Should You Make Your Employee Your Partner?
In an increasingly competitive market, employers, especially in smaller and mid-size companies, are finding challenges to retain good employees. Market rate salaries and benefits are a given, but companies are looking for other ways to keep their workforce engaged. For many companies, bringing in one or more employees as an owner can provide that additional benefit. Structuring these plans, however, can be daunting. Here are factors to consider and options for after the decision to move forward has been made.
Identifying the Goal
There are many advantages to transitioning loyal employees into an ownership model; however, the plan you put in place will depend on what you are trying to accomplish. Is the main purpose to reward and incentivize a handful of employees for their loyalty and longevity with the organization? Or are you trying to reach a broader population of employees to give them a sense of ownership in the company? Is this a succession plan, to identify and bring up the next generation of leaders for the enterprise? Do you as the current owner want to be bought out and compensated for what you have built so far? Isolating the purpose of giving or selling ownership interests is key to how you move forward.
There are certainly downsides to expanding a company’s ownership. The obvious ones are giving up control and money. Although plans can be structured so that control over major issues is retained by the founders, some plans will require that changes be made in decision making and profit distribution. Also any new structure could have negative repercussions with the employees who are not selected to participate, who may choose to leave or lose their long-term commitment to the organization.
Types of Plans
If the plan is targeted towards one or a handful of people who have been identified to participate, or as part of a succession plan, then a more customized approach can be taken, either giving employees shares which they earn (vest in) over time, or setting up a buy-in plan that allows the employee to purchase interests over a set period of time. These plans are usually put in place by contract and often negotiated with employees, and are most often found in service industries such as medical and accounting practices.
If the goal is to reward a larger group of employees, then a restricted stock purchase or stock option plan may be a better choice. These plans give employees the right to buy in to the company at a future date using the company’s current valuation as the buy-in price. These plans are more formal and often follow IRS guidelines, including an independent valuation done before implementation. These plans are mostly used when the employer expects an acquisition transaction within a few years, are not individually negotiated, and designed with an exit in mind. They are popular in technology companies or start-ups that expect a fast increase in value.
Like salary and benefits, the giving of ownership interests in a company is treated as compensation and taxed like ordinary income. However, the plans discussed above can be structured to reduce the taxes the employee pays or at least defer them until the company is sold. Restricted stock and stock option plans can be set up to let employees avoid immediate tax liability.
Bringing in employees as owners requires a certain mindset by the founders, and a readiness to share in the success and the future of the company that you have built. Moreover, the reasons for the change needs to be clear in order to structure the best plan for your organization. A well thought out plan, transition, and communication of the plan is needed to ensure that your goals are maximized.
Business Insights is hosted by the Law Firm of KPPB LAW (www.kppblaw.com).
Sonjui L. Kumar is a founding partner of KPPB LAW, practicing in the area of corporate law and governance.
Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.
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