Don't assume rewarding your team means giving equity away
A common topic that we work through with our clients is how they might reward their key executives when company sale day arrives. They often assume they have to consider the complexity of providing these executives equity in the business and although this is a viable option, it’s not the only one.
At a very high level, here are the options you have for rewarding key members of your team should you desire doing so when you sell your business one day:
- Subjective award at time of exit – this option has you deciding upon exit what dollar amount you may wish to award key members of your team. You have the right as the owner of the business to subjectively award anyone you wish with a payout from the proceeds you will receive from the acquirer. The upside to this option is it’s purely subjective and is determined at time of exit. The downside is this option doesn’t give you an optimal vehicle for retaining and motivating these key people in the years prior as you prepare for a sale because they aren’t aware of your plans to make such a subjective award.
- Subjective award communicated prior to exit – this option simply takes the option above but has you conveying your plans to your key team members years in advance of selling so as to help excite and retain them in their roles. You convey to these team members of your plans to one day reward them at time of an exit but you remain vague as to how much. If your team members highly respect and trust you then they may be motivated by your subjective plans but in most cases, this option might not have the motivational impact as the team members might be skeptical due to the lack of clarity of your future subjective plans.
- Objective award communicated in a letter – this option has you providing select team members a basic letter, not legal in nature, but one that documents your thoughts to reward them at time of future exit. This letter would identify your plans to one day reward them with either a percentage of the deal proceeds you will be receiving or just a fixed lump sum. This letter doesn’t require lawyers to draw up and informally conveys your plans. This can work if your team greatly respects and trusts you to hold true to the non-binding letter you’ve provided.
- Objective award through a phantom equity plan – this option has you working with a lawyer to draw up a plan that imitates actual equity in your business but doesn’t require giving up actual legal ownership shares in your business. A plan of this type assigns phantom shares of stock, documents very clearly how the plan works for you and the participants and is a legally binding agreement that you would give to your key team members years in advance of your exit.
- Equity participation – this is the most extreme and complex option as it does have you issuing equity in your company to the team members. This option has the same motivation drivers as the phantom plan and shows the ultimate degree of commitment from you to your team but also comes with a greater degree of complexity and cost to set up.
There is no best answer as each company situation is unique in terms of how best to motivate, retain and reward the key members of your team and your personal relationship with them. Get guidance from exit planning advisors as firms like ours can help you determine what will be optimal for helping you achieve your future euphoric exit event. In addition, the option you select may have positive tax implications for you as the seller so making the right decision will not only motivate your key executives but can also provide you tax benefit at time of the exit.
