In his recent post Peter wrote about the benefits of making employees feel like owners by giving them stock so they'll act like owners. On the surface that seems like a logical way to go but if
not considered carefully, your good intentions could become a train wreck of problems. What do we mean when we say that we want our employees to "think like owners?" If employees wanted to think like owners, it would seem that they wouldn't have chosen to be employees in the first place but would be out there starting businesses. If we mean that we want them to think in the best interests of the company, stock is not necessarily going to give that result. I know several employees with stock at big companies who are just waiting until their next vesting date to leave because they don't like the culture or the leadership and no amount of stock is going to keep them there for the long term. And while they're waiting for that vesting date, they're complaining, lowering morale, and not giving the company their best performance. Now that's not an outcome that the company counted on!
In technology start-ups, stock or stock options (rights, not obligations, to purchase company stock at a favorable price) are often given to compensate for low pay with the thought that when the company is sold, or goes through an IPO, the employee will get rich. But remember that these are generally private companies so it's very difficult to determine what the actual value of the stock is because there's no market for it. Consequently, unless the employee feels very confident that there is a liquidity event in the company's immediate future, he or she is not going to be motivated by stock. What's more, if the event never happens (which is more often than not), you will have a very disgruntled employee on your hands. The bottom line is that giving employees an ownership stake in the company may not produce the results you want. What's worse, it may produce a lot of results you don't want. For example, what happens when you want to fire an employee who holds company stock? If you have a private company that has granted stock to a few key employees, you could be faced with a long and costly lawsuit claiming that the fiduciary rights of the minority shareholder (your employee) had been violated by the firing. Granting stock is serious business that should not be taken lightly.
There are other ways to "share the wealth" with employees that will reward their performance and commitment without raising the prickly issues associated with ownership. First and foremost is to provide meaningful jobs where employees feel that they're making a difference. Then you'll get an emotional investment in the company that will be worth rewarding. One way to reward employees is with phantom stock, which is not equity but rather stock that is tied to the value of the company's stock as determined by a formula devised with the help of an accountant. So if during a specified period the value of the company's stock goes up by, say, $25 a share and the employee holds 1,000 shares of phantom stock, the employee will earn a check in the amount of $25,000 (on which they'll pay taxes on ordinary income) and the company will get to deduct the $25,000 from its taxable income. You should get the help of your attorney and your accountant in setting up such a program.
If you want your employees to think like owners in the sense that you want them to be thrifty, then you might want to give them a percentage of any money that remains in their budget at the end of the fiscal year, assuming they have accomplished all they were supposed to with the budget.
If you do decide to award stock or stock options, you need to have a well--written shareholder agreement that includes the following:
- A statement that the grant does not change the employee's status with the company
- A clause giving the company the right to buy back the stock if the employee is fired, leaves, or dies (you don't want your stock in the hands of relatives)
- A clause stating that the employee cannot sell or transfer the stock outside the company
Be sure to have your attorney review it to make sure you haven't left anything out that could adversely affect your company. The issue of granting ownership rights to employees is very complex. Make sure you have checked out all the other options first before heading down the equity path.
There are some good points in this -- and some misleading ones. First, there has never been a successful lawsuit (and I am not sure even a lawsuit that has proceeded to trial) that links employment rights to stock acquiresdthrough an equity program. So this is a bogus concern. Second, private companies can ascertain value for shares -- in fact, they have to do so under IRS rules for options and other equity awards. They can do this with an independent appraisal or some internal method that follows IRS guidelines. Private companies can also provide liquidity before being sold or going public (the vast majority get liquidity via sale, not an IPO) by buying back the shares, allowing other employees to buy them, making them available to investors, or, if they are large enough, using one of the recently developed market systems for these shares. Having said this, though, I agree for most private companies, stock appreciation rights or phantom stock make more sense because a) if you are going to solve the liquidity problem internally anyway, that means any shares are just held momentarily before sale, so why bother with shares? and b) it means that employees can get liquidity before a liquidity event occurs, making the awards more real to them. I also agree that merely sharing ownership is not enough. You really need to get employees involved by sharing company performance information broadly and allowing employees to make more decisions about their own work. Companies that do this, research shows, perform vastly better than those that do not. They create a culture of ownership. So why then bother with any kind of equity, phantom or real? Why not just the "sense of ownership?" How about if I take all you sense of ownership folks out to eat to a nice place to celebrate your insight? You can smell the food, soak up the atmosphere, help choose the dishes, and even help pay for it. But no actual dinner for you -- after all, a sense of dinner should be enough. A sense of ownership is just as manipulative and just as ineffective. For a detailed guide on issues concerning private companies, go to www.nceo.org and consider the book The Decision Makers Guide to Equity Compensation, or Equity Compensation for Limited Liability Companies. Corey Rosen Executive Director National Center for Employee Ownership
Great comment from the perspective of someone who works to promote employee ownership. I agree there are ways to ascertain value but they're not bullet proof- at best they're an educated guess at a specific point in time because we have no willing buyer or seller for the business to know what the real market value is. I'm not convinced that employees, in general, are beating down the doors to experience real ownership and all the responsibility and liability that goes with it. Some, yes. As an entrepreneur in the early stages of a company, I don't want to hand out equity like a bonus. I want to be very careful and consider all the ramifications. I simply wanted readers to understand that it's not as simple as it's often portrayed. I'm a big fan of stock appreciation rights because the employee gets the benefit of the company doing well, but doesn't have to take on the responsibility of ownership. Thanks for the comment.
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