"I
want
him
to
have
a
piece
of
the
action."
"I
want
him
to
have
some
skin
in
the
game."
"He
wants
equity
in
the
company."
In
this
case
"him"
is
a
key
manager
or
valuable
employee,
male
or
female.
If
you're
a
business
owner,
you've
probably
said
or
heard
one
of
these
things.
They
come
up
all
the
time
in
meetings
of
Chief
Executive
Boards
International.
There are two sets of assumptions in these statements, both usually mistaken. The employee assumes that he'll become richer if he has a piece of ownership in the company, and that the owner would be inclined to gift that to him. The owner assumes the employee understands the risks and rewards of business ownership, and is willing to take them, including putting some money at risk.
What the employee is usually saying is, "I want to make more money, and I want to be recognized and rewarded for my contribution to the company's success." What the owner usually wants is a way to motivate the employee to better performance, to think more like an owner, and to have some "bronze handcuffs" that would disincentivize him from leaving.
So, business owners spend an inordinate amount of mental energy, consulting fees and legal fees to put plans in place to accommodate additional owners (partners). You need buy-sell agreements, valuation plans, stock restriction agreements, non-competes, employment contracts and a variety of other suspenders and belts to make this work. And then?
"You want me to PAY for that?", the formerly-interested would-be partner exclaims. That's when the business owner gets offended. He can't believe, after all that begging and what he's spent to set the company up for multiple owners, the employee thinks he's somehow entitled to the gift of equity. I've actually seen long-time great relationships between owners and key employees spoiled by this misalignment of expectations.
So, what are the options? First, when the topic of equity comes up, make your position clear -- you're not giving it away and you're not buying into the idea of "sweat equity" (a euphemism for giving equity away). One CEBI member suggested the best response to "I want some equity" is, "How much is your house worth?", meaning "How much money could you come up with to buy into the company?"
That's usually the end of the equity conversation -- when the employee realizes he's going to have to actually put something at risk. So, what are some alternatives to meet both the objectives of both the employee and yourself?
There are two sets of assumptions in these statements, both usually mistaken. The employee assumes that he'll become richer if he has a piece of ownership in the company, and that the owner would be inclined to gift that to him. The owner assumes the employee understands the risks and rewards of business ownership, and is willing to take them, including putting some money at risk.
What the employee is usually saying is, "I want to make more money, and I want to be recognized and rewarded for my contribution to the company's success." What the owner usually wants is a way to motivate the employee to better performance, to think more like an owner, and to have some "bronze handcuffs" that would disincentivize him from leaving.
So, business owners spend an inordinate amount of mental energy, consulting fees and legal fees to put plans in place to accommodate additional owners (partners). You need buy-sell agreements, valuation plans, stock restriction agreements, non-competes, employment contracts and a variety of other suspenders and belts to make this work. And then?
"You want me to PAY for that?", the formerly-interested would-be partner exclaims. That's when the business owner gets offended. He can't believe, after all that begging and what he's spent to set the company up for multiple owners, the employee thinks he's somehow entitled to the gift of equity. I've actually seen long-time great relationships between owners and key employees spoiled by this misalignment of expectations.
So, what are the options? First, when the topic of equity comes up, make your position clear -- you're not giving it away and you're not buying into the idea of "sweat equity" (a euphemism for giving equity away). One CEBI member suggested the best response to "I want some equity" is, "How much is your house worth?", meaning "How much money could you come up with to buy into the company?"
That's usually the end of the equity conversation -- when the employee realizes he's going to have to actually put something at risk. So, what are some alternatives to meet both the objectives of both the employee and yourself?
- A
well-defined
current-year
incentive
compensation
plan
that
pays
out
annually.
Then
give
the
employee
the
option
of
diverting
a
large
portion,
if
not
all,
of
that
payout
into
a
qualified
retirement
plan
(SEP,
SIMPLE
or
401(k)).
- A
long-term
incentive
compensation
plan
that
accumulates
performance
over,
say,
3
years
and
then
pays
out
similar
to
#1
above.
- A
deferred
compensation
plan.
This
is
usually
calculated
on
the
same
basis
as
options
1
or
2
above,
except
that
the
payout
isn't
immediate
--
it
is
deferred
into
the
future,
thereby
incentivizing
the
employee
to
stay
and
quantifying
the
"leave
behind"
in
case
of
termination.
These
types
of
plans
usually
"vest"
some
number
(3-5)
years
after
the
incentive
is
earned
and
then
pay
out
upon
reaching
an
age,
say,
60
or
65
or
in
the
case
of
change
of
control
(you
sell
the
company).
- A
phantom
or
shadow
stock
plan.
These
plans
are
not
"real"
stock.
The
employee
is
neither
an
investor
nor
shareholder.
It's
essentially
a
promise
of
the
company
to
pay
in
the
future
some
compensation
that
emulates
the
outcome
of
stock
actually
owned.
Shadow
stock
would
be
awarded
as
part
of
a
well-defined
incentive
compensation
plan.
The
shadow
stock
would
emulate
the
value
of
real
stock,
thereby
providing
the
key
employee
with an "owner-like"
benefit
without
having
actually
invested
in
the
company.
- A "change of control" agreement. You agree with a key employee that if he stays on until you cash out of the business, he gets a piece of that deal. Can be a fixed amount, an amount based on the transaction value, and may increase over the years. This "bronze handcuff" costs the employee nothing, and you owe him nothing if he doesn't stick with you.
