“I have a key employee who’s asking for some stock in the company or else he may move on—should I give it to him?” This is a question with which many owners of closely held businesses wrestle. It is multi-layered in its implications; however, the answer is really pretty simple: “No. But you should be glad he’s asking for it! This is a great opportunity.”
The question the key employee poses reveals both good news and bad news to an owner. The good news? One of the talented producers in the company recognizes that the business has a compelling and profitable future. He believes in the future so much that he wants a piece of it. And he’s confident enough to believe he deserves it. This is why the question represents such a great opportunity. The bad news? Sharing equity in a private company is a pain. And it’s often one of the most inefficient ways to share value—from both the owner’s and employee’s perspective.
The scenario is understandable. Top performers expect to be paid well; and if they help create economic value, they deserve some of what they’ve created.
Instinctively, owners assume that employees with equity will be better employees. If employees have stock perhaps they will think and behave like owners. Maybe they will have greater incentive to manage expenses, service customers, innovate, work hard and even invest their own money in the business.
These are correct instincts and reactions. It’s obviously desirable to engender an ownership stake, or at least an ownership mentality, among employees. However, the means to achieving those attractive outcomes shouldn’t create more problems than it solves, and too often that’s what happens when closely held business owners go down the path of equity sharing.
Granting stock or even stock options will not usually address all of the issues a business owner needs to consider when creating a value sharing arrangement for key contributors. Here’s why.
Let’s take a look at three different ways to get stock into the hands of Sally, the leader of your national sales team, and the potential consequences of each approach.
The bottom line: the financial results of stock or stock option awards can appear to justify the effort—under the perfect circumstances. But reality is never as simple as you expect it to be. The majority of private company owners will regret the move to stock awards for employees. The perceived value of employee ownership is, nine times out of ten, not nearly worth the price.
 The author acknowledges the primary exception to the rule: if your company is on a clear path to an IPO, stock options offer an excellent and efficient way to reward employees.
Each of the ideas for Sally outlined above has merit. Granting stock is relatively simple and clear-cut. It provides instant recognition and value. It’s great, particularly, for someone who’s been with you for awhile and has made a contribution to your past success. But, the concept carries the baggage described above.
Having Sally buy stock also is intriguing. It deepens her commitment and aligns her with both short-term and long-term goals of the company. But again, there’s baggage.
Stock options are attractive because they’re win-win. Sally only wins if shareholders see their stock value go up. Sally is tied to future growth of the company. But, again, the baggage issue looms large.
What if we could replicate any or all of these approaches without making Sally an actual owner? Is it possible to generate the ownership value and mentality without the baggage? In a word, yes. We can do it with phantom stock.
A phantom stock plan is a contractual agreement wherein a company promises to make cash payments to employees upon the achievement of certain conditions. What’s the purpose? Just as with stock awards, the purpose of a phantom stock plan is to generate an ownership mentality and reward key employees for helping to grow the business value.
However, phantom stock has one big advantage—there is no sharing of actual equity with the employees. No requirement to open the books. No ownership rights. No need to pay dividends (although some plans do). The existing owners stay in control of 100% of the stock or interest in the company.
At the same time, phantom stock can create comparable or even identical value as actual stock. Here are the key things that happen when you create a plan on behalf of employees.
|Starting share price||$10|
As with any rewards strategy, there are plans that work well and others that fail. To ensure your approach to Phantom Stock has a greater chance of success, here are some “do’s and don’ts” to consider.
This article has been an introduction to the processes you can follow to properly structure a phantom stock plan. Hopefully you’ve learned something of value. These plans can be, without a doubt, one of the most important steps you ever take in assembling the team of people who will take your company to new heights. However, there’s something more important that getting the right structure. You need to create the right mindset.
If you create a “perfect” plan but don’t establish the right mindset your plan will flop. You’ll wonder what went wrong with the plan. But it won’t be the plan’s fault. It will be yours. Ultimately, it’s your job to see that the employees not only understand the plan but that they are inspired by it.
Mindset relates to the perception of the plan in the minds of participants. When you make Sally a participant in this plan she should feel like she was just made a partner in the company. She should understand that her financial future is tied to yours (and vice versa). She should realize that you trust her to help produce the results that will create value for both of you.
Always position the plan in a positive light. Explore and discover ways to make your plan one of the highlights of your relationship with your key people. You’re investing in them. Make sure they know how much you value their efforts and how much you trust them to generate great results. Your phantom stock plan is a symbol of your commitment to a partnership relationship. They aren’t getting actual stock but they don’t really want those headaches anyway. They want to know that they have a chance to participate in the value they help create. A phantom stock plan, properly designed, can do just that because it sends the right message about the future:
We’re building a great company.
We’ve got the right people.
We’re united as partners in our financial success.
Let’s go make it happen.
Are You Ready for a Plan?
If you lead a business and are struggling with developing an effective long-term compensation approach, it might be the right time to have a conversation with a VisionLink consultant. To speak with one of our experts about the rewards issues you are facing, call us at 1-888-703-0080.
About the Author
President, The VisionLink Advisory Group
Tom Miller is the founder and president of The VisionLink Advisory Group. He has been consulting with businesses for over 39 years on a range of compensation and executive benefit issues. Tom is a frequent speaker with business groups throughout the country and has authored numerous articles on topics related to compensation, benefits and related issues. He is VisionLink’s chief strategist and innovator.
An inveterate entrepreneur, Tom has founded and operated two compensation consulting businesses as well as a benefits administration company and a registered investment advisory firm. His current company, The VisionLink Advisory Group (“VisionLink”), has served more than 500 companies across North America and Great Britain. VisionLink provides guidance and support on all forms of employee and executive compensation including salaries, short- and long-term incentives, and equity plans.
In 2016, Tom established another company, BonusRight.com, a cutting-edge “software-as-a-service” incentive plan design platform. BonusRight is the first online tool supporting Tom’s mission to transform the way businesses share wealth with their employees.
Tom’s passion lies in converting the visions of business owners into fuel for growth by linking employee compensation to the achievement of challenging goals.
Tom can be reached at email@example.com or 949-265-5700.
Your compensation strategy should make it easy for your employees to invest in your vision—especially your key performers. It should create a unified financial vision for growing your business. As a result, you need an effective way to share long-term value with those who help create it. The dilemma is finding the value-sharing approach that will best help you drive the sustained performance you want.
VisionLink’s new report solves this dilemma by describing nine different types of long-term incentive plans and how to determine which one is right for your company.
Start Building a Unified Financial Vision for Growing your Business!