Rebuilding: Employee Profit Sharing, Co-Ops, & ESOPs
As we have heard over and over again from operators around the US, the current compensation model for restaurants needs to be reimagined.
This article outlines alternatives to traditional business ownership models, including Employee Profit Sharing, Cooperatives (Co-ops), and Employee Stock Ownership Plans (ESOPs). Each section includes an overview of the model, as well as a list of the associated benefits and challenges, and examples of companies using these models.
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Gratuity Free + Employee Profit Sharing ⟶
Thinking about rebuilding your employee compensation model? Let us know. We are here to help think through options that make sense for your business | hello@oystersunday.com
Gratuity Free + Employee Profit Sharing
The gratuity-free model — also sometimes referred to as the “tip-free” or “hospitality-included” model — is a system where servers don't accept tips and are instead paid an hourly living wage, often plus employee benefits like health insurance. Companies raise the prices to be inclusive of service, so tipping is built in, wages are higher, and income is distributed more evenly throughout FOH and BOH. Review this how to guide for building a tip out structure [Here].
Benefits
Equitable wages across front-of-house and back-of-house staff
Operators have said through research and anecdotal experience that standard tips and lower minimum wages in restaurants lead to higher degrees of sexual harassment and racial discrimination, alongside issues tied to immigration status, so removing tipping can raise the bar of equality and help create a safer work environment
Payment comes week to week based on hours worked rather than each night, leading to an increased fairness in shifts
Earning a portion of the weekly revenue also contributes to a collaborative team-based approach - your team will have financial incentive to train their colleagues to be their best because employees earn a portion of the weekly revenue, not just the shifts they specifically work
Lack of need to work during “busy” shifts for tipping allows for more flexibility in shifts for a working parent who may need to be home on weekend nights for example
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Challenges
The switch from the standard tipping model to a no-gratuity model requires a lot of calculations. There is a need to leverage as much sales data as possible to inform menu engineering and allocation of revenue to your hourly employees
It requires a significant amount of time to implement a new gratuity free system when transitioning from a traditional tipping model, which can lead to financial strain
Raising prices to include gratuity can be a sticker shock to some regulars and customers used to the old system so over-communicate that the tip is not expected on top of your pricing is a critical success factor.
Consider communicating at several points in the guest experience including the point of reservation and with the greet at the table.
Consider removing the tip line on your checks in order to provide clarity that your restaurant is a gratuity-free house.
Buy-in from customers is required in the long run to sustain a higher price model
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Relevant examples of Gratuity Free/Employee Profit Sharing Companies
Juliet | Somerville, MA
Hunky Dory | Brooklyn, NY
Zazie | San Francisco, CA
Cooperatives (Co-op)
Cooperatives are interesting to those companies who are interested in having employee engagement baked into the business structure through employee governance and profit sharing. They are less expensive however have many similar tax benefits to ESOPs. Conversions can take anywhere from six months to three years depending on the nature of the business, size and culture. Cooperatives are a great option for leaders who are looking for an exit strategy. Strong company culture and clear leadership are required for cooperative conversions.
The legal set up varies from state to state, and The Sustainable Economies Law Center has a library of resources to guide you through best practices and link you to regional attorneys well-versed in cooperatives. Cooperatives are frequently funded by Community Development Financial Institutions, credit unions, and local banks, or some businesses are able to finance the sale to employees through a Direct Public Offering. [Source]
If considering a change due to COVID-19, visit Project Equity for a free consultation.
Benefits
Empowers staff to be productive employees and leaders, offering variety of perspectives and ideas during crises like COVID-19
Offers unique tax advantages in which the owner and business can benefit from significant tax structures
Provides a potential exit path for leaders looking to leave the business
Provides fair market value once capital and establish lenders finance the sale
Resilience in crisis such as COVID-19, read more about Bay Area Co-Ops success during COVID-19 here
Accommodates flexible financing since employees do not finance the transaction and a leveraged buyout offers maximum flexibility
New employee-owners build equity, preserve business legacy and keep money circulating in the local economy, strengthening the local economy
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Challenges
Lack of strong leadership of company culture will make a cooperative difficult to run- it requires a specific kind of business and business model
Less capital incentives which means they do not appeal as much to big investors to take part
Potential to have slower decision making processes due to more “cooks in the kitchen”
Shared pricing with competition means that coops do not have an edge over competition and have a level playing field, regardless of size.
They are not feasible for everyone. They can be a good choice if you want to start a business, but need more peer support or financing, but they should be avoided if you want more control over the direction of your business.
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Relevant Examples of Co-Ops
Associated Wholesale Grocers
The largest co-op food wholesaler for independent supermarkets in America.Park Slope Food Coop
This is one of the oldest and largest food co-ops in America, located in Brooklyn, New York. In exchange for working a few years every month, members can buy foods and other goods at a substantial discount.Zingermans
The Zingerman's Community of Businesses (ZCoB) is a family of small food-related companies and entrepreneurial ventures. Each is located in the Ann Arbor area. They are operated by one or more partners who share ownership and manage the business.+ More Examples | [here]
Employee Stock Ownership Plan (ESOP)
An employee-owned company plan is more commonly referred to as an “employee stock ownership plan,” (or ESOP), but the name conveys the right message: In an ESOP, the employees are given stock in the company as part of compensation for working at the company, making those employees shareholders in the company. Although this type of plan can have benefits for the employees, it’s also often advantageous to the company itself when it comes to taxes.
An ESOP is essentially a retirement plan in which the company contributes its stock to the plan to be held in trust for the benefit of its employees. The stock is never bought or held directly. Typically, vested employees are sent annual reports detailing their respective stakes in the company. When those employees quit or retire, they receive in cash whatever amount they -- and the company, through increased revenues, new sales and controlled costs -- are due.
Key Requirements for a Successful ESOP
Extremely strong middle/senior-level management teams
Shareholder confidence in management’s ability to grow the business is critical in order to create the cash flow to pay off acquisition debt [Source]
Companies that generally produce consistent and predictable financial results are the most successful ESOPs
Selling shareholders who have a deep interest in preserving the legacy of the company (financially and culturally) and rewarding management and employees with ownership
Strategic thinking around the long term planning and sustainability of the business (accounting for administration costs for the ESOP, potentially repurchasing vested shares from employees who terminate employment, additional retirement plan offerings, etc)
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Benefits [Source]
Financial benefits
Many private business owners use ESOPs as their exit strategy, since ESOP’s are an excellent tool for succession planning, both for liquidity and transition
The flexibility of ESOP transactions allow owners to withdraw slowly over time or all at once, depending upon their needs. Owners can sell from one to 100 percent of their stock to the newly created ESOP. This makes it possible for an owner to remain active in the business even after selling all or most of the company
Tax advantages are significant for selling shareholders if the ESOP is purchasing shares from a C Corporation, using section 1042 of Internal Revenue Code, also known as a 1042 rollover. This means the selling shareholders can roll their proceeds from their sale into other investments tax-free, essentially deferring paying taxes until ultimate liquidation of the rollover investment assets
Tax advantages are even greater for the company, since all payments made to the ESOP are tax-deductible - meaning both the principal and interest payments made to a bank or selling shareholder provide a tax deduction to the corporation
“Regardless of how the plan acquires stock, company contributions to the trust are tax deductible within certain limits.
The 2017 tax bill limits net interest deductions to businesses to 30% of EBITDA for four years, at which point the limit decreases to 30% of EBIT.
In other words, starting in 2022, businesses will subtract depreciation and amortization from their earnings before calculating their maximum deductible interest payments. [Source]
Tax advantages continue if the ESOP holds shares in an S corporation, meaning that because the ESOP is a tax exempt trust, the earnings attributable to the ESOP owned shares are not taxable
Employee culture benefits
“A rising tide lifts all boats” mentality - improvements and success will benefit everyone together
Increased collaboration and brainpower for problem-solving, anecdote from King Arthur Flour [Here]
Absolute transparency in terms of financials, ownership, company management etc
Participants in the plan can receive significant retirement benefits at no monetary cost to them
Research shows ESOP companies are more productive, faster growing, more profitable and have lower turnover — benefits that accrue to all stakeholders including the retirement accounts of the employee-owners
Strong retention and recruitment strategies frequently occur due to effective and ongoing employee communications encouraging employees to think and act like owners
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Challenges [Source]
ESOPs are not a culture fit for every business. They require a culture that promotes collaboration, shared success, long term financial planning and ideally a consistent and predictable financial results
Shareholders using the creation of an ESOP as an exit strategy need to keep in mind that the price that an ESOP can offer per share is limited to the fair market value of the said shares, meaning that the price may be lower than what could be paid be a strategic buyer
ESOPs cannot pay a strategic premium for the shares they acquire
Business owners and management need to keep in mind that potentially costly administration of the ESOP is required (third party administration, valuation, trustee and legal costs)
ESOPs have an obligation to repurchase vested shares from ESOP participants who terminate employment. Therefore, careful cash flow planning should take into account the funds necessary to meet ESOP repurchase obligations. Without adequate planning, repurchase obligations can compete with other capital needs, thereby limiting the growth and potentially the viability of the company.
It is suggested that ESOPs offer retirement benefits in addition to ESOP in case the failure of the business leads to the employees losing any accrued value in their ESOP accounts
Many ESOPs also offer a 401(k) or a profit-sharing plan to prevent this from happening
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Relevant Examples of ESOPs
Bob’s Red Mill, (100% employee-owned)
Chobani (10% employee-owned)
In 2016, Chobani's CEO Hamdi Ulukaya gave 2,000 full-time employees ownership stake in the company, specifically in how many shares they were given, based on tenure. The shares can be converted into stock or cash if the company goes public or sells itself. [Source]
King Arthur Flour (100% employee-owned)
Since 2004, King Arthur Flour has been 100% employee owned. After a year on the job, workers begin to earn stock in the company. This nest egg helps employee-owners secure a better retirement and gives them a clear interest in the company's success.
"Because everyone has a stake in it, we know we're working not just for the company but for ourselves," says Rosie, who's part of the merchandise team that selects which products King Arthur Flour sells. "No matter what, people feel like they can speak up and ask questions and offer advice."
Publix Super Markets and WinCo Foods (+50 percent employee-owned)
List of America's Largest Majority Employee-Owned Companies [Source]
Additional Resources
Employee Profit Sharing
Toast, How Two Restaurants are Thriving on a Gratuity-Free, Profit-Sharing Model
Toast, The Tipping Point: What Happens at a No Tipping Restaurant?
Cooperatives (Co-ops)
Conscious Company Media, How to Convert Your Business to a Cooperative
Green Garage Blog, 10 Pros and Cons of Cooperatives
Employee Stock Ownership Plans (ESOPs)
Design Intelligence: Employee Stock Ownership Plans: The Pros and Cons
Investopedia: Employee Stock Ownership Plan (ESOP)
King Arthur Flour:
General Information
Disclaimer: The consolidated resources are here for your consideration. The information provided above is not legal advice. We recommend talking to your lawyer to ensure all state + federal compliance is maintained. If you do not have legal representation, we would be happy to connect you with legal counsel. We understand that circumstances are changing quickly and we are updating content as it is available.
