Fifteen years ago when I was just starting up in business for the first time, a businessman that I met said to me, "It's hard to find good people when you are a small business and when you do you can't pay them what they are worth. Give them some shares in your business and they will be committed to the company".
I remembered these words and in the first 2-3 of years of business I toyed with the idea of giving several of my best employees shares. I can't remember why, but I didn't actually give out any equity and fifteen years later I thank my lucky stars that I didn't.
In my humble yet very business experienced opinion the advice I was given was grossly wrong and could have been very costly, I'll explain why in a moment. The reason I am writing this blog post now is that in my role as a business mentor I still see this advice floating around now.
It's an attractive proposition to offer equity to a key employee when you consider the equity is not worth much and this might help "buy" you a better caliber of employee, but consider the following.
You are a business owner and entrepreneur, by nature you are a risk taker. It might not feel that way, but you took a serious risk leaving your career to start a business. Someone applying for a job with you more often than not does not have that mentality. Business owners invest now with hard work and money for return in the future, in my experience, almost all employees focus on short term rewards such as their salary. If you give away equity to an employee its likely you will be disappointed with the motivation that this will give them as they simply don't have the same mentality as you, if they did they would start their own business!
I forget how many times I have considered a particular employee irreplaceable and thought my business could not survive without them. However in my experience years later once the company is bigger those same employees can't perform to the new level. The truth is that if you are an ambitious growing business then, in time, you will tend to outgrow most of your staff. Very few people have the skills to grow as an employee at the same rate as your business grows, so there are often people you outgrow where previously you had considered them irreplaceable. This naturally sorts itself out as an employee will leave and you will replace them with someone more suitable for the future. However if you have handed out equity your hand would be tied and you may be stuck with a poor performing employee.
There will also be times in your business growth where you realise that you and your staff just don’t have all the right answers and experience to move forward and therefore it becomes time to bring in someone new with perhaps some more management experience. Often someone like this will come in 'above' some of the existing employees and if one of them has a share in the company then this can cause a lot of politics and resentment - which is a problem you don't need.
Handing out equity also causes you a major legal nightmare in the future. The two most obvious scenarios are if someone leaves under a cloud but own equity, then this can make running the company awkward or when you come to sell your company and the buyer has to negotiate with each shareholder individually. All of these problems can be resolved with a shareholders agreement, but this is something you must pay lawyers for and can be very expensive.
My final point returns back to the mentality of an employee to a business owner. Business owners often dream of future greatness and this drives them whereas most employees dream of a good career where they earn a good income. In my experience I have found that employees are motivated by money, but a dividend is paid often one year after a successful period of the business. I have found that a financial reward so long after the hard work was done does not motivate employees as it does business owners.
Over the years I have settled on one alternative to motivate my key staff which I have refined and I know works well for all parties. Instead of giving away equity with all the political and legal issues this may cause, give the key employee(s) a profit share.
Pay the employee their salary, but at the end of each quarter give them a bonus based on the profits of the previous quarter. This can be done in a number of ways such as a a straight percentage of profits or a percentage of profits above a particular figure. I like to see that an employee could make at least £10K extra if the business grew at the same rate in the next 12 months. I always consider this a 'discretionary' bonus, ie it was calculated by me and was not ever formally added to a contract. I shared the guide formula with the employee(s) but I always reserved the right to adjust the figure for extraordinary expenditure or where a client paid us in advance for work we had not yet completed.
The key benefits to this approach are firstly the employee stays very motivated, when they work hard the company does well and they get paid a bonus to reward them. The hard work and the bonus payment are very close to each other so the employee associates one with the other. Secondly should an employee leave then I don't have any consequences as I would with equity . Finally this approach rewards and motivates key employees but leaves you in total control of the business, which is not only good for you, but also good for the business.