How To Decide to Award Equity to Employees

The decision to grant employee ownership is one of the most consequential offerings that business owners face. There is an attraction to granting ownership. When done correctly, ownership:

1. Is a powerful force for retaining key personnel.
2. Improves the alignment of interests between labor and ownership.
3. Can relieve some cash flow pressure on employee compensation.

Consider the following when granting ownership:

1. Your employees may have shareholder rights in addition to employee rights.
2. Your employees may be entitled to know a lot more about the business than before they became shareholders.
3. The way you spend money may need to change, possibly significantly.
4. The legal implementation and financial compliance costs can be expensive.
5. Once you grant ownership, it can be very hard, even prohibitive, to reverse.

The last point is worth emphasizing. Stock and stock-like assets are generally no “givesies-backsies” in nature. Issuing them is a significant commitment, which means making the right decision in terms of who receives them is critical. When we walk our clients through this process, we suggest that they consider the following:

1) Does the employee create value, or do they provide a service?

Not all employees create value in the business. That doesn’t mean that they lack value or that they don’t contribute value. That’s not the point. Most employees do their job – some do it better than others. They provide a service to the company in exchange for wages, and life goes on for all involved. However, certain employees might make the company more valuable by being a part of it – or they might impair the company’s value were they to leave.

Value is created when the employee does one or more of the following: Increases cash flow, increases the growth of cash flow, or decreases company risk – and the employee does so on a sustained basis. It’s unlikely a janitor does any of those things. It’s possible that a director of human relations, by enabling an environment that systemically reduces the threat of turnover, or a chief financial officer, by ensuring access to cash for growth, does.

2) Is the employee who creates the value prohibitively difficult or expensive to replace?

An employee that meets the first criteria may not yet warrant equity if they can easily be replaced. Features of an employee that might make him or her more difficult to replace might include industry reputation, industry or capital networks, networks that facilitate sales and building partnerships, special rapport with key employees, industry knowledge, consistently outsized, measurable productivity, or highly specialized knowledge.

3) Do you have the capability to consistently pay the employee in question in cash compensation at a level that is commensurate with their value to your company, or what a competitor might pay that employee?

4) Does the employee want to be an owner?

Not all employees, even high-performing ones, want to be owners. Does the employee show a desire to do more than their job description? Does the employee behave in a way that demonstrates that he or she genuinely cares about the company’s welfare? Is the employee motivated more by ownership or cash?

If an employee meets these criteria, then it’s worth considering giving that employee equity in the company or at least the opportunity to earn it. If you decide to offer equity to that employee, more decisions await. How much equity should you grant? What form should the equity take, such as shares, options, or stock appreciation rights? Do you ask the employee to buy in, or do you grant the equity outright?