Employee stock ownership plans (ESOPs) have become increasingly popular in small to midsize companies and for good reason. By giving employees a stake in the company, business owners empower their workforces, and thereby strengthen their organizations’ performances. At least, that’s the theory.

ESOPs have been around for 30 years, and it’s estimated that the number of U.S. workers currently enrolled in the ownership programs is at least 8.5 million. After three decades of observing ESOPs in practice and with millions of workers engaged, the performance theory has been validated after all. While the payoffs of establishing ESOPs are genuine, there are a few caveats.

A plan with a purpose

Typically, companies establish ESOPs to either buy the stock of a retiring owner, or as a way of setting up an employee benefit plan. ESOPs can also be used to leverage financing for expansion, capital improvements, or an acquisition. In fact, tax incentives can make borrowing through an ESOP extremely attractive since ESOP contributions are tax deductible and because interest rates on ESOP loans generally fall below market. As such, a company is able to lower the cost of capital and conserve cash.

More often than not, however, the goal is to give employees a legitimate stake in the company in the hopes that as owners, employees will work to improve an organization’s performance. The rationale is that by giving them the incentive of ownership, they will increase their dedication to the business, which in turn, will translate into bottom-line improvements. This causal link between employee ownership and business performance does in fact occur in the majority of ESOP companies.

A mutually beneficial incentive

Today’s management philosophies are very employee-centric. Promoting work teams and encouraging workers to be business literate and to act like owners are a commonplace rallying cries. Yet, the approach can ring hollow without transference of control or meaningful incentives. Why would an employee invest him or herself unconditionally when the rewards are limited?

ESOPs, on the other hand, can create a true entrepreneurial culture. The program motivates employees to work harder and smarter, improves morale, and increases retention. Workers become more pro-employer, heightening their sense of loyalty and deepening their commitment. An ESOP can also help to attract top talent to your company and safeguard your intellectual capital through a reduction in turnover. The beneficial by-products are more information-sharing, stronger communications, and better decision-making throughout all levels of your organization. And that’s just the beginning. 

Boosting profitability

Time and again, studies show that employee-owned companies do outperform their competitors. Organizations with ESOPs typically experience increased sales, improved productivity, and enhanced longevity. Overall, the decision to become employee-owned translates into better company performance and greater wealth creation all around. Surveys even reveal that ESOP companies often outperform the stock market.

Even more telling is that research indicates sales, employment, and productivity all grow faster in organizations after they’ve established ESOPs than would have been expected otherwise. And those speedier growth rates are realized annually.

Before you share the wealth

Before embarking on an employee-ownership initiative, examine your reasons for doing so. Clearly establishing your motives will help you select the ESOP plan features that will most strongly support your goals.

Bear in mind that selling a majority of your business means relinquishing control. Therefore, setting up an ESOP could be viewed as just the beginning of a long-term plan.

Understand that participative management alone will not necessarily assure results, and in many cases, may not provide long-term effects. However, when combined with an ESOP, organizations can see dramatic increases in performance, productivity, and profitability.