Golden Handcuffs: Use equity to retain key employees… sometimes.

Golden Handcuffs: Use equity to retain key employees... sometimes.
Written by: Karl Sakas

An agency owner reached out for advice because he was considering giving equity to key employees. He was worried they’d leave if they didn’t have equity, but he was worried about giving up control—and giving up a portion of his profits. At the moment, he was the sole owner.

My answer: It’s all negotiable—as the sole owner, you can generally do whatever you want (including giving away equity). After all, you’re your agency’s dictator.

Expect employees to buy-in

I recommend requiring new partners to “buy in.” Get a valuation and ask them to pay proportionally to their desired share of equity. To a point, more partners means more people committed to your agency’s success.

If you offer equity to your best employees, it creates a golden handcuffs situation, where they wouldn’t want to work elsewhere because they’d lose major financial incentives.

Free (or free-ish) equity alternatives

If you want to give your employees equity but they can’t afford it, you have other options. For instance, they can buy-in on an installment basis, or you can give them equity as a bonus when they hit certain performance milestones.

However, it’s worth considering whether you’re opening yourself up to new risks. If they can’t afford the $30K or $100K or $300K to buy-in, what will you do if/when the agency needs an emergency cash infusion? They won’t be able to help you then if they’re in a tenuous personal financial situation.

Also, if you someday sell your agency for $1 million, giving away 15-30% in equity means you handed someone $150-300K for free. If you sell for $3 million, that 30% is nearly a million dollars.

A better alternative: Phantom stock

Phantom stock might be a better alternative than equity, with the help of an attorney to draft the plan. (They can also share other options to consider, like stock options.) Phantom stock can give you the benefit of sharing ownership perks without giving up direct ownership.

Typically, phantom stock focuses on giving people a pseudo “share” of ownership when a business sells. With phantom stock, you can generally structure it to include the benefits you want. For example, you could require two years of further employment for their phantom “shares” to vest—or four years, or whatever you want.

Compared to traditional equity, phantom stock lets you structure ongoing performance bonuses separately from the phantom stock percentages. Some team members might be have phantom stock, others might be in a profit-sharing plan, and others might have both.

Deciding what’s right for your agency

Sometimes you need to add partners—or at least phantom stock—to create win/win alignment with your key employees. After all, they’ll likely be critical in making the exit possible.

Treat equity in your agency as something highly valuable—or something that may become highly valuable. Even if it doesn’t have value now, it might in the future. Don’t be the person who “gave away the farm” because they didn’t think things through.

If you have a phantom stock or profit-sharing “pool,” be sure to reserve some (that is, hold it back) for future hires. And if you’re running primarily a Lifestyle agency, lean toward profit-sharing instead of phantom stock or other equity compensation—if you plan to never sell, equity in your agency isn’t especially valuable.

Question: How do you handle employee equity at your agency?

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