What Are Employee-Owned Companies (ESOPs)?

What are Employee-Owned Companies (ESOPs)?

When a business owner wants to retire or move on to something new, one option is to sell ownership to employees. This can help the business continue running with fewer disruptions during the transition.

Employees already know how the company works. That familiarity can shorten the learning curve compared to selling to an outside buyer.

When transferring ownership to employees, a business owner can sell to a single trusted employee or to all qualified employees through an Employee Stock Ownership Plan (ESOP).

But how does an ESOP work? Does becoming a shareholder in an ESOP make an employee a manager? Do all employees get a share of the company’s profits? This article explains how employee-owned companies operate, and answers common questions about ESOPs in the FAQ below.

What To Know About Employee-Owned Companies

An employee-owned company is one where employees own part or all of the shares of the business. There are several forms of employee ownership, including stock grants, worker cooperatives, and stock options. Each offers different financial benefits and responsibilities, but all are built around the same goal: giving employees a stake in the business.

The ESOP is the most common form of employee ownership in the United States. As of 2023, the most recent year with data available, there were an estimated 6,609 ESOPs in the US at 6,411 companies, covering about 15.1 million participants, according to the National Center for Employee Ownership (NCEO). ESOP plans allow employees to own a portion, or 100%, of company shares.

How Do Employee-Owned Companies Work?

The way an employee-owned company operates depends on the plan or method used to transfer ownership to employees. In the case of an ESOP, the company first sets up a trust and makes annual share contributions for employees who qualify.

That trust can be used to buy stock from the selling shareholder or departing owner, to hold shares for employees, or to borrow money to fund the share sale or transfer.

The business owner sells their shares to the trust. The shares then go to qualified employees and are held there until each employee is eligible to receive them.

An employee must first become vested in the plan to receive ESOP benefits. This means working at the company for a set number of years before receiving benefits, whether partially or fully vested.

There are two types of vesting periods for ESOP plans. Under cliff vesting, an employee becomes 100% vested after three years of service. If the employee leaves before those three years are up, they receive no benefits.

Under graded vesting, an employee typically becomes vested at a rate of 20% per year, starting in year two: 0% in year one, 20% in year two, 40% in year three, and so on, reaching 100% after six years. This option can work better for an employee who expects to leave before the three-year cliff-vesting mark.

The number of shares allocated to an employee depends on compensation. An employee earning $100,000 a year will accrue more shares than one earning $10,000 a year. Each participant receives an annual statement showing the shares they received that year.

The payout process for an ESOP differs from other forms of employee ownership. An employee can only receive payment for accrued shares upon retiring or voluntarily leaving the company. The company then buys back those shares and begins the holding process again for another employee.

In most cases, ESOPs work as an exit strategy for founders or owners. They help motivate and retain employees while giving the owner a way to leave the company with a payout.

Employee Participation

Eligibility requirements for an ESOP are similar to those for a qualified retirement plan, such as a 401(k). Under current IRS rules, an employee generally must be at least 21 years old and have completed one year of service to participate. Employers may extend that waiting period to two years, but only if the plan offers immediate full vesting at that point (IRS Code Section 410(a)).

Employee-Owned Companies Pros and Cons

ESOPs offer benefits to employees, the company, and the selling shareholder. Below are the main pros and cons of an employee-owned company.

Pros

Ability to Borrow Funds

When setting up an ESOP trust, a company can borrow money to purchase stock from the selling shareholder. This is known as a leveraged ESOP. Borrowing lets the company buy more shares than it could afford outright, and pay the selling shareholder in full rather than gradually over time.

Selling to an ESOP can also cost less than selling to an outside buyer. According to NCEO research, selling to an ESOP typically costs 2% to 4% of the transaction, compared to 4% to 9% for selling to another buyer.

Tax Advantages

Managing an ESOP comes with tax benefits for the company and the selling shareholder. The company’s contributions to the ESOP are tax-deductible, subject to IRS limits, since the company (not the employee) makes those contributions. The company can also deduct dividends paid on ESOP shares that are used to repay ESOP loans.

Employees pay no tax on the shares allocated to their ESOP account until they receive a distribution, typically at retirement, according to the NCEO.

Attract Talented Candidates

Companies that offer employee ownership tend to stand out to job candidates. An ESOP also tends to improve employee retention, since staff have a direct financial reason to stay and grow with the company.

Reward Employees

An ESOP is a way to reward employees for their work and the years they have given to a business. The employee also receives a financial payout when leaving or retiring from the company.

No Upfront Cost

One advantage of an ESOP is that the employee pays no upfront money to receive shares. In the case of stock options, the employee would have to pay a pre-set share price.

Employees Get Ownership

An ESOP gives employees a direct ownership stake in the business. Because employees share in the company’s financial outcome, ownership can support morale and engagement across the team.

Cons

Employees Might Not Get Any Control

Even though employees get ownership, they might not get a say in company decisions or direction. That depends on the specific ESOP plan.

Expensive to Implement

ESOPs are costly to set up and manage, and those costs fall on the employer, not the employee. Leveraged ESOPs cost more to establish than non-leveraged ones. The cost ranges below reflect 2026 estimates from the NCEO and other ESOP advisory sources, and can vary based on company size and deal complexity:

Setup costs: typically start around $125,000, and can run several hundred thousand dollars or more depending on the size and complexity of the deal.
Annual administration and valuation: roughly $20,000 to $35,000 a year for most companies under a few hundred employees.
Outside trustee fees (if used): roughly $15,000 to $30,000 a year.
Annual company audit: roughly $10,000 to $25,000.
Legal fees: roughly $5,000 to $50,000.
Share purchase: the company may have to buy shares from the selling shareholder as part of the transaction.

Can an Employee-Owned Company Be Sold?

Yes, it can, though the process is fairly complex. Since employees’ shares are held in an ESOP trust, there needs to be an ESOP trustee present for the sale to occur. The trustee has a fiduciary duty to oversee the sale in the best interest of employees, has the final say, and should be part of the offer discussions from the start.

During the sale process, the trustee is responsible for confirming that:

The deal is fair from a financial standpoint.
The company will receive adequate payment for the shares.

Because of the complexity of the sale process, the trustee typically hires an independent financial advisor and legal counsel.

Employee-owned Organizations

Here is a list of large, established companies that are currently reported as employee-owned, according to the NCEO and other recent industry reporting:

WinCo Foods
Recology
Penmac Staffing
Publix Super Markets
Graybar Electric
Davey Tree Expert

When Is an ESOP Not a Good Ownership Option?

ESOPs are not always a good fit for large, high-value companies. The company may have to spend a large amount of money buying out the departing owner, or purchase shares from the selling shareholder at a price lower than the shares are actually worth.

Multigenerational and family-owned businesses are also often not a good fit for an ESOP, since owners may want to keep ownership in the family.

Small companies with limited revenue may also struggle with an ESOP, since setup and administration costs can be too high relative to the size of the business.

Conclusion

An employee-owned company is one in which employees hold partial or full ownership of the business. There are several forms of employee ownership, but the ESOP is the most common in the US.

ESOPs work as a buyout strategy for departing owners and founders, and give employees a path to ownership. Setting one up requires establishing an ESOP trust, with a vesting period of three years for cliff vesting or six years for graded vesting.

Once an employee is vested, they can receive payment for their shares when they leave the business or retire. Establishing an ESOP offers tax benefits to the employer and no upfront cost to employees, but the setup and ongoing management costs are significant.

Key Points and Facts About Employee-Owned Companies

An ESOP lets a business owner transfer part or all of a company to employees through a trust.
There are about 6,609 ESOPs in the US, covering roughly 15.1 million participants, as of 2023 data.
Vesting takes three years under a cliff schedule, or six years under a graded schedule.
The company’s ESOP contributions are tax-deductible; employees owe no tax until they receive a distribution.
Setup costs typically start around $125,000, with ongoing annual costs of tens of thousands of dollars.

Action Steps for Employee-Owned Companies
Assess whether an ESOP fits the business

Review company size, profitability, and cash flow to see whether an ESOP is financially workable.
Talk with an ESOP attorney or advisor about a feasibility study before moving forward.

Plan for the cost

Budget for setup costs and recurring annual administration, valuation, trustee, audit, and legal fees.
Compare the total cost against other exit options, such as an outside sale.

Set up the plan

Work with an attorney to establish the ESOP trust and draft the plan document.
Set eligibility rules for age and years of service within IRS limits.

Communicate with employees

Explain how vesting works and when employees can expect a payout.
Provide each participant with an annual statement showing their share allocation.

Checklist for Employee-Owned Companies

Confirm business fit
- Company size and profitability support the cost of an ESOP
- Ownership goals (full sale vs. partial transfer) are clear
Line up advisors
- ESOP attorney identified
- Independent valuation firm identified
- Trustee (internal or outside) selected
Set plan terms
- Vesting schedule chosen (cliff or graded)
- Eligibility age and years of service set within IRS limits
Budget for costs
- Setup costs estimated
- Annual administration, valuation, trustee, audit, and legal fees estimated
Prepare employee communication
- Plan explained to employees before rollout
- Process for annual statements and payouts documented

FAQ: Employee-Owned Companies
Does becoming a shareholder in an ESOP make an employee a manager?

No. Owning shares through an ESOP does not automatically give an employee a management role or decision-making authority. That depends on the employee’s actual job and the company’s own management structure, separate from their ESOP shares.

Do all employees get a share of the company’s profits?

Eligible employees who meet the plan’s age and service requirements are allocated shares in the ESOP trust. The value of those shares reflects the company’s performance over time, but the amount each employee receives depends on compensation and years of participation.

How long does it take to become fully vested in an ESOP?

It depends on the plan’s vesting schedule: three years under cliff vesting, or six years under graded vesting.

Can a company with an ESOP still be sold?

Yes. The ESOP trustee oversees the sale process and must confirm the deal is fair to employees and that the company receives adequate payment for the shares.

Are ESOPs a good fit for every business?

No. Very large, high-value companies, family businesses that want to keep ownership in the family, and small companies with limited revenue may find an ESOP less practical due to cost and complexity.

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