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

by WOHe

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
  • 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
  • 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
  • Taking tax benefits. Certain employee ownership structures
    qualify for tax benefits.

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

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

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

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

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

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

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