Firm owners should consider adding key employees to ownership for motivation, transition planning, and financial strength – before it’s too late.
Many owners of firms in this business come to the conclusion at some point that they would like to bring in certain people in their employ to ownership.
There are a wide variety of reasons to do so. Becoming an owner in the firm you work for certainly is a goal or career milestone the most motivated people tend to have. It is part and parcel of the culture of the industry. So if you own a business you are going to be aware of this expectation and of course don’t want to lose anyone over it.
Other reasons include a desire for founders to plan for transition. They realize they must start selling down over time and get others involved in management and leadership so the firm can go on.
In some cases, selling ownership to employees is also a way to ensure the firm is adequately capitalized. New equity beefs up the balance sheet and helps the firm be stronger financially. It can increase borrowing capacity and/or reduce the need for debt financing.
And of course, there is the whole issue of motivation. Hopefully when people have an ownership stake they will be more motivated to do whatever it takes to make the firm succeed. So clearly, there are lots of reasons to add additional owners over time.
But then the big question is, “How?” How should one do it? Do you give the ownership to these key people? If you sell it, how much do you sell it for? How do you expect your people to afford it – most of whom are probably living paycheck-to-paycheck and don’t have a lot of discretionary funds to invest?
These are big questions and not easily answered without considerable thought and study. Giving shares or ownership interest to people may make sense from the standpoint of affordability for the employee, but is that really the best way to make them think like an owner needs to think? Many would say “no.” You also have to consider the tax consequences of that gift. The employee is getting something and the government wants to get their share of that gift by taxing the value of it at ordinary income rates. How will the employee afford to pay those taxes?
If it is sold to the employee, should they be expected to pay for it all at once, or should the company provide some kind of financing so the employee can pay over time? Should those payments come out of regular payroll or should they come from bonus payments? There are pros and cons of each approach.
Then there is the issue of roles and additional responsibilities for these new owners. Should they all be charged with bringing in new work to the firm? Do they all have management jobs? Do they all automatically sit on the firm’s board of directors? How will that be dealt with if the firm adds more and more owners because at some point the board can’t be that large? Or should ownership be simply that – an investment in the place one works with potential for profit distributions and appreciation, and a vote for who is on the board of directors, and nothing else?
Who should be offered ownership is a big source of debate. Should it only be key people? Should they all be registered professionals? That’s an issue in some states. Should people have to be there a certain length of time? Or should it be anyone who wants to invest their money in the firm regardless of position or tenure?
All of these questions are good questions and how each firm answers them and addresses them will create opportunities and problems for them to deal with in the future. There is no one “stock” answer or best practice. There are too many variables to consider. Every firm is different, and every founder is different.
This is certainly one area where qualified consultants or advisors can be helpful. It’s not something you do every day, yet there are people out there who do work on these problems daily who can provide you with some good advice. Your clients need you to do what you do because they can’t do it themselves. So, why would you try to do this stuff by yourself?
If you are grappling with some or all of these questions, we are here to help. Drop me a line at mzweig@zweiggroup.com and I will put you in touch with the right people here. It’s important that you don’t wait too long to do something. I cannot tell you how many 70-year-olds we talk to who have no plan to transition and want to get out. Shutting down a business that has ongoing commitments is costly and difficult. And there is no pot of gold at the end of that rainbow! So don’t wait too long!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.
