Five reasons not to share equity with employees

By John Warrillow March 23, 2010
John Warrillow

 

Five reasons not to share equity with employees
 
The idea of making your employees owners by sharing equity can be tempting, but unless you’re planning an initial public offering (IPO), it’s almost always a mistake. Here are my top five reasons for not sharing equity:
 
  1. Being a minority shareholder in a closely held business is not good for employees who own a minority stake. As the majority shareholder, you can manipulate your financials so that your minority partners see no annual dividends, and you may never decide to sell, making those minority shares next to worthless.
 
  1. Acquirers like to buy businesses in which the ownership structure is tidy. If there are lots of shareholders, holding companies and complicated legal engineering, some acquirers will get scared off.
 
  1. It dilutes the pot. When you start a business, you take all of the risk. If you have built a sellable business, congratulations—you’re among the top 1% of all business owners. You need to be paid in full for the risk you took and not have your equity diluted by employees who want a steady paycheck and the big win.
 
  1. Shareholders are entitled to a reasonable level of disclosure about your financial statements—do you really want to show your employees all of the expenses you run through the business? 
 
  1. There’s a simpler alternative to sharing equity that is better for you and your employees. In each of my businesses, I’ve used a Long Term Incentive Plan (LTIP) instead of sharing equity. Here’s an example of how an LTIP is worded in an employee agreement:
 
“Each year, you will be given an annual cash bonus based on goals the company sets out for you. This annual cash bonus will be paid within 60 days of the calendar year-end. In addition, an amount equal to your cash bonus will be earmarked for you in a long-term incentive plan (LTIP). Upon the third anniversary of the creation of the long-term incentive plan, and every year thereafter, you will be entitled to withdraw one-third of the plan’s total balance. The chart below provides an example intended for illustrative purposes only:
 
 
Year 1
Year 2
Year 3
Year 4
Annual LTIP deposit
$8,000
$6,000
$12,000
$14,000
Total balance in LTIP
$8,000
$14,000
$26,000
$31,420
Total cash eligible to be withdrawn
0
0
$8,580
$10,368
 
 
An LTIP can make your employees feel aligned with your goals and loyal to the company without your having to share your precious equity. Most important, a potential acquirer will like the fact that they have only one person to negotiate with and that you have your management team locked in for the long run.
 
Curious about whether you could sell your business (and for how much)? Take the 10-question Sellability Index Quiz at www.BuiltToSell.com
 
John Warrillow, author of Built to Sell
www.BuilToSell.com
Copyright 2010. Author retains ownership. All rights reserved.
Category: Entrepreneurship, Human Resources, Healthcare, Benefits
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