A Step-By-Step Guide To Setting Up An Employee-Owned Business

Research supports the idea that giving employees stakes motivates their best work. With financial stakes, employees feel a greater sense of purpose and obligation to the company. As a result, the business benefits, improving its overall performance and financial earnings. 

This “win-win” scenario cultivates an engaged workplace culture. When companies make the switch, few back away from the setup because it works. Of course, motivation and stakes can only go so far if the company is not set up financially to preserve this system for the long haul. 

To help prepare your business for its future as an employee owned business, we’ve broken down the key steps to setting one up with the following instructions. Consider this information as you begin building your company for the future. Secure future leaders with what they need to think like employees and employee-owners. 

  • Make tax deductible shares to a tax-exempt trust. 

To establish an employee-owned company, you’ll need to make tax-deductibles of shares to a trust that is tax-exempt. The contributions will purchase shares for the employees. Employees will not pay income tax until they receive their shares. The contributions can be distributed to employees as they relate to salary or the number of years worked; all contributions are accumulated on a tax-deferred basis. 

  • Ask the right questions before starting your employee owned business. 

Setting up employee owned businesses requires asking key stakeholders and company founders questions that prepare them for this new system. Some questions to consider are as follows: 

  1. At what time will you leave your business?
  2. Do you know the company value based on a business valuation?
  3. What financial obligations are needed to achieve post-ownership objectives?
  4. Will your staff be prepared to lead? 
  • Prepare future company leaders. 

The last question is the most pertinent, as only some employees will have an entrepreneurial mindset. Owners must have the entrepreneurial mindset and intuition to take over once the founder has left. Before you legally set up your new system through an employee owned business, identify the leaders you’ll need within your staff and begin preparing them for their future roles. 

  • Make sure employees profit over time.

Once the employees are vested in the system of the new employee owned business, milestone marks reflect how vested they are in the company. For example, at the three-year mark, employees are fully vested. As time passes, employees move closer to being able to sell their shares and profit. 

The employee’s marginal tax rate will tax the profits earned within the year their shares are sold. There are additional ways that employees can defer taxes, such as moving the proceeds acquired from the employee owned business to an IRA or 401(k). 

Ensure that your ESOP succeeds.

Maintain a clear understanding of how many employees you’ll need to keep your ESOP feasible. It will take time to establish, so start planning years before you leave. Develop the right strategy to ensure your eventual employee owned business will succeed.