You’ve been in business a long time now and there are some key people in the business who have helped you grow it to where it is today. It’s decided that you are going to transition the business to the children. But you may give some equity to these key staff members to reward them for their contribution.
My advice? Don’t do it. Don’t even start the conversation because once you have you may not be able to withdraw from it.
I understand the desire to reward valuable employees but giving them equity is not the way to do it.
Why? Well, once you have provided them with equity, let’s say 10%, you have introduced a minority shareholder, an outside party whose interests you must take into account in managing the business. They are a shareholder and you must act in the interest of all shareholders. By granting them equity you have just introduced a complexity into the business that you will likely regret.
If the business is being transitioned to the children, you have just given them a financial partner who they will need to work with. And possibly, at some time in the future, they will need to buy out, at a price they cannot fund. For example, if that employee were to pass away, their equity interest may end up with someone who has no involvement or interest in the business whatsoever.
And the flexibility that you may have enjoyed in managing the business to meet yours and the family’s agenda will no longer exist.
You now have a partner who must be treated fairly and informed of all decisions. This can impact what expenses are incurred, what loans are made, what investments are made, what dividends are paid, and so the list can go on.
There are other ways that you can effectively reward and retain key staff members who are important to the business, some examples are:
- Provide them with a simple bonus for years of service and pay it out.
- Reward them for the performance of the business and pay some now and hold some over to be paid in the future, if they continue with the business.
- Give them a notional interest in the business, which allows them to share in the capital growth of the business should it be sold in the future. No actual equity but a share of any capital gain as a bonus.
Your accountant/financial advisor can assist you in structuring the right reward package but don’t start a conversation about an equity interest with senior managers or employees until you have sought professional advice.
Active Knowledge Questions:
- Do you believe that there are some valuable employees who should be rewarded for their service? If yes, list them out now.
- Why do you believe they should be given something extra? Is it because you are leaving, or making a big gain yourself? It’s important that you be very clear on the driving motives so you are fair to all concerned.
- Have you discussed it with your fellow shareholders, including your spouse/partner if they have an interest in the business? You should also discuss it with your family if they are stepping into the business.
- Have you sought professional advice as to the appropriateness of the ‘bonus’ and how it is best structured? Best to do this before even mentioning it to the possible recipient.
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All the best in the success of your business,
Richard Shrapnel
