Employee Equity Considerations: 10 Practical Tips
Are you considering giving an employee equity in your company? Employee equity is a tool that is often considered by business owners or requested by employees, but does it make sense for you and your business, and will it get you the results you are looking for?
This article focuses on employee equity considerations for closely-held private companies. If you work with a public company, a private company that is in the tech space, or a startup that is seeking or has received venture capital or private equity backing, there are additional factors that you should consider that are beyond the scope of this article.
Here are ten tips for you to consider before you make the decision to give an employee equity in your company:
Consider what you are hoping to achieve by giving the employee equity in your company, and whether giving the employee equity is likely to achieve the results you are looking for. Business owners often hope that employee equity will increase the likelihood of employee retention, lead to greater employee productivity, encourage the employee to take on more responsibility, and/or provide a succession plan for the business that will allow the business owners to take a step back.
Is this particular employee likely to be motivated by the equity in the way you are hoping? Will this particular employee rise up to the additional responsibilities of being an owner of the business in the way that you want? Would this particular employee be equally or more motivated by a bonus or profit sharing plan that doesn’t have the added pressure of ownership?
Consider your current relationship with the employee. How long has the employee been with the business? Do you know if the employee plans to stay with the business long-term? What is the likelihood of the employee leaving the business? The answers to these questions will help determine the level of risk associated with giving the employee equity.
Consider whether it would be more appropriate for the employee to purchase the equity instead of being given it. It may increase the employee’s buy-in if they have some skin in the game.
Consider whether you are comfortable with diluting your ownership in the business. Also, consider whether you expect the employee to have to contribute their proportionate share of capital if the business has a shortfall or needs capital to grow.
Consider the extent of the ownership rights you may be providing in connection with the equity. Should there be any vesting requirements associated with the equity? What voting rights do you want the employee to have, if any? Do you want the employee to be able to sell or transfer the equity to third parties? Do you want the ability to repurchase the equity if the employee leaves the business or has to be terminated, and how will you value the equity if so?
Consider the potential loss of privacy in the running of your business and the additional duties that may be placed on the employee. An employee that has equity in the business may be able to ask for certain records or financial information related to the business. Additionally, ownership is not for everyone, and the employee may not be ready for the responsibility that comes with having an equity interest in the business.
Research the available structures for employee equity and determine which is appropriate for you, your business, and the employee. Available employee equity structures will vary somewhat by entity type (corporation, limited liability company, limited partnership) and by tax structure (corporation, S-corporation, partnership). Available structures may include incentive equity grants, option plans, equity purchase plans, profits interests, or phantom/synthetic equity.
Educate yourself on the tax issues that arise for you, your business, and the employee when you give an employee equity in your business.
Finally, never make a verbal promise to give an employee equity without fully thinking through the above considerations and discussing with your accountant and attorney.
The above tips are not intended to scare you away from giving an employee equity. However, they are intended to help you think through some important considerations before you make the decision to give an employee equity, so that you can make the right choice for you, your business, and the employee.
Be on the lookout for future posts covering employee equity structures and tax considerations in more detail as we continue to discuss the practical issues associated with employee equity.
