Why More Startups Are Choosing Employee Stock Ownership Plans

Startup companies have a variety of necessities to iron out that increase the likelihood of future success. As they figure out the specifics needed to launch, a growing number of them decide to offer employee stock ownership plans (ESOPs). Here are four reasons why:

1. They Give Owners an Attractive Exit Strategy

ESOPs provide employees with ownership stakes in the company via stocks. As such, workers become partial owners in the company. If business leaders decide to leave their startups, some of them create an ESOP as an exit strategy. Doing that allows them to reward employees for their hard work and not have to look for external owners.

Making an ESOP before exiting the company also allows the departing person to receive the fair market value for any stocks held in cash on the day of the sale. Moreover, if a person only sells part of their ownership interest, they stay in control until receiving their full payments.

The business successors are the existing management team, too. They’ve likely played instrumental roles in building and upholding a company’s values and can continue to do that thanks to what an ESOP provides.

It’s also helpful that recent U.S. legislation makes it easier for companies to convert to ESOPs. Qualified companies must have been in business or profitable for at least three years.

2. ESOPs Have More Staying Power

Research indicates that about 90 percent of startups fail, but a more in-depth look at the statistics shows failure rates vary by industry. In any case, startup founders must be aware that the odds stack against them, especially in those all-important early days of operations. However, an academic paper about ESOPs found that those firms have higher survival rates than non-ESOP companies.

The study looked at the most severe instances of disappearing from the marketplace — closure and bankruptcy — as well as lesser factors like mergers. However, the authors admitted they could not find conclusive evidence to explain the longer firm survival aspect associated with ESOPs.

3. Increase Employee Morale and Productivity

Happy employees can be ambassadors for a startup, but disgruntled ones contribute to a toxic internal culture that often leaks to the outside. However, various studies suggest that capital-sharing arrangements, such as ESOPs can make employees feel more satisfied, causing them to want to work harder than they otherwise might.

Other research shows that ESOP companies grew five percent faster than non-ESOP ones. That could occur — in part — because employees feel heavily invested in the company and eager to help it reach goals.

There’s no single and guaranteed way to make productivity rise and keep it at a high level. But, evidence suggests ESOPs play a role in reminding employees that they have a direct interest in helping the company thrive.

4. Retain Employees Even When Paying Lower Salaries

One common challenge for startup founders to overcome is figuring out how to keep employees interested even if the salaries offered are lower than average. Since ESOPs give workers ownership stakes, they could help potential and current employees realize that perks come in many forms.

There are also early efforts to combine ESOPs with cryptocurrency. A company called Neufund wants to execute the stock options on the blockchain through tokens. That system could work even for non-blockchain or cryptocurrency-related companies.

Neufund created an employee incentive program to test its ESOP tokens. The company also made it open-source for other startups to use regardless of location. The ESOP tokens both set and enforce the terms of the agreement, making conventional contracts not necessary.

ESOPs can give employees a greater sense of belonging, thereby increasing their long-term loyalty to the company. Plus, the option to carry out ESOPs on the blockchain as mentioned in the Neufund case brings greater transparency into the equation.

Employees in an ESOP can also receive stock options as performance incentives. If startups cannot afford to give them traditional bonuses, stock options are another possibility that help show gratitude for well-done work.

Hiring for a startup is tricky, especially if people perceive the company as a high-risk opportunity or unknown. But, ESOPs give potential new hires access to more incentives beyond a traditional salary.

ESOPs Gaining Appeal

ESOPs still comprise a relatively small percentage of companies, but this list gives some of the many reasons why startups find them so attractive.

As new companies explore this option, other entities will likely follow those leads and respond in kind.

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