Incentivizing Employees with Equity: What to Know

Many Texas business owners face whether and how to give their employees an equity interest in their company during the lifespan of their business. Here’s what you need to know.

Pros and Cons of Equity Interest

One obvious benefit of doing that is that when you have employees who are interested in the company, they have a sense of ownership and pride in the business, and that’s really a good thing.

However, providing equity to your employees has many disadvantages and consequences. I’ll only go over three of them.

1. Your employees do end up with voting rights in the company. And that may or may not be a significant thing to you.
2. As an equity owner, employees now have the right to inspect the company’s books and records and demand a certain minimum level of financial disclosure from the company every year.
3. This is a big one: you want to ensure you have the right to purchase the employee’s interest if the employee leaves the company. You really don’t want your employees to leave and work with a competitor while they still have an interest in your company.

How to Grant Your Employees Equity

So, once you’ve decided to grant your employees equity, you need to consider how to do that. This can be a complicated decision because many tax and regulatory issues are involved.

Alternatives to Granting Equity

Sell or Grant an Interest

One easy solution is to sell an interest in your company or give your employees an option to buy an interest in your company. The disadvantage of this is that your employees have to come up with cash to purchase that interest.

Another alternative is just to grant employees an interest in the company. This is like giving a cash bonus, but it’s giving your employees a bonus of interest in the company. Now, your employees will have taxable income, so they’ll still have to come up with cash to pay the income taxes on that grant.

Restricted Stock

If you grant interest to employees, you may want to consider granting restricted stock. Restricted stock vests over time, and you can choose the period. For example, if you grant 1000 shares of restricted stock vested over four years with 250 shares vesting yearly over four years.

Cash Bonus Plans

As a final comment, instead of giving equity to your employees, you may want to consider implementing and structuring a solid cash bonus plan. You can base the cash bonus plan on any metrics that are meaningful to the employee, and you don’t have to use the same metrics for every employee, which might end up being a better solution with fewer disadvantages for both you and the employee.

For more information on this topic, contact us today.