Closely held and family-owned businesses, all private companies for that matter, often find it difficult to attract and retain key employees.
Key talent can be easily lured away by publicly held companies that offer company stock (equity) as a key component of total compensation packages.
While the equity in a private company cannot be traded on a stock exchange, and may not otherwise be marketable, private companies can provide long-term equity incentives that also can be liquid investments for their key employees.
Private company employers and business owners dread dilution of ownership and coping with a multitude of minority owners. However, you can provide long-term equity incentives to key employees without issuing real equity or ceding control to them. This post summarizes how to achieve this important retention goal which, in turn, strengthens business performance.
I’ve described tax, legal and accounting implications for each compensation alternative below with this warning: It is prudent to consult with a professional advisor to ensure the proper design of long-term equity compensation programs meet company goals.
Most publicly held companies structure primary compensation around three elements and four benefit components. On the compensation side, that means salary, annual bonus and long-term equity compensation (e.g., stock options or restricted stock awards).
On the benefits side, that means nonqualified deferred compensation, supplemental executive retirement plans, executive life/ disability, and perks (see chart below).
On the other hand, smaller private companies find it difficult to recruit top-level talent, as they typically do not offer the third element of compensation, long-term equity. By offering equity compensation, a private company:
Several long-term compensation tools exist to meet the goals and demands of security holders in a closely held business, similar or the same to what publicly traded companies use. These tools may include any of the following:
The long-term incentives described above can be replicated to varying degrees if the company is a limited liability company or a partnership rather than a corporation.
Companies typically alleviate employees’ liquidity concerns by providing that the company or its other shareholders will repurchase any shares upon certain triggering events, such as the demand by employees after a certain period has elapsed or termination of employment.
Several practical issues arise in connection with issuing equity to employees, including:
I discuss these matters in more detail below.
Maintaining Control. Since the company likely provides only a minority interest, loss of control is minimal. Nevertheless, minority security holders can distract through periodic disruption. Accordingly, put repurchase provisions in place that kick in when an employee departs. Also, a nonvoting equity interest, such as a Class B nonvoting interest, can be issued.
Alternatively, stock appreciation rights settled in cash can be awarded, which provides no rights to management but merely the right to cash, based on the appreciation of company value. To manage cash flow, purchase the shares over time. Namely, if repurchase exceeds $100,000, the company can pay it over time with interest.
Repurchase restrictions. The company will not want employees to transfer their equity to third parties. So, it is best to have each employee enter into certain agreements with buy-sell provisions requiring them to sell back their equity to the company under certain circumstances. These circumstances include termination of employment, sale of the company by the majority shareholder, insolvency of the employee, and so on. Transfer restrictions also ensure compliance with securities laws.
Valuation of equity. A company also needs to determine its fair-market value to issue equity and/or make repurchases. You can do this in several ways, including an annual (or periodic) determination by a valuation expert, using book value, or a formula based on a multiple of revenues or net income. The method chosen depends on the industry, the preferences of the security holders, and the amount of time and money they wish to spend.
Funding the repurchase. Certain smaller companies may not have sufficient cash flow to fund repurchases by the company. You can handle this deficit by making payments over time above certain dollar amounts as discussed above; using certain insurance vehicles if the repurchase occurs in connection with the death or disability of the shareholder; or placing contractual limits on the dollar amount of repurchases made in any year (absolute amount or percentage of annual revenues or net income).
Many insurance contracts can play the role of a sinking fund by growing a cash reserve to use toward the repurchase. The company may also consider a line of credit to assist during seasonal periods when working capital may be low.
Various legal, tax and accounting law will influence the type of equity incentive, type of payments, and the persons offered these incentives. I urge you to work with consultants and tax and accounting experts who can model the impact of various forms of tax, accounting and cash flow on each tool discussed.
The recruit-reward-retain challenge must be a strategic concern for most businesses, particularly if the business seeks to elevate the quality and output of employee performance. I am sure this concern is one reason you decided to read this post. It’s time to think out of the box and study plan designs against best practices, so you can secure the talent who can make a difference in your company’s future.
All too often, key employees view rewards and compensation strategies as somewhat of a “black box.” Not only do they mistrust the system, in many instances, employees carry faulty expectations of results, leading to disappointment when these plans pay out.
As a result, the compensation plan may not realize its original intent to motivate employees and improve the ROI on what may be the company’s single largest cost. The solution? Educate. Communicate. An educational communications approach with clear content and effective delivery can raise awareness in the employee population as to the true benefit of their plan.
Your first step: Ensure your key talent receives unbiased advice. A professional, preferably work with a Certified Financial Planner® (CFP®) who can educate, communicate, and integrate these company benefits with the employee’s personal assets. For transparency, the CFP® remains independent of products and service offerings in a fee-only status.
Second, you need a platform like Smart Tech to consolidate the company’s benefit offerings on one balance sheet— 401(k) plan, life insurance, disability, medical, stock, deferred compensation, and more. Then, as the employer, you can demonstrate value in real time 24/7 and employees physically see the total value.
Finally, by integrating corporate benefits with personal assets on the right digital platform and using a financial coach for guidance and subject matter expert/advisor for implementation, you will place your employees on a life-changing path to build long-term wealth.
A noble goal for every employer.