Comparing Employee Ownership Options

Executive Summary

Small business owners exploring partial employee ownership have several models to choose from, each with distinct costs, benefits, and implications. This report compares four common structures – ESOPs, worker cooperatives, employee ownership trusts (EOTs), and alternative equity arrangements – to help owners make an informed decision. Below is a brief overview:

• Employee Stock Ownership Plan (ESOP): A formal retirement trust that buys company stock for employees. High setup costs (often $100k–$300k) and ongoing administration, but significant tax advantages (e.g. capital gains deferral for sellers, potential corporate tax elimination for S-corp ESOPs). Employees build equity in a retirement account and typically cash out at departure. Governance remains with a trustee, so employee voting power is limited. Best for owners of medium-sized, profitable companies seeking a partial or full sale with major tax benefits, and who can commit ~6–12 months to implementation.
  
  
• Worker Cooperative: A business owned and democratically controlled by employees (each member gets one vote). Lower cost to set up (perhaps $10k–$30k) and simpler administration. Tax benefits exist but are modest – sellers can use the same capital gains deferral as ESOPs if 30%+ is sold to employees, and the coop can deduct profit distributions made as patronage dividends. Employees invest a small buy-in and share in profits and decision-making. Best for companies (of any size) with a strong culture of workplace democracy, often suited to full ownership transitions (though partial conversions are possible in stages). Implementation can be done in under a year in many cases, assuming financing and training are in place.
  
  
• Employee Ownership Trust (EOT): A trust (often a perpetual purpose trust) that holds stock on employees’ behalf. Moderate cost (roughly 40–60% less than an ESOP to set up) – for example, one company spent ~$84k on an EOT vs. $200k+ attempting an ESOP – and minimal ongoing expenses. EOTs do not carry special tax breaks like ESOPs, but they are flexible and simpler legally (not regulated by ERISA). Employees typically receive profit-sharing or bonuses from the trust (taxed as ordinary income) and may get a voice in governance via trustee or board representation. The trust can be structured to prevent any future sale of the company, preserving its legacy. Best for owners who want a cost-effective, gradual transition (partial or 100%) while protecting the company’s long-term mission. Can often be executed faster than an ESOP (a few months once structured).
  
  
• Alternative Equity Structures: These include profit-sharing LLC arrangements, phantom equity plans, and redeemable preferred stock for employees. They generally have low setup costs and little regulatory complexity. However, they do not transfer actual ownership or deliver the deep tax benefits of ESOPs/coops. Instead, they reward employees financially through profit bonuses or simulated equity growth:
  
  
  • Profit-Sharing (LLCs or Bonus Plans): The company simply shares a portion of profits with employees (usually as cash bonuses). This is easy to implement and fully at the owner’s discretion each year. It improves employees’ income but does not give them stock or governance rights.
    
    
  • Phantom Equity and Stock Appreciation Rights: These are “synthetic” equity plans that promise employees a cash bonus equal to either the value of a certain number of shares or the increase in share value over time. Employees get a payout if the company’s value grows (often at sale or after a set period), but no voting rights or actual shares. It’s a way to mimic ownership rewards without diluting ownership.
    
    
  • Redeemable Preferred Equity: The company issues preferred shares to employees or a trust, which pay dividends and can be bought back (redeemed) by the company later. This gives employees a fixed return or profit share and possibly a payout when shares are redeemed, but typically no managerial control. It’s often used in mission-driven “steward ownership” models – for example, a trust might hold all voting common stock while employees and investors hold redeemable preferred shares that yield steady dividends and are repurchased over time.
    
    

Each model comes with trade-offs in cost, tax treatment, employee empowerment, and timeline. The following sections provide a detailed look at each structure’s costs, benefits, and suitability, followed by a side-by-side comparison to guide business owners toward the option that best fits their goals.

Introduction

Planning an ownership transition is a pivotal step for any business owner – especially those who want to reward employees and preserve their company’s legacy. In the United States, there are several paths to share ownership with employees. This report focuses on broad-based employee ownership structures suitable for small businesses, particularly when an owner wants to sell part of the company to employees (a partial transition) rather than full immediate exit. We compare four structures in depth: Employee Stock Ownership Plans (ESOPs), worker cooperatives, Employee Ownership Trusts (EOTs), and some alternative equity mechanisms.

For each, we’ll discuss:

• Setup and ongoing costs – How expensive is it to establish and maintain?
  
  
• Tax benefits – What tax incentives exist for the selling owner and the company?
  
  
• Employee benefits – How do employees gain financially and intangibly (e.g. involvement, job security)?
  
  
• Governance – What voice or control (if any) do employee-owners have in the business?
  
  
• Speed & timeline – How quickly can the transition be executed, and how complex is the process?
  
  
• Legal complexity – What regulations or compliance burdens does the structure entail?
  
  
• Partial vs. full transition – Is the model suitable for selling a minority stake, a majority stake, or the entire company?
  
  

Throughout, we use accessible language for a general business audience and include examples or case studies to illustrate key points. All information is drawn from credible U.S. sources such as the National Center for Employee Ownership (NCEO), Democracy at Work Institute, Project Equity, and others.

By understanding these options, business owners can choose a path that best achieves their goals – whether that’s cashing out gradually, engaging employees as co-owners, securing company values long-term, or simply sharing profits. Employee ownership can be a win-win, improving company performance and employee wealth over time, but the right fit depends on the company’s size, finances, and culture. Let’s dive into each model.

1. Employee Stock Ownership Plan (ESOP)

An Employee Stock Ownership Plan (ESOP) is an employee benefit plan that holds company stock in a trust on behalf of employees. It is essentially a qualified retirement plan (similar to a 401(k), but invested in employer stock). ESOPs are the most common form of broad-based employee ownership in the U.S., used by thousands of companies. They are often used as a tool for ownership succession: the ESOP trust can purchase part or all of an owner’s shares, providing the owner liquidity, and employees then gain an ownership stake indirectly through the trust.

Key features of ESOPs: The company sets up a trust and contributes cash to buy shares from the owner (or contributes shares directly). Shares in the trust are allocated to individual employee accounts over time, usually in proportion to pay or a more level formula. Employees typically don’t pay anything for their shares – the company funds the ESOP. As a qualified retirement plan, an ESOP must include broad employee participation and follow IRS and Department of Labor rules. When employees leave or retire, the company buys back their vested shares at fair market value, providing them a cash benefit (often rolled into an IRA or 401k).

Below we examine ESOPs in terms of costs, benefits, and considerations:

• Setup & Maintenance Costs: Setting up an ESOP is relatively expensive and complex. Typical formation costs range from around $100,000 up to $300,000 (or more for large/complex companies). These costs include hiring an ESOP attorney, a financial adviser to do a feasibility study, an independent valuation firm to appraise the shares, and other legal/admin fees. Annual costs are also substantial – roughly $20,000–$30,000 per year for administration and required annual valuation in a typical private ESOP. If an external trustee is hired to oversee the plan, that can add another ~$15,000–$30,000 annually. Despite these costs, NCEO notes that ESOP transactions often still cost less than selling to a third-party buyer when all factors are considered (e.g. banker fees, due diligence in a sale) – and the ongoing tax advantages (detailed below) can far outweigh the maintenance expenses.
  
  
• Tax Benefits: ESOPs offer powerful tax benefits that can make them very attractive:
  
  
  • For the selling owner: If the company is a C-corporation, an owner who sells stock to an ESOP can defer or even avoid capital gains taxes on the sale by reinvesting the proceeds in U.S. equities (Section 1042 rollover) – provided the ESOP will own at least 30% of the company after the sale. This is a major incentive; the capital gains tax deferral is indefinite as long as the replacement assets are held, and if the owner eventually passes those assets to heirs, the gains may not be taxed at all. (This benefit also applies to sales to worker coops, as noted later.)
    
    
  • For the company: Contributions to the ESOP are tax-deductible, whether used to buy owner shares or to pay back an ESOP loan (both principal and interest are deductible). In other words, the company can use pre-tax dollars to finance the buyout, which is not possible in a normal share purchase. The biggest advantage comes if the company is (or becomes) an S-corporation: an S-corp ESOP pays no federal income tax on the portion of the company it owns, because ESOP trusts are tax-exempt organizations. For example, a 100% S-corp ESOP company pays $0 in corporate income taxes – effectively increasing cash flow significantly. Many ESOP companies use this tax-exemption to rapidly repay ESOP acquisition debt.
    
    
  • For employees: Employees are not taxed on contributions to their ESOP accounts. Their ESOP shares grow tax-deferred, and payouts at retirement or departure are taxed as ordinary income (similar to a 401k distribution) unless rolled over into an IRA. Essentially, the ESOP is part of their retirement plan. Employees typically cash out when they leave or retire, receiving the fair market value of their vested shares (with the company obligated to buy back shares). The ESOP’s tax advantages thus primarily reward the seller and the company; employees’ big financial benefit is building an ownership stake over time without having to invest their own money.
    
    
• Employee Benefits (Financial & Non-Financial): Financially, an ESOP gives employees a significant retirement asset if the company performs well. Research shows that employees in ESOP companies have substantially higher retirement savings on average than employees in non-ESOP firms. The ESOP account value grows as the company’s stock value grows, and many ESOP companies also pay off their ESOP loans using pre-tax dollars, which can accelerate the accumulation of value for employees. On the non-financial side, ESOP companies often report improvements in employee morale, retention, and productivity once employees become shareholders. However, it’s important to note that ESOP participation is usually a passive ownership stake: employees are beneficial owners through the trust, but not direct stockholders. The company can cultivate an “ownership culture” by sharing financial information, involving employees in decisions, and offering participation training, but these practices are voluntary. By default, many rank-and-file employees may not feel or act like owners unless the company intentionally fosters it. Still, knowing that their efforts contribute to their own retirement wealth can be a motivating factor. And importantly, selling to an ESOP often preserves jobs and the company’s legacy compared to an outside sale (which might result in layoffs or relocation), providing employees greater job security.
  
  
• Governance Implications: Legally, the ESOP trust is the shareholder of record, and a trustee (an internal company officer or independent fiduciary) votes the shares on behalf of employees. In privately-held companies, employees usually do not directly vote their allocated shares except on major issues like mergers or liquidation (and even then, often only if the ESOP plan or state law requires “pass-through” voting). This means governance remains largely in the hands of the existing board and management. The ESOP trustee, however, has a fiduciary duty to act in the employees’ best interest as plan beneficiaries. In practice, if the ESOP becomes a majority owner, the trustee (guided by the board) can influence or appoint board members. Many ESOP companies keep their pre-ESOP leadership and governance structures, at least initially, with perhaps added oversight from an ESOP committee or an employee representative on the board (this is optional, not required by law). So, employee-owners under an ESOP have only limited formal control. That said, companies often report that employees become more engaged and informed when ownership is announced, leading to a culture of greater transparency and collaboration even without formal voting rights. A key governance consideration for owners: you can sell to an ESOP and still remain actively involved in the business. Many owners stay on as executives or board members after an ESOP transaction, allowing a gradual leadership transition while employees accumulate ownership.
  
  
• Speed of Implementation & Timeline: Implementing an ESOP typically takes several months to a year from initial feasibility study to transaction close. A commonly cited timeline is 6–12 months for the whole ESOP setup process. This includes conducting a feasibility analysis, hiring legal and financial advisors, structuring the transaction (which might involve bank financing or seller financing), valuing the shares, creating the ESOP plan documents, and closing the stock purchase. With a very prepared team and simple deal, it can sometimes be done faster (in rare cases as little as 3–4 months), but often regulatory steps and negotiations take time. Compared to selling to an outside buyer, this timeline is as fast or faster on average (third-party sales often take 6–10 months or more), and it offers the owner more control over timing (you’re not waiting for a buyer to appear; you can decide when to initiate the ESOP). However, ESOPs are not instantaneous – owners should ideally start planning a year or more before they want to begin retiring or stepping back.
  
  
• Regulatory / Legal Complexity: ESOPs are subject to strict regulations because they are ERISA-qualified retirement plans. There are rules governing which employees can be excluded or must be included (generally all full-time, tenured employees over age 21 must be included), how shares are allocated (typically proportional to compensation up to a cap), and how quickly employees vest (ESOPs must vest no slower than 6 years). The plan must be administered in accordance with IRS and Department of Labor rules, and an annual Form 5500 filing is required. A big legal requirement is that the ESOP cannot pay more than fair market value for the shares – an independent appraisal is required to justify the price. The trustee has to ensure this appraisal is sound, since overpaying would violate fiduciary duty to the employee participants. All these requirements mean lots of legal paperwork and ongoing compliance (plan audits, updates to stay compliant with tax law changes, etc.). Companies will need to dedicate internal staff time or hire consultants to manage the ESOP administration each year. In short, an ESOP is more complex to set up and run than other forms of employee ownership, but for many medium-sized companies, the complexity is manageable and considered worthwhile. (It’s often said that an ESOP is no more complex than the process of selling your business to a third party – both involve detailed agreements and due diligence – and running an ESOP is comparable to running a 401(k) plan with an investment fund that happens to be your own company stock.)
  
  
• Suitability for Partial vs. Full Transitions: One of the strengths of ESOPs is flexibility in how much ownership an owner sells. An owner can sell any percentage of the company to the ESOP – from a small stake (e.g. 10–30%) to 100% full ownership – and can do so gradually or all at once. Many owners start by selling a minority stake to “test the waters” and get some liquidity, then later sell additional tranches to eventually reach 100% ESOP ownership. This incremental approach is fine, as the ESOP can buy more shares over time when the company can afford it. Notably, if a C-corp owner wants the capital gains tax deferral, the ESOP must own at least 30%, so partial sales below 30% wouldn’t qualify for that particular tax break. But owners still might do a smaller ESOP for other reasons (e.g. share wealth and engage employees). ESOPs work well for partial transitions, and they are also one of the only feasible routes for a 100% employee buyout of a larger company. In fact, many ESOP companies eventually become 100% employee-owned S-corps and enjoy the full tax-free status. The suitability does have limits: very small companies (under ~15–20 employees) often find an ESOP’s complexity and costs hard to justify. NCEO suggests ESOPs tend to make sense for companies with at least 15–20 employees and consistently solid profits (enough to cover the costs and buyout expense). Project Equity recommends a threshold of ~40+ employees and $2M+ in revenue for an ESOP to be advisable. In summary, if your goal is to partially cash out but retain some ownership and you run a profitable business of a sufficient size, an ESOP can be a great mechanism. If your goal is a full exit, an ESOP can accomplish that too (often with the owner financing part of the sale via a note). Just ensure the company can bear the financial commitment of repurchasing shares and debt service, and that succession management is in place (ESOPs need competent management to carry on without the selling owner at the helm).
  
  

ESOP Example: A well-known success story is Quaintance-Weaver, a hospitality company (hotels & restaurants in North Carolina) that became 100% ESOP-owned in 2016. Despite the industry’s high staff turnover, the owners believed employee ownership fit their long-term values and would secure the company’s future. Today, over 600 employees are co-owners through the ESOP, and the company credits the ESOP with driving a strong ownership culture and preserving its mission. This case illustrates that even in unlikely industries, an ESOP can work with careful planning and a commitment to employee engagement. On the other hand, ESOPs are not right for every situation – for instance, Text-Em-All, a 40-person tech firm in Texas, initially pursued an ESOP but found the costs too high for their size. They spent over $200k in setup efforts and faced $50k–$100k annual valuation costs, leading them to abandon the ESOP before closing. Instead, they switched to an EOT (discussed below) at much lower cost. The lesson is that owners should weigh the cost-benefit: the ESOP’s tax breaks and legacy preservation can be fantastic, but for smaller companies or those with thin margins, a more lightweight model may be preferable.

2. Worker Cooperative (Co-op)

A worker cooperative is a business that is 100% owned and governed by its employees on a democratic, one-person-one-vote basis. In a worker coop, employees buy a membership share (usually a nominal amount like a few hundred or thousand dollars) and become member-owners. These members elect the board of directors, and major decisions often require member votes. Profits are distributed to members as “patronage dividends” – typically allocated in proportion to each member’s labor contribution (e.g. hours worked or wages) rather than their capital invested. Co-ops operate on the principle of equity and inclusion, often with a social or community-oriented mission in addition to profit.

Worker cooperatives have been a popular choice for small business conversions that value employee empowerment and egalitarian governance. They are especially common in certain sectors (such as retail, services, manufacturing, and food) and often in values-driven companies. Notable U.S. examples include cooperative bakeries, cleaning companies, manufacturers, and even tech firms.

Let’s break down the key considerations for worker co-ops:

• Setup & Ongoing Costs: Converting to or establishing a worker coop is generally far cheaper than an ESOP. Project Equity notes that worker co-ops have lower setup and administration costs compared to ESOPs. Initial legal costs might range from about $10,000 to $30,000 depending on the complexity (e.g. drafting new bylaws, incorporation as a cooperative entity, setting up any necessary financing). If the business is an LLC or sole proprietorship, it might be reformed as a cooperative corporation or an LLC with cooperative provisions. Many states have cooperative incorporation statutes; in others, co-ops can be formed under regular corporate law with a cooperative charter. On an ongoing basis, there is no mandatory annual valuation or heavy federal filing solely due to being a coop – the business just operates like a normal company, filing taxes (some co-ops choose to be taxed under Subchapter T of the IRS code, which allows patronage dividends to be deducted as a business expense). There will be some costs in maintaining member records, conducting annual meetings, and possibly educating new employee-owners, but these are modest. In sum, coops are less expensive to maintain than ESOPs. Even the buy-in from employees is usually small (often <$5,000 per person) and can sometimes be financed via payroll deductions or seller financing so that lack of personal funds isn’t a barrier. External support organizations (like local coop development centers) can often provide technical assistance to reduce costs.
  
  
• Tax Benefits: Worker cooperatives enjoy some tax advantages, though not as extensive as ESOPs:
  
  
  • For the selling owner, a coop conversion can qualify for the 1042 capital gains tax deferral just like an ESOP. Under federal law, a qualified worker cooperative corporation that ends up with 30% or more employee ownership can be treated similarly to an ESOP for the purpose of this tax rollover. This means an owner selling to a coop can defer capital gains by reinvesting in U.S. securities. In practice, relatively few retiring owners know about or use this, but it is available and is a strong incentive to sell to employees via a coop structure.
    
    
  • For the company, if the coop is structured under Subchapter T of the tax code, the profit allocated to workers as patronage dividends is tax-deductible to the corporation. Essentially, instead of paying corporate income tax on that portion of earnings, the company distributes profits to the members and those distributions are then taxable to the members (often at their personal income tax rate, which may be lower). This avoids double-taxation on distributed profits. Note that any profit the coop retains (not distributed as patronage) would be taxable at the corporate level, so coops have an incentive to distribute most profits to members (or to reinvest in the business for growth, which can still be fine as long as they manage tax liabilities).
    
    
  • For employees, the patronage dividends they receive are generally taxed as ordinary income (or as dividends) on their personal tax returns. One nuance: because coop members are technically business owners, there have been questions about whether patronage payments are subject to self-employment tax; however, in most cases coop members are treated as employees for tax and receive a W-2, so patronage may be taxed similarly to wages or as a dividend. The NCEO notes the law is a bit unsettled on whether patronage is subject to FICA/self-employment tax. Regardless, from the member’s perspective, taxes on patronage are akin to taxes on a profit-sharing bonus.
    
    
  • Co-op member-owners also typically get to share in any increase in equity of the business. Many coops maintain internal capital accounts for each member, which accumulate the member’s share of retained earnings over years. When a member leaves, they cash out their capital account (subject to the coop’s policies and the company’s financial ability to pay out over time). These payouts can be viewed as the member’s equity in the firm. There aren’t special tax breaks on these (usually it’s treated either as a capital gain or as a redemption of equity), but it’s a benefit of building wealth.
    
    
  • At the state level, some states offer additional coop incentives or tax credits. For example, Colorado recently has tax credits for businesses converting to employee ownership (including coops), and other states have loan funds or technical assistance grants.
    
    
• Overall, a coop’s main tax benefit is the patronage dividend deduction (which can eliminate corporate tax on distributed profit). This is advantageous, but keep in mind it requires profitability and distribution of those profits to realize the benefit – it doesn’t help an owner’s personal taxes unless they use the 1042 rollover on sale.
  
  
• Employee Financial & Non-Financial Benefits: In a cooperative, employees directly become co-owners of the business, which has profound financial and non-financial implications:
  
  
  • Financial: Members typically receive annual profit shares (patronage) when the business is profitable. For example, a coop might decide to distribute 50% of profits to members based on hours worked. If a member contributed, say, 10% of the total work hours, they’d get 10% of that distributed pool. These payouts effectively act like a profit-sharing bonus. Additionally, as mentioned, members build equity in the firm via their capital accounts or increased share value. Unlike an ESOP, where equity value is only realized at departure, coop members can sometimes see their share value appreciate and may vote to redeem equity if they leave. However, coops often design policies to ensure affordability and solidarity – e.g., one member-one vote usually also means that everyone invests roughly the same amount (a modest buy-in) and gets roughly equal profit shares per hour of work. So coops are less about windfall gains and more about steady wealth-building. Over time, though, the difference can be significant: coops tend to have lower wage inequality (the pay ratio between highest and lowest earners is often much smaller than in conventional firms) and distribute a larger portion of profits to frontline workers, improving average worker income. There’s evidence that worker coops can have positive impacts on employee wealth and stability (a study cited by Project Equity notes 90% of worker coops are still in business after 5 years, far above typical survival rates, which suggests more stable jobs for members).
    
    
  • Non-Financial: The hallmark of a coop is democratic governance and ownership culture. Each worker-member has an equal vote in major company decisions (e.g. electing the board, approving bylaws changes, sometimes strategic directions). This can lead to a strong sense of empowerment, as employees literally own and steer the company. Many coop members report greater job satisfaction, commitment, and trust in management (often management is elected or at least approved by the worker-owners). Cooperatives often foster a culture of transparency – financials and plans are open to members. Training and education in business skills are commonly provided so that workers can participate effectively in governance. All these are huge non-monetary benefits: members gain business knowledge, leadership opportunities, and a voice in their workplace, which can be very rewarding. On the flip side, some workers may feel the burden of responsibility – participating in governance takes time and effort, and not everyone wants to be involved in decisions. But overall, for those seeking a participatory workplace, coops excel. They also tend to explicitly bake in values like fairness and equity; for example, decisions on pay or company direction are made with broad input, often resulting in policies that prioritize job security and sustainable growth over short-term profit.
    
    
  • Another benefit: job stability and local roots. A worker coop is effectively “anchor-owned” by the employees, meaning it’s far less likely to move or be sold out from under the workforce. This long-term stability can be comforting to employees and beneficial to the community (jobs and profits stay local).
    
    
• Governance Implications: Governance in a worker coop is democratic by design. Typically, each member has one voting share and votes directly on shareholder matters. The most common model is that worker-members elect a Board of Directors (with each member getting an equal vote for board elections). The board, which usually has a majority of worker-members, oversees management. Many coops also require member votes on major decisions like mergers, changes in articles of incorporation, or large investments. Day-to-day management is often handled by professional managers or an elected management committee, but they are accountable to the membership. This structure means owners (the workers) have ultimate control. It’s a contrast to ESOPs/EOTs where a trustee or existing board holds the power. In a coop, the workers are the shareholders, so they have the highest authority.
  
  
  • In practical terms, coops often operate with a high degree of participatory management. Some use sociocratic or consensus decision-making in teams; others operate like a conventional business but with the knowledge that the employees can replace the board or change policies via their vote. Each cooperative can define its governance in its bylaws – some small coops are run directly by all members (direct democracy in meetings), whereas larger coops adopt representative systems (e.g. a board, or departments elect reps). The key is that ownership and control are not separated – those who work in the company collectively control it.
    
    
  • This governance model is ideal for owners who care deeply about maintaining their company’s mission or culture. By entrusting the business to the employees, they ensure decisions will be made by people who are intimately connected to the work and likely to uphold its legacy. However, owners need to be comfortable with shared control. Converting to a coop usually means the original owner will cede control (though they can often stay on as a member if they continue working in the business, or sometimes as an advisor). If an owner’s priority is to keep some control while selling equity, a coop might not be the right model (an ESOP or minority sale might be better). But if the priority is to empower employees fully, coops are unmatched in that regard.
    
    
• Speed of Implementation & Timeline: Converting to a worker cooperative can be done relatively quickly, but it varies. Many conversions take around 6 to 12 months from kickoff to completion. This timeline involves educating employees about ownership, negotiating a price with the owner, setting up the legal entity, securing financing (often a combination of bank loans, seller financing, and maybe outside coop-friendly lenders), and transitioning governance. In some cases, it can be faster – a small business with a willing owner and a few key employees might do it in under 6 months. In other cases, especially if training employees for management or arranging complex financing, it could take a year or more. A Democracy at Work Institute guide notes 6–18 months is a common range depending on complexity. The due diligence and negotiation part is generally easier than selling to an outside buyer – since the buyer is essentially the employees, there’s often trust and a shared goal, and less need for extensive market outreach. But one factor that can slow coop conversions is cultural readiness: employees must decide to become owners and take on new responsibilities. Thus, a period of workshops or meetings is often needed to ensure everyone is on board and understands the coop model. Many technical assistance organizations include a training phase as part of the process (e.g., a few months of governance and financial training while the legal conversion is in progress). Once the coop is up and running, transitioning operations and leadership may also require an adjustment period. Overall, however, coops can be implemented on a similar timeline to ESOPs, and potentially with less procedural complexity (no government approvals needed aside from any securities exemption if members buy shares, and basic incorporation filings).
  
  
• Regulatory/Legal Complexity: Worker coops are relatively straightforward legally. There is no overarching federal coop law analogous to ERISA for ESOPs. Instead, cooperatives are governed by state laws (many states have a cooperative corporation statute) and general business laws. Key legal tasks include drafting the coop’s articles of incorporation and bylaws to enshrine one-member-one-vote and profit-sharing rules. If the business raises capital from members to buy out the owner, it may need to comply with securities laws – typically this is not onerous, as offering membership shares to a small number of employees can often be done under federal and state private offering exemptions. Coops can also sometimes use an exemption for “intrastate” offerings if all members are in one state. In any case, legal advice is needed but it’s much like setting up any small corporation, just with a cooperative twist.
  
  
  • One unique complexity is securities and financing structure: if employees are paying the owner directly (say each employee invests a certain amount to collectively purchase shares), you must structure that carefully. Often, though, employees themselves don’t pay the bulk – instead, the coop entity borrows money to pay the owner, and then the coop repays loans through future profits. This is essentially an “internal buyout” similar to an ESOP loan but without the ESOP’s legal framework. Seller financing (the owner takes a promissory note for some or all of the price) is common, as are loans from community development financial institutions that specialize in coops. Legally, these arrangements must ensure the coop corporation itself ends up owning the shares and that members gain ownership through their membership interests.
    
    
  • Regulatory compliance for a coop mainly involves standard corporate compliance (holding annual meetings, filing taxes, etc.) and any specific cooperative statute requirements (some states require coops to file annual reports or maintain a certain percentage of business with members, etc.). If using Subchapter T tax status, the coop must pay patronage dividends on the basis of quantity or value of business done with the members (in a worker coop, “business done” is labor contributed) to get the deduction. That is usually straightforward.
    
    
  • Another aspect: employment law and co-determination. In a worker coop, the workers are still employees (unless structured as a partnership LLC). They are covered by labor laws (minimum wage, overtime, etc.) just like any other employees. However, management and discipline become internal matters governed by democratic processes. Coops often create policies for how to handle hiring/firing as an owner – e.g., an employee-owner might be terminated only by a vote of the membership or board, etc. These aren’t external legal issues but internal governance ones that need to be thought through.
    
    
  • Bottom line: the legal complexity of a coop conversion is moderate – more involved than just selling to one buyer for cash (because you’re setting up a new governance system and possibly doing a leveraged buyout), but simpler than an ESOP in that you avoid federal pension law regulation. Many small coops handle their own bookkeeping and operations without needing specialized outside administrators.
    
    
• Suitability for Partial vs. Full Transitions: Worker coops are fundamentally about collective ownership by the workers, so the model most naturally fits a full transition where employees end up owning a majority or 100% of the company. In most coop conversions, the end goal is 100% employee ownership. However, there can be scenarios of partial transitions:
  
  
  • Sometimes an owner will form a coop and initially give employees a majority stake but retain a minority stake themselves (as an investor member, if allowed, or via a separate class of stock). For instance, the owner might keep 30% ownership and 70% goes to employees. This can be workable if the governance is still one-member-one-vote for the employees on their portion, and the owner’s shares are non-voting or somehow don’t override the democratic process. Some coops allow external investors or founders to hold preferred shares that have limited rights. The Cooperative Principles generally call for member-owners (workers) to control the coop, so a common guideline is workers must own >50% of equity and voting power.
    
    
  • Partial steps: An owner could also phase the transition – e.g., sell 40% to a worker cooperative entity now, and plan to sell the rest over 5 years. During that time the business might be a hybrid: part coop/part traditional. This is complicated to manage but can be done via multi-stage agreements.
    
    
  • In practice, many owners who choose the coop route are motivated by its principles and therefore opt to transfer controlling interest to employees. If an owner isn’t ready to part with control, an ESOP or trust (where they can remain on the board or as trustee) might be a better fit. Coops aren’t as well suited to minority employee ownership because the whole governance model relies on employees being the dominant owners.
    
    
  • Therefore, worker coops are ideal for full succession when an owner is ready to exit (or at least exit control) and wants the company to continue under employee stewardship. They are also suitable for small companies and even micro-businesses – there are coops with as few as 3–5 people. (In a tiny company, all employees become co-owners and often also manage collectively.) For very small firms, coops are often the only economically feasible broad ownership model, since ESOPs have fixed costs that would be too high. Indeed, coops are described as “appropriate for companies of all sizes” and especially very small closely-held companies where a democratic philosophy is present.
    
    
  • One caveat: companies with highly hierarchical cultures or where owners are uncomfortable with democratic decision-making may struggle as coops. There is a cultural shift when moving to one-person-one-vote – it requires trust in your employees’ judgment and willingness to operate transparently. But many owners find that with training and the right team, a coop can thrive and even outperform, thanks to high employee buy-in.
    
    

Co-op Example: Happy Earth Cleaning, a residential cleaning business in Minnesota, is a recent example of a small company that converted to a worker cooperative. The founder wanted to align the business with her social values and reward her cleaning staff. With help from Project Equity, she transitioned ownership to her employees, who now democratically manage the company. The result has been greater employee satisfaction and retention, and the business continues to grow while rooted in its community. Another case is A Yard and A Half Landscaping near Boston – when the owner retired, she sold the business to her 25 landscape crew employees via a coop in 2013. They have since grown the company and even weathered economic downturns with no layoffs, attributing that resilience to the high engagement of employee-owners. These stories show how coops can be a compelling legacy: the company’s know-how and culture remain with the people who built it, and those people gain an ownership stake in return for their hard work.

3. Employee Ownership Trust (EOT)

An Employee Ownership Trust (EOT) is an emerging model in the U.S., inspired by a long-standing practice in the U.K. In an EOT transition, the business owner sells some or all of the company’s stock to a perpetual trust created for the benefit of the employees. The trust then holds these shares indefinitely (or long term), and the company operates for the benefit of employees and possibly other stakeholders. Employees typically do not directly own shares or have individual accounts; instead, the trust is the shareholder. Employees are the beneficiaries of the trust, meaning they can receive financial benefits (like profit-sharing or bonus distributions from the company via the trust) and sometimes have certain governance rights (such as electing employee representatives on a trust advisory committee or board). Importantly, EOTs can be structured to prevent a future sale of the company, ensuring the business remains independent and mission-driven for the long haul.

EOTs have gained attention because they offer a simpler, more flexible alternative to ESOPs – often described as “the ESOP without the ERISA rules.” They are particularly attractive to owners who prioritize legacy and employee welfare over maximizing sale price, as EOTs don’t fetch synergistic buyer premiums but provide continuity.

Key points about EOTs:

• Setup & Maintenance Costs: Establishing an EOT is significantly cheaper and easier than an ESOP. There is no need for Department of Labor approval, no ongoing appraisal requirement by law (though valuation is usually done for fairness), and less complex legal structuring. Typical initial costs range roughly from $20,000 to $50,000, mainly for legal fees to draft the trust agreement, transaction documents, and any financing arrangements. (One source notes EOTs are about 40–60% less expensive than ESOPs to set up and run.) For instance, the tech company Text-Em-All that abandoned its ESOP mid-process was able to set up an EOT for $84k, after spending over $200k on ESOP preparations. Ongoing costs are minimal – there’s no annual appraisal mandated, unless the trust deed or trustees decide to get valuations for internal purposes. The trust will have to file a tax return if it earns income (often it doesn’t itself earn income; profit shares usually flow through to employees as compensation). Administrative costs might include trustee fees if using an external trustee, but many EOTs have company insiders or a small committee as trustees, keeping costs low. Overall, maintenance is much simpler than an ESOP: no annual government filings specific to the EOT, no complex allocation or vesting rules, etc. The trust does need to be overseen (trustees must ensure the trust’s terms are followed), and some legal advice is prudent as years go on, but these costs are modest.
  
  
• Tax Benefits: This is where EOTs currently differ sharply from ESOPs – EOTs do not come with special tax breaks in the U.S. as of now. Unlike in the U.K., where selling to an EOT can qualify for 0% capital gains tax, in the U.S. there’s no equivalent tax incentive in federal law (legislation has been discussed but not passed as of 2025). So:
  
  
  • For the selling owner: There is no ESOP-style 1042 rollover deferral specific to EOTs. The sale is a normal stock sale for tax purposes (capital gains would be due). However, some owners mitigate this by donating a portion of shares to the trust. If an owner donates some shares, they might get a charitable deduction (if the trust is structured as a charitable trust or if donated to a separate charity that funds the trust) and avoid capital gains on that portion. But most EOTs are not charitable (they are typically private trusts for employees’ benefit), so donations are less straightforward. In practice, some owners take a slightly lower price in exchange for the other benefits of an EOT (legacy, simplicity).
    
    
  • For the company: The company can typically deduct any profit-sharing or bonus payments it makes to employees (including those made via the trust) as ordinary business expenses. Also, if the company contributes to the trust (e.g., contributes cash to enable the trust to buy shares from the owner), those contributions might be deductible as an employee benefit expense, though the law here isn’t as explicit as with ESOPs. Essentially, an EOT company may operate much like a regular company that shares profits – payments to employees reduce taxable income. But there is no equivalent of the S-corp ESOP complete tax exemption. So an EOT company will continue paying taxes on its profits (minus any deductions for wages/profit-sharing).
    
    
  • For employees: Employees in an EOT firm usually receive annual profit-sharing or cash bonuses as the primary financial benefit, since they don’t own shares individually. These payouts are taxed as ordinary income (just like a bonus or paycheck). If the trust eventually allocates equity to employees or gives some stock out (some EOTs allow for hybrid models where certain equity rewards exist), those would be taxed like equity compensation (typically ordinary income at grant or vest). But most pure EOTs stick to cash profit distributions. So from an employee tax perspective, it’s akin to getting a year-end bonus – no special treatment, but also no deferring tax until retirement as in an ESOP.
    
    
  • One potential tax benefit: if the owner donates some shares to the trust initially (as part of the deal), that could be a charitable donation if the trust qualifies (some EOTs are structured with a charitable purpose or paired with a nonprofit). That could yield a tax deduction for the owner and eliminate capital gains on the donated part. This is an advanced strategy and outside the typical scope of most small-business EOTs.
    
    
• In summary, EOTs trade off tax advantages for simplicity. Project Equity bluntly states EOTs “are not eligible for the potentially significant tax benefits of an ESOP”. Owners considering EOT vs ESOP often weigh: do the cost savings and flexibility of an EOT make up for losing the tax breaks? For smaller deals, often yes; for very large deals, the tax benefits of ESOP can overwhelm other concerns.
  
  
• Employee Financial & Non-Financial Benefits: Employees under an EOT become beneficiaries of the trust that owns the company. What does this mean for them?
  
  
  • Financial: Typically, the company will pay a profit share or bonus to employees each year (or each quarter) out of the company’s earnings, as a way to share the economic benefit of ownership. Some EOT companies issue this as a uniform percentage of salary or a flat amount to all employees; others might use tenure or role to differentiate. For example, in the U.K., EOT companies often pay an annual tax-free bonus up to a certain limit to all employees. In the U.S., since no special tax exemption, it’s just a bonus. But it is a key benefit – employees get regular profit-sharing checks that they wouldn’t in a conventional company. Over time, this can be quite substantial, improving employees’ incomes. However, unlike an ESOP, employees do not accumulate a big equity stake that they can cash out at retirement; the company shares stay in the trust. Instead, the trust is meant to provide continuous shared prosperity (through profit distributions and perhaps enhanced job security).
    
    
  • Because the trust typically never sells the company, employees won’t get a windfall from a future sale – instead, the benefit is that their company won’t be sold out from under them. This suits companies where maximizing sale value is not the goal; continuity is.
    
    
  • Some EOTs might institute mechanisms like employee equity grants or stock option plans alongside the trust, to let employees individually benefit from any increase in equity value or to partake in governance. Chapter 6 of a recent EOT guide discusses how trusts can share equity rights with employees. For example, a trust could hold 100% of common stock but the company could issue phantom stock or SARs to employees to simulate equity growth benefits. Those tools would be similar to the phantom equity discussed earlier. This is optional and varies by company.
    
    
  • Non-Financial: EOTs often come with an ethos of preserving company mission and giving employees a say. While not as inherently democratic as coops, EOT structures can include employee involvement in governance. Many EOTs set up an employee advisory council or have employees elect one or more trustees or board directors. For instance, the trust might have a three-person board of trustees: one representing the original seller or an independent, one representing management, and one elected by employees. This way, employees have an indirect voice in major decisions via their trustee. The trust deed can stipulate certain company values or stakeholder considerations (community, environment) that trustees and directors must uphold. So, employees benefit from knowing that the company’s purpose and jobs are safeguarded. The trust structure can protect against drastic changes in leadership or strategy that would harm employees.
    
    
  • Additionally, EOT companies often promote an ownership culture akin to ESOP companies – open-book management, soliciting employee input, etc. The difference is employees don’t formally vote on shareholder matters (the trust does that), but morale and engagement tend to increase when employees know the company is effectively “theirs” (through the trust) and won’t be sold off. A recent study highlighted by Common Trust noted that employee-owned companies (including trust-owned) are 3-4 times more likely to retain staff during times of turmoil. So, employees see benefits in job stability and potentially career development, as EOT companies often reinvest for long term.
    
    
  • One non-financial benefit specific to EOTs: If the trust’s mandate is multi-generational, employees can feel confident that even after current leadership retires, the company will continue and future employees will also enjoy the benefits. It creates a sense of pride and continuity – employees are part of stewarding a legacy company.
    
    
• Governance Implications: Legally, with an EOT, the trust becomes the shareholder of the company (much like an ESOP trust does), but the trust’s purpose is different – it’s typically designed to act as a steward of the company rather than an investment vehicle. The trust agreement can be tailored to define governance roles:
  
  
  • Usually, the trust will hold either a majority or 100% of the voting stock. The trustees (or a trust board) then vote those shares in board elections and major corporate decisions. The question is: who controls the trust? Often, the original owner chooses initial trustees at sale. But to ensure employee benefit, many EOTs incorporate employee representation. For example, the trust might stipulate that a certain number of trustees must be elected by employees or that an employee committee has the right to approve certain decisions. Common Trust (a U.S. EOT facilitator) notes that a typical trust board has 3–5 members including key employees and sometimes the selling owner and/or independent persons.
    
    
  • The company’s Board of Directors still exists and oversees management. The trust, as owner, can appoint or remove directors (via trustee votes). Some EOT models have the trust essentially mirror a traditional ownership but with a mission lock: the trust might agree not to sell the company or might require a supermajority of trustees (including an employee trustee) to approve a sale, effectively locking in the ownership.
    
    
  • Employees do not directly vote on regular corporate matters as shareholders, but they may have a consultative role. In the U.K., many EOT companies set up an employee council that meets with company leadership to provide input and ensures the trust is meeting employee interests. The U.S. is adopting similar practices. So, governance is a hybrid: not one-person-one-vote as in a coop, but also not the conventional top-down model – employees get a voice, if not a vote.
    
    
  • One notable governance power in EOTs: The trust can be mandated to never sell the company (perpetual ownership). This is a huge governance difference from an ESOP, where the company can still be sold if the trustee and potentially participants agree. Many ESOP companies ultimately do sell to third parties (if an offer is high and trustees deem it in participants’ interest). An EOT, by contrast, can lock in independence: e.g., the trust might state “the shares shall not be sold; the company shall remain private and employee-focused.” This aligns with owners who want to ensure the business isn’t flipped in the future.
    
    
  • For the selling owner, an EOT offers an ability to define the future governance philosophy. The owner can step away completely, or they might stay on the trust board or company board to guide the transition. There’s flexibility: some EOTs allow the former owner to be a trustee or hold a special veto on sales (though eventually, true succession means the owner exits those roles too). The trust structure can be designed to balance interests of founding owners, employees, and even community (some trusts include a provision to donate a portion of profits to charity, etc., as part of their purpose).
    
    
  • In summary, EOT governance is less democratic than a coop but more mission-aligned than a conventional company. It formalizes in legal trust form the idea that the company is run for employees’ benefit. So long as trustees honor that, the employees’ interests (job security, good workplace, profit share) are front and center. Many refer to EOTs as a form of “steward-ownership”, meaning the company is owned by an entity (the trust) that stewards it on behalf of a group (the employees and possibly other stakeholders) rather than for external shareholders’ gain.
    
    
• Speed of Implementation & Timeline: EOT transactions can often be executed more quickly than ESOPs because there’s less regulatory drag. Once an owner decides on an EOT:
  
  
  • You need to create the trust agreement and structure the sale (often via a seller note or bank loan). The legal drafting of a trust is not trivial, but standard templates have been developed by practitioners and organizations like the Common Trust Institute.
    
    
  • Financing is similar in effort to other buyouts: the company’s future cash flows usually fund the purchase. This can be done via the company borrowing or the owner taking installment payments from future profits. So some financial modeling is needed, but not much more than a typical sale.
    
    
  • There’s no external government approval needed. The timeline might largely depend on negotiations and preparing legal documents. It’s feasible to complete an EOT transition in a few months once advisors are engaged. Some sources indicate 3–6 months is achievable.
    
    
  • For example, if a company’s owner and employees are aligned, they could announce in January, draft trust docs and loan agreements by March, and close the sale by April or May. Compare this to an ESOP, where even after deciding, you might have additional layers like plan submission, compliance checks, etc., which push it further out.
    
    
  • Of course, if you involve employees in designing governance or need to educate them (which is recommended so they understand the new arrangement), that could add some time. But often, since employees are not required to invest their own money or make a complex decision (they’re not individually buying shares, just being informed beneficiaries), the process is smoother internally.
    
    
  • In short, EOTs can be one of the faster ways to implement broad employee ownership. Common Trust touts it as a more straightforward sale process, and it can be done on a “predictable timeline” since you’re not dealing with third-party buyer due diligence to the same extent.
    
    
  • We should note: As of 2024, EOTs are still new in the U.S. (only a few dozen companies have done it so far). Owners may need to find advisors familiar with the model, which is becoming easier with groups like Project Equity and Common Trust offering guidance. But not every mergers & acquisitions lawyer or CPA is versed in EOTs yet, which could affect timeline if they need a learning curve. Engaging specialists is wise to keep things efficient.
    
    
• Regulatory/Legal Complexity: Since EOTs are not (yet) defined in federal law as a specific qualified plan, they operate in the realm of trust and contract law, which gives a lot of flexibility. However, it also means careful drafting is needed to ensure the trust accomplishes the desired goals.
  
  
  • The EOT is often set up as a “perpetual purpose trust”, which is a type of trust allowed in many states that isn’t just for charitable purposes but for a specific purpose (like ensuring employee ownership). Some states like Delaware, Wyoming, Oregon, etc., have statutes allowing perpetual purpose trusts or similar entities (some call them stewardship trusts). If not, one can use a regular trust and just draft it to last a very long time (or tie it to something like 21 years past the death of last beneficiary, etc., to comply with perpetuity laws).
    
    
  • There is no ERISA/IRS qualification needed, which means no formal limitations on coverage or allocation. But also no tax-qualified status. The trust document will specify how the trust benefits employees: typically by requiring the company (owned by the trust) to distribute a certain portion of profits to employees or to use profits for their benefit. It might also specify that all employees meeting some criteria (like tenure) are considered beneficiaries – aiming for broad-based benefit.
    
    
  • One legal complexity is ensuring that the transaction is fair: since there is no external ESOP trustee mandated to negotiate, often the selling owner and the initial trustees decide on a price. It’s wise to still get an independent valuation to justify that the price is fair market value (especially if the owner is financing it – you want to be sure the company can support the debt). The absence of strict “no more than fair market value” rules (like ESOPs have) means there’s technically flexibility, but practically any overpayment just hurts the company’s future. So responsible parties will handle it as they would a normal sale.
    
    
  • If employees are paying nothing and just receiving benefits, there’s likely no securities issuance to employees, so securities law issues are minimal. If the trust borrows from a bank, that’s just a loan like any other corporate loan – no special restrictions beyond usual lending.
    
    
  • Trustees have fiduciary duties under trust law – they must act in the interest of the beneficiaries (the employees). This is somewhat analogous to ESOP fiduciaries, but without DOL oversight, enforcement would come via general trust fiduciary principles (state law) or possibly state Attorney General if it’s a purpose trust. In practice, it means setting up good governance (like having independent trustees or clear rules) to avoid conflicts.
    
    
  • Complexity is lower than ESOP: NCEO notes EOTs are “not covered by any specific set of [federal] rules, they are less complicated and more flexible” to set up and run. There’s no annual reporting to DOL, no nondiscrimination tests, etc. The tradeoff is the trust itself must encapsulate all the policies you want (who gets profit share, how to remove a trustee, what happens if the company fails, etc.), so that document can be intricate. But it’s a one-time effort.
    
    
  • Regulatory status: It’s possible that in the future the U.S. might pass laws giving EOTs official recognition and perhaps tax incentives (there’s growing interest in EOTs among policymakers). As of now, doing an EOT requires working within existing legal frameworks – which plenty of companies have done successfully by customizing trust agreements.
    
    
  • Summing up, legal complexity is moderate: more complex than simply selling to one buyer (because you’re designing a new ownership entity with rules), but far less than an ESOP in ongoing compliance. It’s a “private” arrangement, which appeals to owners who dislike red tape.
    
    
• Suitability for Partial vs. Full Transitions: EOTs are quite flexible in ownership percentage. An owner can sell any fraction of shares to the trust:
  
  
  • Some owners do a 100% sale to an EOT, effectively making the company wholly owned by the trust for employees. This maximizes the cultural and legacy benefits (the company is now fully employee-oriented). If the owner doesn’t need all cash upfront, they might finance the sale via a note repaid from profits over time.
    
    
  • Partial sales are also common. For example, an owner might sell 30% now to an EOT (perhaps to let employees have some skin in the game and start profit-sharing) and plan to sell more later. In the interim, the owner keeps 70% of shares and perhaps control, but the trust owns a stake and benefits employees correspondingly. This is a bit different from an ESOP because with an EOT, even a small stake can be structured to give employees a voice (if the trust has certain consent rights beyond its ownership percentage). It’s very customizable. Over time, additional tranches can be sold when the company can afford it.
    
    
  • The Text-Em-All example is effectively a staged approach: Common Trust set up an EOT where initially the trust holds one share out of 800,000 (a token amount to establish the trust’s role), and the company will buy back the other 799,999 shares from the owners over time as cash is available. This means initially the former owners still hold essentially all equity but they’ve committed to a gradual buyout – eventually the trust will end up owning the whole company without needing an upfront loan, just using profit each year to redeem shares. This innovative approach shows how an EOT can facilitate very gradual transitions if desired, something an ESOP can’t easily do without incurring big costs each step. The trade-off is that until the trust’s ownership percentage grows, employees’ financial benefit might be smaller (though a trust can still mandate profit sharing even as a minority owner).
    
    
  • EOTs are suitable for owners who value partial exit flexibility. If an owner isn’t ready to give up control, they could start with a minority EOT and still retain majority ownership and maybe board control, but signal commitment to employees and lock in a path for them to eventually own more. However, one should be cautious: a very small EOT stake won’t qualify for any tax benefits and might be largely symbolic unless tied to a serious plan for more.
    
    
  • Many EOT pioneers advocate for at least 51% to the trust to firmly entrench the legacy/mission protection (because with >50%, you can guarantee no outsider can gain control). Also, in the UK, the tax benefits only kick in at 51% sale to EOT. In the US, since no such rule, it’s open. But likely most EOT conversions aim for majority employee trust ownership sooner or later.
    
    
  • Company size suitability: EOTs can work for a range of sizes. Project Equity suggests typical EOT transactions in the U.S. have been in companies with 10+ employees and transaction values of $3–20 million. So midsize, but smaller than many ESOP companies. Because there’s no heavy fixed cost, even relatively small businesses could do an EOT if they have the right cash flow. Very small (<10 employees) could too, but at that size often a coop or simple direct sale might be equally viable. EOTs shine for owners who could do an ESOP but are deterred by cost/complexity, or who aren’t keen on the retirement-account aspect and want more direct sharing.
    
    
  • One thing EOTs are not suited for is if the owner’s primary goal is maximizing sale price. Since EOTs emphasize continuity and usually avoid open-market sales, the owner typically sells at fair market value (not a strategic premium). And if the owner wanted a partial buyout at a high price, an ESOP might pay similar fair market value anyway. But if the owner’s goal was to eventually sell to a strategic buyer for a high multiple, an EOT blocks that outcome. So EOT is for those prioritizing legacy and employee stakeholders above top-dollar exit. (In fact, NCEO notes companies seeking “tax-favored liquidity” are not good fits for EOTs – implying if you want those tax breaks, do an ESOP; EOT is more about the softer benefits.)
    
    

EOT Example: Fireclay Tile, a California-based manufacturer, transitioned to an EOT in 2021. The founder chose an EOT to preserve the company’s mission of sustainable manufacturing and to reward employees. Under its trust, Fireclay distributes a share of profits to all employees annually and has an employee advisory committee to provide input. The owner retained some involvement initially, but the trust structure ensures the company can’t be sold and that employees will benefit from its growth long-term. Another example, mentioned earlier, is Text-Em-All: two owners of a messaging software firm aborted an ESOP midstream due to cost and embraced an EOT. They liked that it was inexpensive and flexible for their 42 employees. They spent roughly $84k on the trust setup and now have “minimal expenses” going forward, versus the steep ongoing costs of an ESOP. The trust they set up will gradually buy out their shares over time, and meanwhile employees are sharing in profits. The owners have publicly said they found the “right thing” in EOTs after years of not finding a good fit in other models – a sentiment that underscores how EOTs fill a niche for mission-driven owners.

4. Alternative Equity Structures (Profit-Sharing, Phantom Stock, etc.)

Aside from the formal ownership models above, there are alternative strategies to share profits or economic value with employees without actually transferring ownership or setting up new entities. These can be thought of as “halfway” measures – they give employees some upside of ownership (financial rewards tied to company success) but not the full bundle of ownership rights (like voting control or asset ownership). They can be useful for owners who want to incentivize and reward employees for performance or loyalty, but who either aren’t ready for an ownership transition or who have reasons to keep equity consolidated (for example, regulatory or investor constraints, or the company is too small for an ESOP but wants to start sharing wealth).

Common forms of such alternative structures include profit-sharing plans, phantom equity plans, stock appreciation rights, or issuing preferred stock with repurchase agreements. We’ll discuss each in turn:

• Profit-Sharing Plans (Cash or Deferred Profit Sharing): Profit-sharing simply means the company decides to share a portion of its profits with employees. This can be done in a variety of ways:
  
  
  • The simplest is an annual bonus pool. For instance, the business might allocate 10% of net profits each year to be divided among employees. The division could be equal, or based on salary, or hours, or performance, at the company’s discretion (though setting a clear formula helps with transparency). These payments are typically cash added to employees’ pay – tax-deductible to the company and taxed as wages to employees.
    
    
  • Another approach is a qualified profit-sharing retirement plan, where the company contributes a portion of profits into a tax-qualified trust (similar to a 401(k) profit-sharing). However, those are more like retirement plans and less flexible in giving immediate benefit (plus they have contribution limits and coverage rules).
    
    
  • For our context, we consider profit-sharing in the broader sense of discretionary cash profit sharing. It’s a low-cost, low-complexity option. You can implement it with virtually no legal setup (it’s just a bonus policy) or with minimal input from a lawyer to draft a plan document if you want formalization.
    
    
  • Employee benefits: They get extra money when the company does well. It can improve morale and retention (who doesn’t like a bonus?). However, because it’s discretionary, employees might not feel a sense of ownership, especially if the formula or continuation of the practice isn’t guaranteed. It’s essentially a form of variable pay.
    
    
  • Owner perspective: Profit-sharing doesn’t dilute control at all. The owner keeps full ownership and simply shares some upside. It can be a way to incrementally prepare for ownership culture – e.g., open the books and share profits to get employees thinking like owners – even if actual ownership transition happens later.
    
    
  • Cost and complexity: Very little. It’s just a compensation expense. No regulatory oversight unless you set it up as an ERISA plan (which you likely wouldn’t unless for retirement).
    
    
  • Suitability: Profit-sharing alone won’t transfer ownership – it’s not a succession plan, but rather a permanent bonus program. It can, however, complement partial transitions. For example, if an owner sells some shares to key employees or a trust, and wants the rest of the employees to also benefit, a profit-sharing plan ensures everyone gets something. Or if an owner cannot yet afford to sell equity to employees (due to valuation or debt constraints), profit-sharing gives employees a stake in success in the interim.
    
    
  • One downside: If done inconsistently or without transparency, employees may discount it (“Will we really get a bonus next year? Maybe not.”) – so many companies that use profit-sharing make it part of the culture (some even put up posters of profit targets and track progress, fostering teamwork).
    
    
  • Profit-sharing can take a long time to significantly shift ownership of wealth. A note from NCEO: profit-sharing plans might require many years to build up enough assets to result in majority employee ownership if that’s the goal (implying if you hope to transfer value via profit shares for them to buy you out, it’s slow).
    
    
  • In summary, profit-sharing is a quick, reversible, and straightforward way to give employees a slice of the pie, but it’s not ownership per se. Think of it as a powerful incentive tool, not an exit strategy on its own.
    
    
• Phantom Equity Plans: “Phantom stock” is a mechanism to mirror the financial benefits of stock ownership without issuing actual stock. Under a phantom stock plan, the company awards employees a certain number of “phantom” shares or units. These units have no voting rights and aren’t real equity, but they track the value of the company’s real shares. Over time, as the company’s valuation grows (or upon a future sale), the employee holding phantom shares gets a cash payout equivalent to the value increase (or full value) of those shares.
  
  
  • For example, say a key employee is granted 1,000 phantom units when the company is worth $100 per share. If in 5 years the company is worth $200 per share (doubled in value), the employee would receive a bonus of $100 * 1,000 = $100,000 (the increase in value) at that time. Or if structured to pay full value, they’d get $200 * 1,000 = $200,000, effectively as if they owned 1,000 shares and the company bought them back.
    
    
  • Stock Appreciation Rights (SARs) are a similar concept: an SAR gives the employee a right to the increase in value of a certain number of shares over a period. SARs often can be exercised at the employee’s choice after vesting, whereas phantom stock typically pays out at a set time or trigger event.
    
    
  • Financial benefit to employees: Phantom stock and SARs let employees share in the company’s equity growth without any investment. If the company’s value grows, they get a lump sum or series of payments. This can be very lucrative if the company thrives (and conversely worth nothing if the company’s value doesn’t increase). It’s like giving employees a slice of the future sale proceeds or valuation increase. It can strongly align employees with growth goals. For instance, many startups use these for key hires so that if an IPO or sale happens, those hires get a significant payout.
    
    
  • Non-financial: Employees do not get votes or control from phantom equity. They remain in normal employee roles. Culturally, though, knowing “I have phantom shares worth X” might make them feel more invested in company success than if they were just getting salary. It’s an incentive for performance and retention (often these awards vest over years, encouraging the employee to stay).
    
    
  • Cost and complexity: Drafting a phantom stock plan requires legal help to define how payouts are calculated, who gets grants, what happens if someone leaves, etc. But it’s a one-time plan document (not requiring government approval, unless covering a broad group might inadvertently trigger some ERISA rules – typically companies avoid that by limiting to select management or by structuring as bonuses not retirement plans). Each year, you might need to determine company valuation if it’s privately held, to know the phantom shares’ value. This can be done via a formula or external appraisal. That’s a bit of effort but not nearly on the scale of an ESOP’s formal valuation requirement (and no fiduciary risk since it’s a contractual obligation, though obviously you want fairness).
    
    
  • Tax-wise, phantom payouts are ordinary income to the employee when paid and deductible to the company. There’s no favorable capital gains treatment because the employee doesn’t actually own stock. This means from the employee’s perspective, it’s like a cash bonus (albeit possibly a large one). From the company’s perspective, it can plan for that cash obligation. Sometimes companies set aside reserves or buy insurance to cover future phantom payouts, especially if a sale might trigger a big payout.
    
    
  • Use case: Phantom equity is ideal if an owner eventually plans to sell the company to an outside buyer and wants employees to get a piece of the sale proceeds. By granting phantom units that vest at sale, the owner ensures employees will cash out alongside them, which can seem fair and can motivate employees to help increase the sale value. It’s also common in family businesses or others where you might not want to dilute ownership now, but want to reward a few key people as if they were owners later.
    
    
  • As a partial transition tool, phantom equity does not solve succession (because the owner still eventually needs to decide who will own the company or sell it). But it can be part of bridging to a later full transition, or it can be layered with something else (e.g., you could set up an EOT or coop for majority and still have phantom bonuses for some employees).
    
    
  • If an owner never wants to fully sell, they could still use phantom stock to periodically reward employees based on increases in company value (like a 5-year valuation event, pay out growth). In essence, that mimics equity value sharing while the owner retains the stock. This could go on indefinitely, with phantom grants rolling or renewing.
    
    
  • Pros: Very flexible (you can pick which employees get how much, it’s not all-employees necessarily – though broad-based plans are possible too). No loss of control. Aligns incentives to company value. No external regulation beyond normal contract law.
    
    
  • Cons: Employees might not feel the same pride as actual owners since it’s “phantom”. There’s a risk they don’t fully understand it (education is needed so they value it). Also, if the company’s value drops, the phantom might end up worthless, which can demotivate – whereas with real ownership in a coop or ESOP, even in down times employees still have a voice or other reasons to engage.
    
    
  • Example usage: A regional bank (not big enough for ESOP, or maybe an LLC) might give senior managers phantom stock units, so that if the bank is acquired in 5 years, those managers get a chunk of the sale money proportional to equity value created. Or a small tech firm gives all 10 employees SARs equal to 10% of the company’s value increase to share any future sale proceeds.
    
    
• Redeemable Preferred Equity: This approach involves actually issuing stock to employees (so it is a real ownership interest), but a special class of stock – usually preferred shares that are redeemable by the company at a later date.
  
  
  • Preferred stock typically means shares with a fixed dividend or payout preference, often without voting rights (or limited voting). “Redeemable” means the company can buy back those shares at a predetermined price or formula, either at a certain time or at the company’s discretion (or sometimes the holder’s discretion).
    
    
  • How can this be used for employee ownership? One way is to give employees (or an employee trust) preferred shares that, say, pay a quarterly dividend based on company profits and can be redeemed by the company after X years or upon retirement of the employee. The employees thus get a steady income stream from dividends (like profit share, but legally as dividends on stock) and a cashout at redemption. But the preferred likely carries no voting power, so control stays with the common shareholders (which could be the original owner or others).
    
    
  • Another scenario: If an owner doesn’t want to dilute common equity, they might create a block of non-voting preferred shares equal to, say, 30% of the company value and give or sell those to employees (or an EOT). The employees then effectively own an economic interest (30% of value via the preferred) but no votes. Over time, the company may redeem those shares (buy them back) at a fixed price (perhaps original value plus some growth factor or interest). This in effect is similar to a loan that employees make to the company by accepting stock: employees front labor and in exchange get these preferred shares that the company later pays off.
    
    
  • Benefit to employees: They receive dividends if declared (which could be regular if set up that way). Dividends on preferred could be fixed (like 5% of par value annually) or variable (say, a certain portion of profits). When the company redeems the shares, employees get cash for their shares (which might be at par value or some formula). This gives a more predictable benefit than common stock – they’re not exposed to full market risk if redemption is guaranteed at a price. However, they also usually don’t get upside beyond the set return. If the company’s value skyrockets, the common owners keep that; the preferred holders typically just get their fixed dividend and redemption value.
    
    
  • Non-financial: If structured as non-voting, employees don’t gain governance influence (beyond maybe if dividends are not paid, some protective provisions might kick in, depending on design). So it’s more of a financial instrument than a power-sharing one.
    
    
  • Use cases: Redeemable preferred shares can be a component of stewardship structures. For example, the Organically Grown Company (OGC) case we discussed: they set up a perpetual trust to hold common voting stock and raised capital by issuing non-voting preferred stock to investors with a set return. In theory, one could issue similar preferred to employees (though OGC’s were to outside investors). Employees could receive preferred shares as a bonus or purchase them at a discount. The company gets to utilize future profits to pay those dividends and redemptions rather than giving away governance.
    
    
  • Another scenario is a company converting to a coop or trust might use preferred shares to compensate the owner: e.g., the owner exchanges common for a note and some preferred stock that pays them over time, while the common goes to employees/trust. That’s more of a seller financing tool though.
    
    
  • Taxes: Dividends paid to employees on stock are generally taxable to the employee (usually as dividend income, which for individuals can be taxed at capital gains rates if qualified). The company (if C-corp) cannot deduct dividends (unlike wages). So from a tax view, paying employees via dividends is worse for the company (not deductible) but can be slightly better for employees if qualified dividends (lower tax rate than ordinary income). If the company is an S-corp, you generally can’t have preferred stock at all (S-corps can’t have multiple classes of stock that differ in economic rights), so this approach is mainly for C-corps.
    
    
  • If employees receive shares as a grant, the initial value is taxable as compensation unless arrangements (like 83(b) elections on restricted stock) are made. Usually, one would structure it so either the value at grant is low (to minimize tax) or have them purchase it (perhaps via some of their profit-sharing).
    
    
  • Complexity: Issuing a new class of stock requires corporate charter amendments and possibly securities filings (if giving to many employees, that’s a securities issuance). It can typically be done under private placement exemptions (e.g., Section 4(a)(2) or Rule 701 for stock compensation to employees up to certain limits). So some legal overhead but not prohibitive. There might be a need for an annual valuation if you plan to redeem shares at “fair value” annually or allow ongoing buyback (similar to internal markets).
    
    
  • Redeemable pref can be thought of as “employee loan in disguise” – employees essentially loan their future share of profits to the company in exchange for a defined return. It doesn’t foster a sense of ownership like common stock or coops would, because employees know they won't hold these forever and have no votes.
    
    
  • It is suitable for partial, temporary ownership involvement. For example, an owner might say: “I want to share profits for 5 years with employees and then buy them out.” Issue redeemable preferred that pays dividends for 5 years and is then redeemed by the company at a set price. Employees get that stream of income and a final payout, after which they cease to be owners. The company returns to solely the original owner (or the owner might have slowly sold common to someone else).
    
    
  • Perhaps not surprisingly, this is a niche method. It’s more common for raising capital (like bringing in outside investors who want a fixed return) than for broad employee ownership. But it’s an option if an owner wants to treat employees as investors to some degree without giving control.
    
    
• Other Alternatives: There are other variants and hybrids:
  
  
  • Stock Options / ESOPs in LLCs: Traditional stock options can be given to employees to allow them to buy stock at a low price, but this usually implies eventually those employees become shareholders (partial ownership). For many small businesses, having a few employees exercise stock options can complicate the cap table but is doable. However, broad options to all workers is less common unless planning an exit event (like a startup aiming for acquisition).
    
    
  • “Direct Ownership” programs: Some companies set up direct stock purchase plans or matches (like employees can buy shares from the owner at fair market value, sometimes with the company matching shares as a bonus). This gradually spreads ownership. It requires managing potentially many small shareholders, which can be messy but possible (with proper buyback policies, etc.).
    
    
  • For instance, a company could allow employees to buy up to, say, $5,000 of stock a year (either directly or via payroll deduction), possibly at a slight discount or with a match. Over time, employees could accumulate, say, 10% of the company. It’s a slow partial transition and entails securities compliance (Rule 701 usually covers employee stock sales under certain limits).
    
    
  • Direct ownership often necessitates a mechanism for employees to sell their shares if they leave (since no public market), meaning the company or others should be ready to repurchase (this is similar to how many private companies handle having multiple shareholders). The NCEO comparison notes companies that do direct ownership typically set up internal markets with annual valuations for employees to buy/sell stock. That has ongoing admin needs, but not as heavy as ESOP oversight.
    
    
  • Employee Stock Purchase Plans (ESPPs): These are more common in publicly traded companies, but private companies can mimic them by allowing employees to purchase stock through payroll. Without liquidity, though, private ESPPs are tricky (employees might be stuck holding shares they can’t sell easily).
    
    

Key Takeaways for Alternative Structures: These methods are highly customizable and usually low-cost to implement, making them attractive for smaller companies or interim solutions:

• They do not require giving up control (phantom and profit-sharing give none; preferred equity and direct share purchase can be structured with little to no voting power transferred).
  
  
• They lack the robust tax advantages of an ESOP (no tax-free entity or deferral for owner).
  
  
• They can be put in place quickly – a phantom stock plan or profit-sharing bonus can be adopted in a matter of weeks.
  
  
• In terms of partial vs. full transition, these are generally about partial incentives. They are not a full exit plan by themselves, but they could evolve into one (e.g. an owner starts with phantom stock, then later might do an ESOP or sale – employees will still benefit from phantom at sale). If an owner’s goal is to eventually exit by selling to employees, these can be stepping stones (building a culture, possibly accruing some wealth to employees which they could later use to buy shares).
  
  
• From an employee perspective, these alternatives often feel more like bonus programs than true ownership. They may be easier to grasp than an ESOP’s technicalities, but they don’t confer the pride or control of owning the company. It’s crucial to communicate their value clearly, so employees see them as part of the compensation package tied to company success.
  
  

For example, consider a small consulting firm with 15 employees where the owner isn’t ready to do a full coop or ESOP. The owner could implement a profit-sharing bonus (say 15% of profits split among staff) and also give phantom equity equal to 20% of the company’s value growth to the key 5 senior employees. As a result, all employees get some extra reward each year, and the key ones stand to gain if the firm’s valuation increases by the time the owner eventually sells (perhaps to those same employees or to a third party). This approach keeps the owner in control and is very flexible, but it also sets the stage: employees are used to sharing in outcomes, which might make a future transition smoother (culturally and financially, since employees might use their phantom payouts or profit bonuses to finance a buy-in).

Having detailed each structure, the next section will compare them side-by-side on the major factors. This will help highlight which model might be best depending on an owner’s priorities (tax savings, cost constraints, timeline urgency, desired level of employee participation, etc.).

Side-by-Side Comparison of Structures

To crystallize the differences, the table below compares the four structures across key dimensions:

Table: Comparison of employee ownership structures on key factors.

As the table shows, each model has distinct advantages and drawbacks. The ESOP stands out for its tax benefits and ability to facilitate large-scale buyouts (including 100% employee ownership with no corporate taxes), but it comes with high complexity and cost, making it suitable for larger small businesses (often 40+ employees) with strong profits. The worker cooperative excels in empowering employees and lower cost structure, and can fit companies of almost any size (including very small ones) where the culture supports democratic management – it’s best for owners willing to relinquish control and who want an egalitarian legacy. The EOT is a newer option offering a middle ground: simpler and cheaper like a coop (and appropriate for 10+ employee companies), but without requiring democratic governance changes. It’s great for owners focused on long-term mission preservation and steady employee benefits rather than immediate tax perks. Finally, the alternative structures are more like tools to share success in a targeted way – ideal for smaller firms or interim steps when a full transition isn’t yet feasible. They’re easy to implement and can be very quick, making them useful for owners who want to start sharing ownership mindset or rewards now without major structural change.

Conclusion & Recommendations

Transitioning to employee ownership is a transformative decision for a small business owner – it can ensure your business’s continuity, reward the people who built it, and often improve company performance and employee well-being. The best structure for a partial employee ownership transition depends on your goals, company size, financial situation, and culture:

• If you seek maximum tax advantages and the ability to cash out a significant stake while still allowing a gradual exit, an ESOP might be the right choice (provided your company is large enough to support it). ESOPs work especially well for owners of midsized companies who want to sell 30–100% of the business and want employees to have a funded retirement benefit. Be prepared for the complexity and ensure you have (or can afford) solid management and advisors to run the ESOP properly.
  
  
• If your priority is embedding employee voice and fairness into the company’s DNA and you are philosophically aligned with workplace democracy, a Worker Cooperative is highly suitable. Co-ops are a natural fit for smaller companies and owners who don’t mind letting go of control in exchange for knowing the business will be collectively stewarded by the employees. It’s often the most affordable path and can be done even when profits are modest (with creative financing like seller notes, and possibly outside coop-friendly lenders or grants). Co-ops are also a good fit if you want all employees – not just a select few – to have equal say and stake.
  
  
• If you want a flexible, permanent solution that protects the company’s mission and gives employees a share in the profits without the red tape, an Employee Ownership Trust (EOT) is very appealing. EOTs are still gaining traction in the U.S., but they offer a straightforward way to ensure your company will never be sold to an unwanted buyer and that employees will be financially rewarded yearly for their work. They are great for owners who are less concerned about immediate personal tax breaks and more about long-term legacy and employee welfare. EOTs also allow you to set the pace – you could start partial and increase the trust’s ownership over time, making it a gentle transition.
  
  
• If you are not ready to transfer ownership or your business is currently too small or not suited for the above structures, consider implementing alternative equity sharing methods now. A profit-sharing bonus or phantom stock plan can start building an ownership culture and show employees you mean to share success. These can coexist with or lead into a later formal transition. For example, you might do profit-sharing for a few years to strengthen performance and then, once the company grows to a certain point, establish an ESOP or sell to a coop. Or you might combine approaches: perhaps set up an EOT for majority ownership and also give key employees phantom equity for additional incentive – these are not mutually exclusive.
  
  

One can also combine structures in creative ways. Some companies start as a partial ESOP (say 30%) and later convert fully to an EOT or coop, essentially blending benefits. Others maintain an ESOP and supplement it with phantom stock for executives (since ESOP allocations are by pay, an extra incentive can reward high performers). The choice doesn’t have to be one-size-fits-all; it should fit your unique company.

Encouragement: Employee ownership, in any form, tends to be positively correlated with business success – research and real-world experience show employee-owned companies often enjoy higher productivity, better resilience in downturns, and employees who are more engaged and stay longer. By giving employees a stake, whether through shares or profit-sharing, you tap into an “ownership mentality” that can drive innovation and growth. For the employees, it can be life-changing: it turns jobs into wealth-building opportunities and gives people a real voice in their work lives.

For the owner, transitioning even partially can be deeply rewarding beyond the financial aspect. Many owners cite that seeing their employees take the reins and thrive is a legacy they are proud of, and it reflects the trust and appreciation for those who helped build the company. And practically speaking, selling to your employees (via ESOP, coop, or trust) can be a “friendly” exit – you often get a fair price with more control over the terms, and you know the business will carry forward in familiar hands, rather than being absorbed by a competitor or private equity firm solely interested in quick returns.

Next steps if you’re considering these options:

• Get educated on the model that intrigues you – there are plenty of resources from NCEO, Project Equity, and others (many referenced in this report) that provide deeper how-tos.
  
  
• Consult experts: Talk to an ESOP consultant or attorney, a coop developer, or an EOT specialist (there are a growing number of attorneys familiar with EOTs). Many will offer initial consultations. They can help do a feasibility check on your numbers and desires.
  
  
• Engage your key employees carefully: If you have a management team, gauge their interest and capability to help lead an employee-owned company. Their support will be crucial especially for a coop or EOT (which rely on engaged leadership from within).
  
  
• Consider financing: An ESOP or EOT can be financed with bank loans or seller notes – start exploring what that might look like (there are even specialized ESOP lenders or programs in some states encouraging employee ownership financing). For a coop, often seller financing and community development financial institutions (CDFIs) come into play.
  
  
• Timeline and communication: Plan out how you will communicate the plan to your employees. Transparency and inclusion can smooth the process – for instance, in a coop conversion, you’d likely involve employees from early on so they feel ownership of the idea, not just the company. In an ESOP, you might educate employees about how the ESOP will work for them as a benefit.
  
  

In closing, whether you choose the high-road of an ESOP with its powerful tax shields, the heart of a cooperative, the elegant simplicity of a trust, or a custom approach with phantom shares, you’ll be joining a movement of businesses across the country proving that employee ownership can strengthen companies and communities. As one business owner put it when he sold his company to his employees, “There is nothing more meaningful and powerful than having your team be the new owners of the company you founded”. By considering these models, you’re already taking a step toward that meaningful outcome – one where everyone in the business has a stake in its success.

Sources:

• National Center for Employee Ownership (NCEO) – Comparison of Employee Ownership Structures and various articles on ESOPs, equity compensation, etc.
  
  
• Project Equity – Resources on ESOPs, Worker Co-ops, and EOTs.
  
  
• Common Trust – Insights on EOT vs ESOP costs and implementation.
  
  
• Democracy at Work Institute – Data on coop conversions and timelines.
  
  
• ESOP Association / ESOP experts – ESOP pros, cons, and timeline considerations.
  
  
• ImpactAlpha news – Case studies like Text-Em-All and others on EOT outcomes.
  
  
• The Tax Adviser / other publications – Discussions on phantom equity vs profit interests.