Should You Offer Equity to an Employee?
In a recent article, we tackled a loaded topic: offering equity to employees. We discussed the thoughts, concerns, and questions that go through your employee’s mind when you tap them on the shoulder to be an equity partner.
Today, let's shift our focus to you. What should you, as a business owner, consider before offering equity to your employees? While offering equity can be an excellent way to reward and retain top talent, it requires careful consideration. Here's what you need to know about offering equity to your employees.
Evaluating Your Desire to Offer Equity
Before we dive into the considerations, let's pose a question. What prompts you to consider current employees as potential equity partners? Typically, it boils down to one of these four reasons:
Sharing the load. You may have a valuable employee who acts as your right-hand person, yet they don't get to share in the agency's success. However, they also don't have to experience the same stress during tough times (but that's a topic for another article).
Feeling fatigued. Your vacations never truly feel like a break. Although your team has gotten better with implementation, your clients still rely on you for strategic input. In many ways, it feels like you have failed at nurturing talent inside your agency. And you know this current path is unsustainable.
Retaining talent. Your people are the key to your success. You want to keep those employees who are essential to the core of your business for as long as possible. If you got hit by a bus, these individuals would step up. Offering equity could be a great way to acknowledge their hard work and provide an incentive for continued success.
Legacy. Offering ownership internally allows you to transition to a new phase in your life. You’re able to pass on a legacy to the people instrumental in building it.
8 Things to Consider When Making an Employee a Partner
Next, let's unpack the essential questions you must answer when developing your internal transition plan:
1. Buy-Sell Agreement
When bringing on a new partner, don't overlook the importance of a buy-sell agreement. All partnerships eventually end, either amicably or not. Prepare for unforeseen situations by crafting a buy-sell agreement that addresses various scenarios:
What if a partner wishes to resign or retire?
What if a partner's ex-spouse is entitled to equity due to a divorce settlement?
What if a partner wants to sell their equity for financial reasons?
What if an outsider offers to purchase a partner's equity?
What if a partner becomes disabled, incapacitated, or passes away?
2. Share Valuation
What formula will you use to calculate share prices?
How will share prices be adjusted annually?
3. Buy-In Options
You will need to explore creative buy-in options, as employees often lack the necessary funds for a significant investment in your business:
What alternatives to cash investment are available? (e.g., salary reduction, bonus waivers, promissory notes)
Would you consider reducing the buy-in amount in exchange for a percentage of future profits?
How many shares will you initially grant to incoming owners?
Will incoming owners have the option to purchase additional shares in the future?
4. Governance
Will new partners have voting rights?
Which decisions require unanimous approval, supermajority, or simple majority?
Are there specific decisions for which you want to retain veto power?
5. Profit
What is your working definition of profit?
How will profits be distributed?
What is the distribution schedule for profits?
How much profit do you expect a new partner will add to your agency?
6. Liabilities
Which liabilities, if any, will new owners assume?
What types of personal guarantees will incoming owners be required to provide?
7. Noncompete
Will new owners need to sign a noncompete agreement to become a partner?
What are the noncompete terms if an owner decides to leave?
If an owner departs, will they be able to solicit employees?
8. Managing Expectations
How will your role change with a new partner?
Have you defined the roles and responsibilities for new owners?
What leadership skills do you expect from incoming owners?
Key Takeaway
When deciding who should receive equity in your business, consider how each potential partner fits into the bigger picture. With careful consideration and upfront planning, offering equity can become a powerful tool for rewarding top talent while fostering future growth in your agency.