Are you considering selling equity in your company because you need an infusion of cash? Are you trying to put together a succession plan?
Or are you concerned that you don’t have the resources to pay key employees the market rate for their work? Do you want to reward your staff for a job well done?
The answer to all those concerns could be the same: giving some equity ownership to employees.
“Sharing equity ownership can help retain and motivate key employees who keep the business running and thriving, who would be difficult to replace and who would negatively impact the performance of your business if they left,” says Ben Howatt.
However, the decision requires careful thought. That’s especially true if you are considering it to help retain and motivate employees, Howatt notes. “The most common mistakes owners make are being too generous and not recognizing the future consequences of the decision.”
The first question to ask yourself is what the employee will add that will benefit the company, says Steve Hockfield “You don’t want to do it just because it’s a nice thing to do. After all, you are giving away part of a valuable asset.”
Another key, Hockfield says, is compatibility. “If they’re not marriage material, don’t do it. Do they have a bad temper? Do they treat other employees badly? You’ve got to trust them fully.”
Still, selling an ownership stake to an employee has many benefits. “They’re good prospects — you know them in a business setting,” Hockfield says. But, he adds, you might also consider playing tennis or a round of golf with them. “If they cheat at sports, they’ll probably cheat at business, too.”
Also, a key employee “understands the company and is closer to the situation — it would be harder to make a pitch to an outsider,” says George McAllister. “And because they’re not totally clueless, you can have confidence they can take the company forward when you retire so your employees can keep their jobs. They probably won’t crash and burn.”
Be aware, however, that once an employee has some ownership in the firm, it changes your relationship with that individual. “They may want to see the financials and want more of a say-so in the decision-making process,” McAllister says. “And they need to understand they can still be fired — they don’t have a job for life.”
That’s why a written agreement reviewed by an attorney is a must. “If you make it a handshake deal, you will probably live to regret it,” Hockfield says. It’s wise to make sure you maintain control of the company, he adds. You should also negotiate noncompete and nonsolicitation pacts.
Howatt says the written agreement should establish rules and procedures for buying back stock and describe the methods for calculating a buyback price. You also should review your corporate bylaws and shareholder agreements with an attorney to fully understand the obligations created by issuing equity ownership.
Of course, you’ll need to decide how — and how much — the employee will pay for the equity. Will it be with cash or sweat equity? Don’t forget there are tax implications to consider.
Howatt reminds business owners that if their main objective in sharing equity in their company is to reward employees, there are other options to consider, such as cash bonuses, deferred compensation plans, phantom stock and stock appreciation rights.
Whatever your motivation for sharing equity with your employees, go through with it only if it will benefit the company in some way.
Consider all the implications — financial and legal as well as how your relationship with the employee will change and how it may impact how you run the business.
Consult an attorney to put the agreement in writing. Be sure you keep control of the company.