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Retaining rural businesses through employee ownership

Twp employees working at a manufacturing pipe facility

The rural business succession crisis

A generation of business owners is retiring and many lack a succession plan. According to the U.S. Census Bureau, in 2016, more than 110,000 Minnesota and Wisconsin businesses with employees were owned by people 55 years or older. For these businesses, a lack of succession planning could lead to the loss or relocation of thousands of jobs and instability in local economies across the Upper Midwest.

This trend is particularly problematic in rural communities where the ability to retain and expand existing businesses is often the best strategy for economic development. The idea of employee ownership, particularly in the form of worker cooperatives, may be a possible solution to this dilemma.

Becoming employee-owned can keep businesses’ doors open, save jobs and offer community benefits. It is a triple-win solution for the owner, the employees and the community.

Employee ownership: A business succession solution

What is employee ownership?

Businesses with fewer than 100 employees that are employee-owned are typically organized as worker cooperatives. A worker cooperative is owned and managed by employees. It is a value-driven business with the core purpose of putting worker and community benefit first. The two central characteristics of worker cooperatives are:

  • Workers own the business and participate in its financial success on the basis of their labor contributions.
  • Workers vote for their representation on the board of directors, with the principle of one worker, one vote.

In addition to economic and governance participation, worker-owners engage in day-to-day operations through participatory management structures.

More than 465 worker cooperatives exist in the United States, employing approximately 6,400 people and generating more than $505 million in annual revenue. The number of worker cooperatives has grown steadily during the past 10 years and increasingly includes longstanding businesses sold to employees by owners. Any business can be worker owned and controlled.

Between worker cooperatives and Employee Stock Ownership Plans (ESOPs), there are fewer than 7,500 employee owned companies in the U.S. When compared to the approximately 6 million firms in the country — including 2 million firms that employ more than four employees — there is a great deal of opportunity to convert businesses to employee ownership. This is especially true in this time of transition of ownership from boomers to other generations.

Benefits of employee ownership

Some benefits of employee ownership for selling owners, employees, and local communities include:

  • Financially rewarding exit path with potential tax savings for the selling owner(s).
  • Lasting legacy for the selling owner(s).
  • Reward for employees who helped build the business.
  • Potential to improve business performance and increase employee engagement, productivity and retention.
  • Retention of services, jobs, wealth and tax base in the local community.

Potential tax benefit of selling to employees: The 1042 rollover

Section 1042 of the IRS Code allows a business owner to defer tax on capital gains related to the sale of the business if they sell at least 30 percent of the business to an Employee Stock Ownership Plan (ESOP) or worker cooperative.

In order to qualify, the seller must reinvest the proceeds from the sale into “qualified replacement properties” within 12 months of the sale. While the 1042 rollover has not been widely used by worker cooperatives, thousands of ESOPs have made use of the 1042 rollover since it became available in 1984.

Examples of employee-owned businesses

For stories across the nation about employee-owned businesses, visit the Becoming Employee Owned website.

Stages of transition

Converting a small business to employee ownership requires an investment of both resources and professional assistance to ensure success and long-term benefits. While the process is unique for each business, it generally has five stages.

Below is an outline of the stages, with approximate durations and costs — though these may vary widely depending on the complexity of the business and the readiness of employees to become owners.

  1. Explore

    • Duration: Time varies
    • Cost: $0
    • What: Key stakeholders consider the idea and decide if it is worth pursuing. Selling owner clarifies his or her desires, concerns and realities related to selling the business
    • Who: The selling owner, a local adviser who can offer confidential guidance, sometimes key employees.
  2. Assess

    • Duration: 3–6 months
    • Cost: $5,000
    • What: A business valuation is completed and experienced professionals affirm that a financial, legal, and organizational transition is feasible.
    • Who: The selling owner, trusted professional advisers, sometimes key employees.
  3. Structure

    • Duration: 6–12 months
    • Cost: $10,000
    • What: Terms of sale and any organizational or leadership changes are established; legal documents are drafted for the transaction and new entity; financing is secured.
    • Who: The selling owner, a representative team of the employees, professional advisers.
  4. Complete

    • Duration: 3–6 months
    • Cost: $10,000
    • What: Loans are drawn; the company legally changes hands; bylaws are formally adopted; a founding board is elected.
    • Who: The selling owner, the employees, professional advisers, lenders.
  5. Support

    • Duration: Varies
    • Cost: Varies
    • What: Ongoing training addresses leadership and operational gaps and orients management to new roles.
    • Who: The employee-owners, professional advisers.

Resources

Following are some resources available on a regional and national level, as well as co-op friendly lenders.

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Partners in this education and research project are the University of Minnesota Extension, University of Wisconsin Center for Cooperatives and Cooperative Development Services. Grant funding is provided by the North Central Regional Center for Rural Development at Michigan State University.

Reviewed in 2020

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