The Employee Equity Conundrum

January 21, 2013, 12:05 pm Kochie's Business Builders Yahoo!7

Offering employees a stake in the business can be a cash flow friendly way to retain key talent, but is it such a smart move?

The Employee Equity Conundrum

Start ups and small businesses often struggle to attract and retain the talent they need to grow their business. We hear it weekly from the KBB community and unfortunately it’s just one of the many challenges posed by competing against deep corporate pockets.

Cash flow is hard enough to balance when trying to draw a wage for the owner, let alone keep up with market rates to retain the rest of the team!

One approach entertained by a lot small outfits, and especially start ups, is to offer shares in the company to tie down top talent.

But is this a smart solution?

It’s certainly a great motivator. Employees with a vested interest in the business are charged to work harder, explore more opportunities and make smarter decisions as their long term interests become aligned with those of the business.

Related: 3 Pools Of Great Employees

This is the same reason behind big listed companies offering shares as part of executive pay packets.

And that incentive shouldn’t be underestimated. Just look at the early employees of Facebook, Microsoft and Google, who made millions by accepting lower salaries with equity components.

Of course equity offerings also help alleviate the cash squeeze by bringing down wage costs, which is often the main motivation from the business owners perspective.

But while these benefits are attractive, there are some serious pitfalls to offering a slice of your small business to employees.

First of all, the new owners you bring on board will need consulting in all the big business decisions if they’re to be kept on side. Sure, you might retain control of the company, but having the new owners continued support is essential otherwise the benefits of doing so will quickly disappear.

This is especially important as a lot of small business owners start up their operation to escape the controls and consensus driven protocols of the corporate world. Having joint ownership can bring these bothers back home to roost very quickly.

Related: When To Outsource Work

There are also tax implications, and also exits to carefully consider too. What happens if the employee leaves? Usually there will be a buy back agreement written into the contract, which might mean you stumping up to take their stake back.

And without a listed market to readily recognise the sale price, this means getting an outside valuation that costs a bit of money at best, and is contentious at worst.

So if you are weighing up offering equity to your employees, be sure to carefully consider these factors, as well as examine the exit strategy before entering any agreement and how the share in the business might vest over time.

However if you decide it is an over complicated course of action, a smart alternative to incentivise employees and align interests is with profit sharing. It might be tied to agreed KPI’s on an employee specific bases, or bigger business wide goals that will trigger a cut of the cake.

Whatever you decide on, make sure that it’s fair, correctly drawn up and that you’re comfortable with it. Because no talent is worth retaining if it ultimately undermines your small business dream.

How do you retain your best employees? Come and share your experience.