I. A Clash of ValuesS

Employee ownership is a valuable asset for anchoring a business locally, which provides many related community benefits. Any restrictions created to ensure retention of employee ownership diminishes the market value of the stock. Thus, individual employees pay the price for maintaining a community asset for the common good. This paper briefly explores the legal, social and moral issues involved.

Employee ownership is a growing trend in business globally and particularly in the high technology sector. Companies and people are motivated to provide and seek employee ownership for a variety of reasons including: employee motivation and retention; compensation based on company performance; a desire for control by employees; a desire by selling owners to "do the right thing"; a need to create a market for closely held stock; a need for capital, etc.

For many companies employee ownership is a transitory phase entered into to meet a specific financial or tax planning need. In most such circumstances there is no concern or planning around perpetuating employee ownership. In other circumstances, especially employee buyouts created to obtain control over a company during a change of ownership, employees expect employee ownership to be a permanent change. In some cases, where employee ownership was initially created simply to meet an immediate financial need, the corporate culture changes after the transaction to one where a permanent expectation of employee ownership develops.

As businesses are increasingly controlled by global corporations, there is increased desire for more local control of businesses. Creating permanent employee ownership to accomplish this end presents several problems and challenges. In an open market, any restriction on sale of stock will decrease the value of that stock. Upon creation of an employee owned company, the parties need to consider and balance the social and economic interests of the parties involved.

II. The Law Prefers the Free Market

When an ESOP receives a stock tender offer, the ESOP trustees have an obligation under ERISA to take the highest financial value for participants' stock, regardless of its effect on their job security. Similarly, corporate directors have a legal obligation to maximize shareholder value when a bona fide offer is made for their stock. Under both these scenarios, the law favors obtaining the highest dollar value over almost all other considerations.

III. The Road Less Traveled - Preservation of Employee Ownership

There are things some people value more than money. These often include independence, community, control over their own circumstances, etc. Yet, amongst any group, different individuals may place different priorities on each of these and on money. The same individual may value each of these differently at different points of his/her life.

How can these issues best be dealt with in the context of designing an employee owned company? In most cases they are not dealt with at all. The default position under the law is that employees have a right to sell their stock (once they get it, upon termination with a vested interest) to whomever they choose in an open market.

This essay deals with the more uncommon circumstance where a group of people wish to preserve employee ownership because they value it, understanding that its preservation will have some negative impact on market value of shares.

IV. Methods of Employee Ownership Preservation

An ESOP can preserve employee ownership by requiring the ESOP to repurchase stock from terminating employees and by reallocation of the repurchased stock to new employees. If this is done from the start, the ESOP participants are unlikely to gripe about the dilution of their stock this creates. However, such recycling of stock creates a never-ending repurchase liability as the stock (which hopefully increases in value) is continuously repurchased. This continuing repurchase liability burden can be substantial. However, many ESOP companies do this to ensure perpetual employee ownership.

Many majority employee owned companies require a supermajority vote of the shareholders to permit sale of substantially all of the assets of stock of the company. However, a generous financial offer is often enough to obtain a supermajority vote in favor of a sale to non-employee owners.

One of the best means to ensure continued employee ownership, is to avoid fiduciary liability by creating a direct and non-trusteed type of ownership. This allows the individual employee owners to act in their own interests, without the overlay of ERISA or corporate fiduciary standards.

Co-operatives are the most common method for doing this. In the US we have not seen many large, successful industrial cooperatives. However, the Mondragon industrial cooperative community, near Bilbao, Spain has established a formidable and dynamic model retaining ownership by workers and the community and providing necessary capital investment. They've accomplished it by creating a set of interlocking cooperatives including a bank, multiple manufacturing entities, several educational institutions, and a variety of business and social services.

For individual enterprises in the US, the limited liability corporation (LLC) may provide the most useful business entity form. It allows the members to contract with each other to control ownership on any agreed upon basis, called an Operating Agreement. The state laws generally created a set of rules that apply if there is no operating agreement or if it neglects to cover certain issues. The parties have great flexibility to allocate shares and powers amongst themselves as they see fit. Many states require an Operating Agreement for any LLC with more than one member. The trick to making perpetual employee ownership work in an LLC, is for the members to have a serious understanding of the trade-off they are making between control of the company and the value they might otherwise create for the company and themselves if they let shares be sold on the open market. Access to capital may also be limited when membership shares are not readily tradable on the open market. An example of this situation is a high tech company that wants to remain employee owned, and attract desirable high tech workers. If it values its stock on an IPO basis, it will shortly be forced into an IPO in order to pay its repurchase liability. To retain their independence, the members must agree on a formula for valuing the stock so they are not forced into an IPO and the inclusion of non-employees as shareholders.

V. A Global Discussion of Alternatives

There is a wide range of alternatives available to involve more employees and other stakeholders (such as customers and suppliers) in governance of a company. These alternatives intend to allocate corporate power to the diverse parties who create that wealth, rather than to the distant shareholders who currently hold the most favored default legal status. A more extensive discussion on the whole subject of Stakeholder Governance is underway on the Capital Ownership Group (COG) Homestead discussion group. To view the discussion goes to the library at the COG website (http://cog.kent.edu) and view the Homestead discussion. To receive the current email on this discussion, go to the COG website and register for the Homestead discussion. If you have questions about these discussions email cog@kent.edu. COG is a global virtual think tank on use of broad ownership to counteract the negative effects of globalization. It currently includes 236 participants from 58 countries, engaged in eight discussion groups in several languages.