Should You Share Equity With Your Employees?

Offering stock (or options) is a great way to attract and retain key employees, but it can be risky and expensive. Before you do it -- and regret it later -- consider this alternative.

The first time I was tempted to share equity in my ad agency was to attract a creative director I'll call Alison. Alison was earning $80,000 a year working as a writer for a big multinational ad agency, and I wanted her to join our team to boost our creative credentials.

I was offering $105,000 per year as a starting salary, which was enough of a premium over her existing wage to make her agree to meet with me. At the end of the second interview, Alison told me she was interested but wanted some equity in my business in return for walking away from the security of her big-agency job.

I was tempted to give Alison a piece of the business for three reasons:

  1. I wanted her to join our team.
  2. I felt lonely as the sole shareholder and wanted to experience the thrill of building a business with someone as my partner.
  3. I wanted Alison to be loyal and stick with our company through the inevitable roller coaster of building it.
At the time (15 years ago now), the decision felt like a biggie, so I went to my dad to bounce the idea off him. My father was in the midst of retiring after a 25-year career at a very large company. My dad is from the old school -- a generation that believes the line between owners and managers should rarely be crossed. He was adamant that I not share equity with Alison. To him, the opportunity to buy equity in a company was something you earned over time and not something that should be given before an employee even starts.

While discussing the idea of sharing equity with my dad, I played the devil's advocate, accusing him of being a dinosaur while trotting out all of the usual rationale for sharing equity:

  • To attract senior talent at lower-than-market compensation
  • To align and motivate managers with the vision of the company
  • To retain people through the harshest bits of building a business
He listened carefully to my argument but stood firm. Like a protective father who wants his child to slow down on the steepest parts of a hill, he wanted me to avoid something I would end up regretting.

He argued that there was plenty of time to share equity with key employees after they had proven they were worth it.

I countered with the need to attract Alison to my company in the first place. He dug in even further and explained that, as a minority shareholder in a small business, Alison would hold shares that weren't very practical because I may never sell the business or declare a dividend. As a shareholder, my dad piled on, she would also be liable for the business's commitments and could be asked to contribute cash if things went wrong. Equity, he argued, is a two-way street.

The alternative
Finally, I asked him what he would do instead, and he showed me a long-term incentive (LTI) plan that would still be attractive to prospective employees. He suggested I offer to take an amount equivalent to Alison's annual bonus and put it into an LTI plan for her. Alison would not be allowed to touch the money for three years, after which, assuming she was still with the company, she could withdraw one-third of the plan's balance. Each year I would add to the plan, keeping her loyal and motivated. Here's an example of how it worked:

Year 1 Year 2 Year 3
Plan contribution (equivalent to Alison's annual bonus) $12,000 $15,000 $17,000
Plan balance $12,000 $27,000 $44,000
Amount eligible to be withdrawn by Alison (one-third of the total) $14,667
In the end, I opted not to share equity with Alison and instead offered her the LTI plan above. Alison agreed to join and became a loyal and motivated employee while I maintained the control, discretion, and economic value of owning 100% of the equity in my company.

Over the past 15 years, I've encountered six other Alison-like scenarios in which I was tempted to share equity to attract a key employee, and each time I pause, remember my old man's sage advice and use an LTI instead.

What is your philosophy to sharing equity in your company?