How To Give Employees Ownership Or Equity Value
By Wade Myers
Q: When and how should I give equity or other incentives to my senior managers in order to retain them? I’m considering giving them equity, but not sure how to do that.
A: While I absolutely understand the need to retain key management staff, I would be careful about giving up ownership to them and the manner in which you do so. In order to create an incentive for managers to stay with an organization and to give them some “upside,” there are basically the following options:
* Form a corporation and issue stock options – This is the typical way of giving equity to your key employees in the most tax efficient manner. This is also an expensive prospect as you would need to incorporate and create an options plan that is properly structured, meaning a fair amount of legal fees. You will also have an issue of how to structure an exit that facilitates liquidity for the optionees.
In a typical stock options situation, the company is either a public company that already offers liquidity for the optionee or is a venture-backed company that is planning either an Initial Public Offering or a strategic sale of the company in order to create liquidity.
* Value sharing agreements – These are usually more complicated than a deferred compensation plan and less complicated than a stock options plan, but this can still be difficult to structure in that there must be strict agreement on how to value a company and the participants’ share of the value accretion. Value-sharing agreements can be used in a situation where the company is not publicly traded.
* Deferred compensation – This is often referred to as a long-term incentive plan (commonly referred as an LTIP). The concept of deferred compensation plans is to reward employees for staying with the company because the bonus associated with the plan is paid out over a certain number of future years, thus providing “golden handcuffs.” Deferred compensation plans can easily be used in a company that is not publicly traded.
Originally posted 1/7/2014.