again at employee-owned companies.

"When it comes down to crunchtime, we're a team," says Susan Becker, a receptionist at King Arthur Flour, which was owned by the same family from 1790 to 1996, when the Norwich, Vt., company's owners began transitioning ownership to their employees. In 13 years, the ESOP has gone from a five-employee concern selling to a niche New England market to a 160-employee venture with an expanded product line on supermarket shelves in 50 states, plus a thriving catalog business, store, and baking school. Key to its success is the energized workforce.

"The way I see it, I'm working for Harriet – she's a packer downstairs who will be retiring soon," says P.J. Hamel, a 20-year veteran of the company. "I want her to get a good retirement."

A cost-cutter at every desk

It's not just that employees work harder. They also contribute original ideas and cost-saving solutions at the job level. "When you start to accumulate a lot of ideas, the amount of money generated is huge," Mr. Rosen says. "And it's not a copyable thing that a competitor can do cheaper."

Forming an ESOP not only increases sales and boosts employment, it also causes sales per employee to rise some 2.3 percent a year over what the company's pre-ESOP performance would have predicted, according to a 2000 study by Douglas Kruse and Joseph Blasi of Rutgers University. The study compared the performance of 343 pairs of closely held ESOP and non-ESOP companies. Over a 10-year period, that would make the ESOP company a third larger than its paired non-ESOP match. Other research confirms that employee ownership – when combined with a participative management culture, and especially where the majority of employees are owners – results in substantial gains.

ESOP tax breaks unfair?

Not everyone's sold on the idea. Norman Stein, a professor at the University of Alabama School of Law, objects to the generous tax benefits ESOPs receive. He also says they present too much risk to employees, who may "lose their jobs as well as their retirement savings in one stroke."

Many ESOPs, however, offer 401(k)s rather than pensions, allowing employees to stash retirement funds in other companies. To Bob Graybill, president of FMS, an ESOP is a safer retirement plan in today's economy than a 401(k): "You don't have to put any of your own money into the [ESOP], and you're in control of your own destiny, instead of throwing money into a public company that's making decisions you have no control over."