Be careful about awarding stock to your employees as part of their compensation package! Most business owners will struggle at some point with attracting and retaining key employees and/or properly aligning the interests of the key employees with those of the business. One way to help with both is to grant employees an ownership interest in the company through stock options, restricted stock, or similar devices (all of which we’ll simply refer to as “stock” in this post). But should you do it? Here are four items to consider:
Point 1 – Will It Work? Although giving stock sounds like it would align the interests of employees and the company, it doesn’t always work. According to the SHRM 2012 Employee Job Satisfaction and Engagement Survey which is summarized here, compensation ranked third in the list of top five criteria for employee job satisfaction, behind “opportunities to use skills and abilities” and “job security.” That doesn’t mean compensation is not important, and compensation in the form of stock can contribute to job satisfaction, but other factors may be more important in retaining a key person.
In my judgment, stock will often help incentivize higher level employees, particularly in companies where a sale or other exit event is planned in the not-too-distant future, but in many other cases it doesn’t work as well as many business owners might think.
Point 2 – Giving Stock Creates Complexity – Cash and bonus compensation plans are simple. Stock compensation is more complex, requiring upfront costs to create, implement, and communicate, and ongoing accounting and legal costs. This is not something you should attempt on your own – you’ll need help from your attorney to think through, among other things, tax and securities issues. And your accountant can help you understand the impact on your income statement for both tax and book purposes.
Point 3 – Giving Stock Often Creates Conflicts of Interest and Fiduciary Duty Concerns – Many small businesses are managed by very few owners or maybe a single family. When stock is given to employees, the employees now have a vested interest in the business, its cash flows, etc. (which is the goal after all) but there is a significant downside to this structure too. Take the owner’s personal compensation, for example. The owner has a fiduciary duty to the employee-stockholders and it’s a conflict of interest for the owner to set his or her own compensation. So if the owner doesn’t have an independent board of directors and decides to increase his pay, that means money out of the pocket of the employee-stockholder who now has standing to challenge the owner’s actions. In fact, giving employees stock can create many fiduciary duties and conflicts of interest and give employees legal standing to sue.
Point 4 – There Are Alternatives – There are many alternatives available to stock compensation such as deferred compensation plans, phantom stock plans, and stock appreciation rights. I typically advise employers to consider these alternatives before issuing stock, mainly to alleviate some of the fiduciary duty and conflict of interest concerns discussed above.
Stock compensation can be a great tool for the right company with the right employees but be cautious and consider other alternatives first. For those interested in reading further, you can see my series of blog posts entitled Retaining Key Employees in a Privately Held Company through Equity Compensation starting here: http://www.strictlybusinesslawblog.com/2012/05/28/retaining-key-employees-in-the-privately-held-company-through-equity-compensation-part-1-introduction/.