Business owners will often offer their employees—key or otherwise—shares of stock in the company. This is typically done in lieu of additional cash compensation, to motivate behavior changes, to reward employees for their part in creating value, or for retention purposes. Employees often desire stock ownership to feel part of the organization and to be rewarded both short- and long-term for their efforts.
Although issuing stock to employees can sometimes accomplish everyone’s goals (Employee Stock Ownership Plans are an effective solution in the right circumstances), the process is full of pitfalls and unintended consequences.
From an owner’s perspective, some of the negative aspects include:
- A potentially much more expensive way to reward employees.
- A possible requirement to make pro-rata distributions to minority stockholders.
- Minority stockholders can interfere in the ultimate sale of the company by claiming the deal is not fair.
- Desired behavior changes often never materialize.
- The way you lead your life within the company is more closely scrutinized, as a minority owner may be desirous of the same benefits you enjoy. This may ultimately result in a strained relationship.
From an employee’s perspective, owning stock does not always result in benefits they desire. The employee is a minority stockholder and often has little or no say in running the business. Plus, the perceived value of the employee’s interest may not increase over time and the employee may have been better off with cash today, rather than a chance at a bigger payout later. Finally, in some circumstances, there could be elevated legal liability for the employee.
An employee often views stock ownership as a path toward more current compensation, a reward for long-term value they helped create, and a chance for a spot in the inner circle where decisions are made. However, these goals can all be accomplished without the expense and potential pitfalls of issuing stock to employees.
How might this be done? Here are some options for each type of employee objective:
- Additional compensation. Implement a bonus-based/variable compensation plan through which an employee can earn more money by achieving certain tangible results.
- Participation in the creation of long-term value. Develop a form of phantom stock or stock appreciation right plan to reward the employee for the value created under their watch.
- Being part of the inner circle. Create a management committee that meets regularly to discuss various strategic and tactical issues and include the employee on the committee.
The moral of this story: Don’t issue stock to employees unless there is a compelling reason to do so that cannot be accomplished with an alternative strategy.
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