Profit-Sharing Cited as Key to Retaining Employees, Experts Offer

Profit-Sharing Cited as Key to Retaining Employees, Experts Offer

Kitchen and bath dealers who want to attract and keep the best employees and who want to motivate them to help the dealership become more profitable may want to consider establishing a profit-sharing or employee stock ownership (ESOP) plan.

You may share ownership with your employees for a variety of reasons. For some people, the reason may be simply "it's the right thing to do." For most others, however, there are purely practical reasons to share ownership. Employee ownership can have benefits for owners of businesses, employees and their companies. Among those benefits are:

  • Attracting and retaining good employees. Many small businesses have trouble attracting and retaining good employees. Using employee ownership as an employee benefit can be an important way to address this problem.
     
  • Buying out an owner. In almost every small business, the owner or owners will eventually want to leave. Often, no family member or colleague can take over and there are no buyers willing and able to buy the business at a reasonable price. Selling the business to employees can be a way out of this dilemma.
     
  • Sharing entrepreneurship. Starting or running a small business is difficult. Many people find that sharing the risks and responsibilities of ownership with others lessens these burdens.
     
  • Raising capital. Employee ownership can help provide additional capital. Employee owners may be willing to contribute to the company by buying shares or taking lower wages in return for stock. Employees with no stake in the business see little need to pitch in.
     
  • Helping the business to perform better. Many studies demonstrate that employee-owned firms perform substantially better, on average, than non-employee owned firms. This is especially true when employee-owners can participate in decisions affecting their work.
     
  • Taking tax benefits. Certain employee ownership structures qualify for tax benefits.

There are several types of profit-sharing or ESOP plans to consider.

Profit-sharing plans provide for the participation in company profits by your employees or their beneficiaries. Company contributions may be determined either by fixed formula or at the discretion of your board of directors.

In a cash profit-sharing plan, profits are paid directly to employees in cash, check or stock as soon as profits are determined. (This type of profit-sharing plan is not a qualified retirement plan.)

A deferred profit-sharing plan is designed to provide benefits to participants upon retirement. Benefits at retirement are based strictly upon the sum total of the contributions made and the result of investments. This plan must provide a definite pre-determined formula for allocating contributions made to the plan participants.

With a profit-sharing plan, your company must place the assets in a trust, which must be administered by an independent trustee.

Profit-sharing has major tax advantages for both your company and your employees. The contributions your company makes to the plan are immediately tax-deductible, and your employees pay taxes only when they cash out.

An employee stock ownership plan (ESOP) is a type of tax-qualified employee benefit plan in which most or all of the assets are invested in stock of the employer. Employees do not actually buy shares in an ESOP. Instead, the company contributes its own shares to the plan, contributes cash to buy its own stock (often from an existing owner), or, most commonly, has the plan borrow money to buy stock, with the company repaying the loan.

All of these uses have significant tax benefits for the company, the employees and the sellers. Employees gradually vest in their accounts and receive their benefits when they leave the company (although there may be distributions prior to that).

Like profit-sharing and 401(k) plans, which are governed by many of the same laws, an ESOP generally must include at least all full-time employees meeting certain age and service requirements.

These plans are ideal if you have more than 20 employees. Smaller businesses, however, may find these too costly and cumbersome to operate.

Your business must be set up in one of three ways: as a sole proprietorship, as a partnership or as a corporation. In a sole proprietorship, business property, liability and income are treated as the personal property of a single person. If your business is set up this way, you may have to change before you can consider one of these plans.

If you have only a few employees with whom you have a long-standing and close relationship, you may want to consider changing to a partnership and making them partners.

However, this is not recommended by many experts. Among other drawbacks, the more partners there are, the more chance there is that a partnership will run into problems. One such problem is that the entire partnership can be committed to a binding contract by any one partner. Another is that the entire partnership can be liable for the wrongful acts of any one partner. In addition, partnerships may require consensual decision-making on many issues, and they may legally terminate with the departure of only one partner.

However, a partnership is also the least expensive way to share ownership among less than five or six employees. Using self-help books, you can probably write a partnership agreement yourself and pay for legal counsel only to review the completed agreement.

A corporation is the best way to share ownership.

Any incorporated business, no matter how small, can give or sell shares directly to employees. New shares can be created or they can be purchased from a previous owner. If employees acquire shares directly, they become direct owners, and can exercise all of the rights associated with ownership, including a share of the company's equity value and voting rights. Employees can receive shares that give only voting rights, only equity rights, or both, and with any percentage of the total voting or equity stake.

Employees can be allowed to re-sell their shares freely, or resale can be limited for any reasonable business purpose. If employees buy shares, the company must obtain an exemption from securities registration. This must be obtained on both the federal and state level. You must also file anti-fraud disclosure statements to employees. This can cost several thousand dollars.

With "restricted stock," companies can grant employees shares that are subject to restrictions. Under these plans, your employee receives a defined number of company shares. They are subject to forfeiture and transfer restrictions unless certain qualifications are met, such as the employee staying with the company for a defined number of years, the company meeting specified profit goals, or the employee meeting specific individual goals.

Taxation issues are complicated, and a tax attorney should be consulted. But, generally, the value of the shares becomes a tax deduction for your company. However, your employees may have to pay tax on receiving the shares, unless they elect to defer them.

Cooperatives can also be used for employee ownership. They are a type of company in which control is on a one-person/one-vote basis. Cooperatives can be set up as partnerships or corporations, and in some states, there are worker cooperative statutes.

Whatever form a cooperative takes (most are set up as corporations), they qualify for special federal tax benefits.

Cooperatives are the oldest form of employee ownership in the United States, dating from the early 1800s. Although they are not common in larger businesses, they make up a large portion of small, employee-owned businesses. Set-up costs are very low, and there are distinct tax advantages.

Cooperatives generally set up an internal account, and profits are allocated to the cooperative members based on a pre-arranged measurement, usually hours worked. The profits are deductible to the company and taxable to the employee. When an employee leaves, he gets his account balances, usually with interest. When a new employee is hired, he buys his share at a base price.

The costs of setting up these plans can range from very low, in the case of cooperatives, to very high; an ESOP can typically cost about $20,000. But the tax advantages and gains in productivity from more motivated and committed workers may offset these costs.

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