Giving Employees Equity
Q. I have an employee who is key to my business. She brings a skill set that is different than mine and she has added tremendous value. As a result of her work, I’ve taken the business in a new and better direction. She has said that she wants to share in the value she has helped and will help create and has asked me about letting her have 20 percent of the business. I want to reward her for what she brings to the table, but I am reticent to part with equity. If the business does what I hope it will, 20 percent will be worth millions, perhaps tens of millions, of dollars. Do you have any advice?
A. You are right to be reticent to part with equity. We have seen too many small business owners give up equity in their company only to regret it later. The reason for giving your employee equity is to keep her engaged and motivated. However, before agreeing to give up 20 percent (or any other amount) of your company, we suggest that you consider four questions.
Would 80 percent of your business with this key employee be worth more than 100 percent of your business without her? If the answer to this question is clearly no, then don’t give your employee the 20 percent she wants. However, if you think your business could grow to a value of $100 million with this key person, but would likely be worth only $50 million without here, consider what she has requested—$80 million is more than $50 million.
Can you keep this employee engaged and motivated at a lower cost? If there are less expensive ways to keep your employee engaged and motivated, you might consider these as an alternative to the 20 percent equity she has requested. Perhaps she would be happy to settle for 10 percent instead of 20 percent. Maybe a generous incentive compensation plan that gives her a share of the current year’s profits, but not a piece of the long term value of the company would be acceptable. If there are less expensive ways to accomplish the same thing, consider them.
Can you hire the skills she brings to the table at a lower cost? Your key employee is likely not the only one in the world with her skill set. If you could replace her easily at a lower cost, this may be a good option. Be sure you are considering all of the value this woman brings to the table—her specific skill set, work ethic, fit with you and your business, experience and judgement, knowledge of your industry, etc. If you are reasonably certain that all of these things can be replaced at a lower cost, don’t part with the equity.
Is there a cost to having this employee compete with you? You said that this employee has helped you take your business in a new direction. Presumably the two of you have discovered something of value together. If you aren’t willing to include her in the upside you will generate together, don’t be surprised to find her working with a competitor who will—a competitor who brings your skill set to the table. If you think you can create tremendous value without her, perhaps she will conclude that she can create the same value without you. At the end of the day, you should do what is in your own best interest. However, your employee will also do what is in her best interest. Remember this when you are thinking through the pros and cons.
Parting with equity in your business is a big decision. You are right to consider the situation carefully before giving equity to employees, but there are times when it is the right decision. Many businesses have been hugely successful, at least in part, because the owners were willing to share the upside with employees who helped create the value. Consider all of the large corporations who attract, retain and motivate their people with stock option plans. By all means, do what you think is right for you, but don’t be penny wise and pound foolish. Depending on your answers to the four questions above, you may want to incent your key employees with equity.