“Movin’ on up, To the east side.
We finally got a piece of the pie.” The Jefferson’s Theme Song
I just spent another week having another dozen discussions with entrepreneurs regarding equity splits. It is probably because I am a little slow to pick up but I realized that more than half of these discussions could have been avoided if the employees had been better educated about equity. They work so hard to get a piece of the pie, but I am not sure they understand what they get. Many of us spend our time guiding entrepreneurs on the difficulties of equity ownership that we never fully consider their challenge of explaining it to current or future employees. So, I will try to help that cause.
While entrepreneurs have some common traits and core values, employees come in all shapes and sizes and from all walks of life with different capabilities and their knowledge about equity covers a pretty wide span. So, here are some tidbits for owners to share with employees about equity:
- Hey, where were you when somebody had to write those first checks? Most people know that if a business is starting to ramp up and requires investment, angels, venture capitalists and others command a relatively high price for investing in that growth. Usually, the majority of that comes out of the owners “hide,” but what about the reward owners should get for their early funding of the business. Who took the risk to lay out the dough to get the Company to the point where there is something viable to bring to an outside investor?
- Why is equity so important? I do not mean to imply that some form of ownership reward is not desired but equity is extremely difficult to deal with. Let’s look at a couple of the challenges:
- If the owner gives you equity at too low a price, you the employee can have a tax problem. This requires coordination with professionals, obtaining an appraisal and other cool money and time commitments that may be better spent on the business.
- Getting in is not as tough as getting out. So, what happens if you have some type of ownership (stock options, restricted stock, whatever) and the Company does not sell or go public. Where does the money come from to buy you out? Just ask any banker how comfortable they are lending a Company a pile of money and watching it go out the door to former employees. Not pretty, is it?
- What about an alternative instrument? This is the 21st century and there have been many great advances in other instruments which are equity like – they can provide you with liquidity and appreciation and come with a lot less bells and whistles. Let’s face it, if the Company doesn’t go public or sell, your shares will probably not have significant value. Let’s be realistic.
- What makes you think a percentage point is not a lot? For years, many venture capitalists and others financed deals and put aside 10% (or maybe 15) for the management team. It is not unusual to have 5 or 6 members on the team (some more senior than others) so my advanced math skills tell me that averages to a couple of points each.
The purpose of any equity like plan is to motivate employees so why would an owner come up with a plan that is a disincentive for an employee. It just doesn’t make sense. Everyone is going to take some risk and a great reward is in place for those that succeed. So, as Eric Schmidt the Executive Chairman of Google said, “If you are offered a seat on a rocket ship, you don’t ask what seat. You just get on.”