I recently found an article written by a former SCORE colleague, Tuck Aikin, about the risks of offering employee ownership to incentivize employees he wrote several decades ago. The message remains as true today as it was when Tuck penned it. I hope you enjoy it as much as I did.
In his 2006 book How to Run Your Business So You Can Leave it in Style, author John H. Brown describes a variety of incentive plans that a small business owner might use to attempt to retain key employees. “Although there are many ways to provide incentives, most owners offer either stock or a cash-based bonus. Both methods are strong stimulants for key employees and can be used effectively to motivate them to perform well and remain on the job …” Brown says.
Cash-based bonuses have been used for decades as a retention/reward strategy, and their positive effect, when designed correctly, is well known. But what about offering ownership? It sounds good, but as with many other things in life, there can be a big gap between theory and practice, and as usual, the critical component is how the offer of ownership is executed. My business partner and I learned this the hard way.
Wanting to stimulate profitability in our small firm that had struggled for decades, we decided to offer a 10% ownership in the company to our newest and certainly most capable general manager. The ownership would be earned based on specified profitability and growth criteria – no cash payment was required. Further, we were interested in selling the company within the next few years, so initiating an ownership interest in the firm by our most likely eventual purchaser seemed to be a good strategy. Within two years, our manager had earned her ownership, but about a year after that, she and her family had decided to either move to his hometown or buy the rest of our company and stay here. Then the negotiations began, and we soon learned that ownership is perceived entirely differently by a key employee who has acquired a minority interest solely through “sweat equity” – no cash investment. We also learned that:
The earned ownership was perceived as an entitlement for good performance, a deserved “perk,” nothing more. The normal ownership concept of risk of failure was completely absent. If the firm floundered, that was our problem, not hers, because she had virtually no “hard” assets invested.
When called upon to purchase the remaining stock with cash or borrowed money, the sudden perception of risk was palpable. In fact, so much so that we never even arrived at a purchase price despite our offer of a very attractive valuation that would take into consideration her accomplishments. We had the distinct impression that she felt the remaining ownership should be given to her because she ‘grew’ the company. No appreciation of our years of struggle and risked investment was in evidence. In the end, she decided her family would move, and she insisted that we buy out her interest at an unrealistically high evaluation. So much for ownership as an incentive!
On reflection, here’s what we should have done:
Combined earned equity (ownership) with a pre-determined cash investment that was understood to lead to eventual full ownership. At the outset, then, psychologically, our new owner would likely have assumed a more normal (and desirable) ownership role.
Established a formula to determine the eventual purchase/sale price. This would probably have substantially reduced the potential of damaging our working and personal relationship during the transfer of ownership.
Made sure that our new partner/owner had the capacity and willingness to make further proportionate cash investments as more equity was required for growth. This would eliminate potential resentment between those with cash at risk and those without.
There are several other important considerations in establishing a workable ownership incentive plan, so if you are looking into the idea, be sure to consult a good financial planner, CPA, and business attorney before proceeding. I wish we had.
Tuck Aikin was a former SCORE colleague of mine for many years until his retirement. Tuck is a prolific writer and wrote small business-themed articles for the Colorado Springs Gazette for many years. As a co-mentor, Tuck was my inspiration for me starting this blog. The preceding post is reproduced with permission from the author.
