If you’ve set up an employee share plan or are considering doing so, you’ve probably read plenty about the topic, including several contributing articles in Forbes. One of those in particular, argues categorically against offering equity to employees. However, we think its author only tells half the truth about employee equity.
Here is a summary of the author’s arguments, countered by our own (backed by some facts and expert opinions):
1. “Pressure to Sell”
Employees might press for a premature acquisition, as - excluding dividend issuance - this is the only way for them to cash out their shares.
Indeed, employees could exert non-formal pressure in the direction of an early exit, especially if their role within the organisation is central. However, as far as formal influence is concerned, employees normally convert their options into share classes with limited or no voting power. Also, if employees have proportional voting powers, they should represent a smaller fraction of the combined share capital, making it very hard for them to ‘force’ the company into a serious decision - at least not without the other shareholders backing their motion. Of course, it’s important to involve employees in company processes as much as possible to increase their engagement and establish a collaborative culture within the company. But at the end of the day, it is uncommon for the employee body to have the last say over a question of acquisition.
Besides, claiming that equity is only valuable for employees in the case of a dividend or acquisition is inaccurate. Employees are presented with options like secondary transactions, meaning that they can cash in on part of their contributions to share-price-value increases, by selling parts of their vested equity. Usually, investors are very keen to buy those (typically at a discount price). Also, companies like Spotify use direct listing to ensure that employees can achieve liquidity. Therefore, there is a counterargument to be made to the Forbes contributor’s first claim, both from the business owner and the employee’s perspective.
2. “Loss of Privacy”:
Shareholders will expect information about the company’s performance, which the owner might not be prepared to disclose.
Keeping skeletons in your company’s closet is probably never a good thing, as it means there’s something ‘off’ about your finances. Arguably, the obligation to maintain some level of transparency can actually help you keep your company’s financial health in check.
In any case though, we should note that minority shareholders (like employees) are usually treated differently from majority investors, and employee shareholders normally do not become majority investors overnight. Therefore, in most companies there will probably be processes in place that distinguish between the information stream reaching each group of shareholders, depending on their capital position.
3. “Loss of Tax Write-Offs”:
Business owners will no longer be able to claim personal expenses as business-related because, apart from the tax-office, now they will need to lie to shareholders to do so.
Employee equity aside, spending company assets for personal reasons is never the best idea, and neither is lying to tax authorities. So again, being held accountable by shareholders is a small blessing, not a problem. Not to mention that, if taxes are your main concern, most governments (including the UK) offer strong tax incentives for those partaking in employee share plans.
4. “Employees Can Be Squeamish”:
Some employees prefer a cash-in-hand remuneration system than the uncertainty of equity ownership.
Indeed, there are certain employees who are not attracted to the idea of receiving equity as a reward. For example, a recent study found that younger professionals tend to be less willing to wait for their options to vest, because they don’t plan to stay in one company for too long. However, it should be remembered that offering employees equity is not an either/or option. It is possible to offer different remuneration schemes to employees of the same company based on what they prefer, or to let them combine multiple forms of rewards - for example, receive some equity but also a performance-based cash bonus.
In any case, it is interesting to note that the Employee Ownership Association (EOA) found 44% of all adults in the UK to be likelier to apply for a job at an employee owned business. Also, if employees particularly believe in your mission and/or perceive your brand as robust and reliable, the chance of equity functioning as an incentive will probably be even higher. For example, when Royal Mail was privatised, 99.7% of employees who were offered shares in the company accepted.
Secondly, equity is not meant to create a funnel approach to your hiring process, but to attract and maintain key employees who can perceive the potential of the company and help fulfil it. As another Forbes contributor (more convincingly) argues, true company contributors gradually understand the value they add to it, so if you want to keep them engaged longterm, you eventually have to offer them a slice of the cake. Indeed, a recent study by Loughborough University proves this, finding that “75% of employees who understood their (equity) plan felt their expectations had been met. These employees were more likely to state that they were more committed, motivated, integrated, likely to stay longer; produce better work, consider the cost implications of their actions or make suggestions about company issues.” Another study by Cass Business School also arrived at similar conclusions.
Considering the effort and risk founders put into making their company succeed, they “deserve the lion’s share of the rewards”.
This is a very short-sighted view of your company’s success. Yes, sharing part of the company with employees means you own a smaller part of it, but if those employees have contributed to a growth and revenue you couldn’t possibly achieve on your own, your diluted ownership will probably still be more profitable for you.
Linking back to the argument about employee commitment, employees working for companies they have equity in, often deliver higher results. Look at the UK Employee Ownership Index, for example, which found that British companies sharing or reserving at least 3% of their shares for staff consistently outperform those who don’t. As the EOA explains, “companies which are employee owned, or who have large and significant employee ownership stakes, now contribute £30 billion to GDP. The sector is growing because employee ownership is proving to be a durable, successful business model that’s extremely well suited to the challenges of 21st century’.
In fact, large venture capital firm Index Ventures recently argued in The Times that the reason why European startups fail to scale up to the standards of Facebook or Amazon is precisely because they’re unwilling to share as much equity with employees as their US competitors. It’s worth keeping in mind here that, at least as a company’s first recruits go, the value these add is simply extra manpower, but also skill, expertise, access to markets and other assets that are essential to your business’s success and that you didn’t have before. In other words, being a team player can take your business to a whole new level. No wonder the British government is trying to entice you to implement an employee share plan.
And a few parting thoughts:
The Forbes contributor ends his article by presenting an ‘alternative to giving employees equity’ in the form of a story about a certain employee owner who shared no equity with his staff but, instead, offered them 10% of the proceeds upon selling his company, essentially giving them a bonus equal to a year’s salary.
However, share plans generally serve to attract new talent, increase staff loyalty, and align their interests with that of the company’s on a long-term basis. Compared to that, offering a bonus - especially one that wasn’t pre-agreed upon - is a very limited remuneration tool.
Having said this, the very act of offering equity to employees is not a magic trick that can solve the problems of an otherwise poorly run business. Neither is employee equity necessarily the best business model for every company at every stage. As Malcolm Hurlston CBE, Chairman of the Employee Share Ownership (Esop) Centre told Capdesk: “For making employees feel part of the business, sharing equity with them makes every sense when the company is quoted or when a quote is in the offing. When a company is taken over, for example, a broad-based employee share ownership throughout the merged company may be the best way of reinforcing corporate glue. For private companies, however, ESO makes sense only in certain circumstances.”
Also, if an equity plan does suit your business goals, ensuring that it works as it should is no small deed. As Christian Gabriel, CEO and co-founder of Capdesk explains, “if you do not have a plan for equity ownership nobody will benefit. The plan should be based on well-calculated dividend projections - i.e. how much would the employee earn if we achieve certain milestones? How realistic is it to achieve this goal? How can we explain this to the employees? If the employees know what should be achieved in order to receive a certain dividend, then they are more likely to value their ownership. Unfortunately, we’ve seen many companies implement employee share plans where the employees did not get anything upon exit”. Not to mention the tax penalties you might end up receiving if you don’t manage your equity plan properly. Consulting with a legal and/or financial advisor prior to setting up your plan, as well as using equity management software like that of Capdesk, is highly recommended for those reasons.
Finally, when equity plans are not properly explained to employees, all parties may miss out on actually reaping its benefits. As Gabriel notes, “We have seen a lot employees leaving options worth hundreds or thousands of pounds without realising it”. From the employer’s perspective too though, when employees don’t understand how equity benefits them, then the perks of employee commitment, motivation and loyalty are lost. “Ownership is the most expensive perk you give to the employee, so it should be as transparent to track and understand as stock markets are.”
Nevertheless, to dismiss employee share plans single-handedly, like the particular Forbes contributor, would be rash. Plenty of companies out there use equity sharing to enhance recruitment, employee productivity and retention, growth and productivity, brand culture and reputation, tax reduction, and more, beyond what they could ever achieve otherwise. Sharing equity with employees should still be seen as an attractive financial and business development option for companies, provided that they are designed and executed properly. As Hurlston puts it, “Successful employee participation of all kinds depends on two factors - quantum and spin. Quantum means that each employee should be able to envisage a reward of life-changing magnitude; spin means that the employer must genuinely convince employees that all are in it together and everybody is prized.”