Should Small Businesses Use Equity as a Form of Compensation?
Cash is often tight for small business owners, so shaving short-term expenses can be a sigh of relief. That’s why alternative forms of compensation, like equity, are an option frequently used by small businesses. Equity as a form of compensation can be effectual, but there are some drawbacks to be aware of before making that decision. Check out what you’ll need to consider.
Weighing the Pros and Cons of Employee Equity
Let’s first consider why – and why you shouldn’t – use employee equity as a form of compensation.
How You’ll Benefit from Using Equity as Compensation
There’s many reasons why employee equity is a great alternative form of compensation; that’s why many use it in the first place.
This is the reason most will even consider equity; you raise capital. Either this can be in the form of savings from replacing normal compensation with equity, or it can be in the form of employees reinvesting their earnings in the business through the purchase of equity.
It Better Motivates Employees $$$
There’s a reason many corporate CEOs receive equity as a major part of their compensation. If they successfully run the business and make it profitable, they’ll directly benefit. The same idea works with employees. Normal salaried employees receive the same check regardless of the work they do. Using equity as a form of compensation encourages them to work harder, because they’ll directly receive the rewards.
Responsibility is Shared
Giving employees a stake in the business gives them a greater sense of responsibility. Although you may be the primary owner, having other smaller owners relieves you of some of the responsibility. It also makes their work feel more meaningful. Most employees want to actively be involved; otherwise, they’ll lose interest.
Attract/Retain Better Employees
Equity can be a great benefit to tout around when attracting new employees, and those employees may be of higher value. Further, equity can help you retain good employees longer. The rewards and responsibilities of the ownership encourage them to stay.
It Can Make Business Transitions Smoother
In the event that a business owner leaves, the business doesn’t have to suffer the chaos of such a transition. Employees can buy out the owner and keep the company going.
Potential Drawbacks of Equity
The benefits make equity sound like a no-brainer, but slow down. Here are some considerations.
You’re Giving Up Ownership
You may only be giving up small pieces of your ownership, but it adds up. Either way, you are not the sole voice of the business anymore, so if you’re hesitant to give up some control, don’t proceed.
What Happens When They Leave?
You have to figure out before you dish out ownership what happens when an employee leaves. Do they sell it back? Do they still own a piece, but just take a less active day-to-day role? What if they leave in an unquestionably negative way? Decide what you’ll do in situations like this ahead of time and clearly outline it in writing. Speaking of writing…
You Have to Do it Legally
You may have to completely change your business structure in order to do this, which takes paperwork and, sometimes, lawyers or other outside help. You need to follow the law before anything else.
It’s Just Overall More Complicated
It’s simply harder to manage. How much ownership should you give? How much is too much? Are you following the law? What happens after they leave? How much equity are you going to give them vs. how much cash? There’s a lot you have to think of when you share ownership that were not even on your radar beforehand.
Employee Equity: Right for Some, but Not for All
For cash-strapped companies, equity-based compensation can be the ultimate solution, but it makes things complicated. This is what businesses will ultimately have to consider when deciding whether or not to use equity.