Founders Cash Out, but Do Workers Gain? As more entrepreneurs approach retirement, many are choosing to sell their companies to their employees, rather than outside buyers

April 17, 2013, 7:02 p.m. ET

Founders Cash Out, but Do Workers Gain?

U.S. Employee-Owned Firms Top 10,000, With More Expected as Owners Retire; Critics Point to Potential Drawbacks


Mandy Cabot wants to make sure the shoemaking business that she and her husband built over the past 20 years remains in good hands after they’re gone. The 58-year-old co-founder of Dansko, a West Grove, Pa., company with more than $150 million in annual sales, says she fears that selling to a competitor, or a private-equity firm, would result in layoffs or other cost-cutting measures. So last February, the couple transferred ownership of the business to its 180 employees. By “keeping it in the family” and giving workers a real stake in its future, Ms. Cabot says she hopes the company will keep going strong for years to come. “This is our baby, but at some point we have to cease being parents and become grandparents,” she adds. As more entrepreneurs, like Ms. Cabot, approach retirement—about 30% of the nation’s business owners are 55 or older, according to the U.S. Small Business Administration—many are choosing to sell their companies to their employees, rather than outside buyers.

Known as employee stock-ownership plans, or ESOPs, the move is being embraced by smaller firms, especially those struggling to find buyers during the weak economy. Under typical plans, an owner’s interest in a business is bought out, in part or in whole—often through a bank loan—with the stock being held in trust. Employees then cash in their shares as they retire.This week, a bipartisan group of lawmakers introduced a bill to encourage employee-ownership plans. But critics of the plans say owners who are looking for an easy exit are simply spreading the risks of business ownership by convincing employees to gamble their retirement savings. Many point to high-profile failures at shared-ownership companies, including Enron Corp., where workers lost their savings. The real attraction for owners, opponents say, is generous tax breaks that shelter capital gains and dividends tied to the plans.

Andrew Stumpff, an outspoken critic of the ESOP model who teaches at University of Michigan Law School, says it’s bad enough to risk your retirement savings in a single company. But it’s even worse if that company is your employer, he says: “If the company fails, you lose your savings and your job.” That risk is very real, he adds, citing Enron, WorldCom and Lehman Brothers as examples of large firms that offered employee-stock ownership before going bankrupt.

As of 2011, there were an estimated 10,900 employee-owned businesses across the country, a 12% increase from 2007 and a record high dating back to the mid-1970s, when the plans first appeared, according to the National Center for Employee Ownership, an Oakland, Calif.-based advocacy group. Nearly all of the employee-owned businesses have fewer than 500 workers.

Some 10 million employees are currently enrolled in these plans, representing more than $860 billion in assets, the group estimates. In the decade since lawmakers first allowed so-called pass-through entities, known as S corporations, to offer employee stock-ownership plans, the number of these firms offering ESOPs has more than doubled, according to Matrix Global Advisors, a consulting firm. Most S corporations tend to be small firms.

Norman Stein, who teaches law at Drexel University, says employee ownership under the ESOP model causes more harm than good. Many of the plans are based on a bloated assessment of the value of the businesses, especially in the wake of the recession, when buyers were looking for deals. Many workers who are participating in the plans are left holding overvalued shares, long after the original owner has cashed out: “I’m not against employees owning some stock in their employer, but not if it’s tied to a retirement plan,” he says. “It’s a troubling trend.”

Others say the plans offer costly and unnecessary tax subsidies. The Obama administration recently proposed closing a tax break on dividends paid out of employee-ownership plans—a move attacked by the ESOP Association.

“What we’re seeing is demographics meeting good tax policies,” claims Michael Keeling, president of the ESOP Association, a Washington lobby group, referring to the growing number of firms owned by baby boomers that are converting to employee ownership. “A company’s success isn’t just driven by the brilliance of the CEO, but also by its employees, and more owners feel [their employees] deserve something more for that,” he adds.

Separate studies by Harvard University and Rutgers, as well as by the National Bureau of Economic Research, have found that businesses with shared-ownership plans fared better during the recession than more traditionally structured firms, including fewer layoffs, higher productivity and stronger employee loyalty. Data from the General Social Survey, for instance, shows businesses with employee stock plans laid off workers at a rate of just 2.6% in 2010, compared with 12.1% at companies without such plans.

Dawn Huston, 31, started working at Dansko 11 years ago, sorting shoes for delivery. Now a warehouse processor, she says the idea of owning a piece of the company made her nervous at first—though she wasn’t worried about her retirement savings, since the company offers a separate 401(k) plan, she adds. Over the past year, she’s begun referring to Dansko as “our company.”

“I feel like they consider us family and it feels like a family,” she says of the switch to employee ownership.

Adele Connors, 60, co-founder of Adworkshop, a Lake Placid, N.Y., marketing agency, says a move to employee ownership “really changed the culture of our company.” Since turning over 33% of the firm to its 30 employees four years ago, she says workers are “more engaged” and that “they get that the harder they work, the more impact they have on the business’s success.” The company expects to convert to 100% employee ownership within the next few years, she says.

Kelly Frady, 43, an account supervisor at Adworkshop since 2008, says the agency’s employee-ownership plan has fostered a team spirit among its staff. “Everyone knows that you do well and your stock will rise,” she says. “It’s a driving factor in making the company succeed in the long term.” Ms. Frady, a mother of three, says she joined the agency after being laid off from a previous job at a nearby resort that had lost its financing during the recession.

Kim Jordan, who co-founded the New Belgium Brewing Co. with her husband in 1991, says employee ownership ensures that the company’s values and culture will remain intact—including its commitment to sustainable farming and an environmentally friendly production process. In December, she extended full ownership of the Fort Collins, Colo., brewery to its 480 employees.

“We’ve always tried to involve our people in the running of the business,” she says. The goal, she says, isn’t just to reward employees, but also to foster innovation by creating a company culture where workers think more like entrepreneurs.

Ms. Cabot, who launched Dansko in 1990 by selling shoes from the back of a Volvo station wagon, says the tax benefits associated with employee stock ownership enabled the S corporation to manage the long-term debt of buying out the couple’s ownership stake. But, she adds, “It’s not some tax dodge.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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