Want to make your business more appealing to jobseekers, and incentivise your current employees to stick around and keep bringing their A-game? Then you should be looking at ways for your team to share in your company’s success.
Over the past several years, we’ve had ongoing conversations here at SBO Financial about how we can implement equity-like compensation for our team. Now that we’ve gone ahead and done just that, I want to share the thought process behind our decision, and take a look at how you can encourage your employees to think like a boss.
In this article:
What is ‘equity-like’ compensation?
Why would we do this?
Why we chose a profit-sharing model
What is equity-like compensation?
It’s common for start-ups and scale-ups to dish out shares (or share options) as part of their benefits packages as a way to attract and incentivise employees.
When we talk about equity-like compensation, we’re talking about compensation that doesn’t come in the form of shares in the company, but is similar in the sense that it’s:
At-risk. Unlike, say, a signing bonus, this money isn’t guaranteed.
Residual. It’s derived from the amount left over after expenses are deducted from income – the profit, in other words. This means there could be no compensation, or there could be a lot.
Aligned with how the underlying company is performing. As the company offering equity-like compensation grows, so will the compensation. If the company shrinks – yep, you guessed it, so will the compensation.
To achieve equity-like compensation for our team, we arrived at a profit sharing model in which profits are pooled and divided between employees.
Why would we do this?
As a business owner, the most compelling reason to share profits with your team is that it aligns your interests with the interests of your employees.
That’s because, as an equity holder in the business, your primary motivation is to increase your profit. To do this, you need to grow your revenue and manage your expenses. But your employees may not share that motivation.
Sure, in an abstract sense, they know it’s better for their long-term employment prospects if the company is doing well. But without an element of compensation that’s driven directly by your business’ profits, they won’t share your devotion to the bottom line.
Profit sharing reduces the risk of divergent interests emerging – it directly incentivises your employees to help grow your profits, and it motivates them to think like an owner.
When your team shares in your profits, it brings everyone together with a common goal. As a result, you might find that your team becomes more productive, and decisions about expenditure are viewed through a different lens.
For instance, instead of defaulting to hiring a new employee when you have too much work on, one of your employees might figure out how to automate a process, or how to handle their current workload more efficiently. This is a win-win scenario – you won’t increase your headcount unnecessarily, and that employee’s share of your profits won’t be diluted.
Equity-like compensation is also a great way to share the upside. We all know there are implicit costs for employees that join small, early-stage businesses, compared to larger, more mature firms. There are often less resources for training, systems and HR, and you may only be able to offer below-market wages as your business grows.
By inviting your team to share in the future growth of your business, you’re letting them know they’ll be rewarded in the long term for these short-term difficulties and sacrifices.
This should help you to build loyalty within your team, and to attract talent you wouldn’t have a chance of signing if the current salary was all you had to offer. Better yet, instilling that long-term mentality should help to drive better decision making across the business.
Why we chose a profit-sharing model
There are plenty of ways to incentivise your employees. Employee Stock Ownership Plans (ESOPs) are particularly common, and are available to all companies, whether they’re listed on the stock exchange or not.
An ESOP provides employees with an ownership interest in their company through stock ownership. It gives them shares or options in the company. They’ll be taxed on the value of the shares or options they’re issued – the ATO essentially treats this stock as income. (Unlike wages, it’s the employee’s responsibility to pay the tax, not the company’s.)
But you don’t have to jump directly to giving away stock options. This is, after all, a dilutive strategy – for every share you issue, your own shares will make up a smaller percentage of the company.
In our case, we shifted away from the typical ESOP model for a couple of reasons.
The first is that it’s essentially pointless if no equity liquidity is planned. We have no intentions to sell or raise capital, so there wouldn’t be any opportunities for employees to monetise their shares on the horizon.
The second is that ESOPs can be notoriously complex, costly and time-consuming to administer in compliance with legislation.
To provide our team with equity-like compensation without those issues, we concluded on a profit sharing model, in which employees receive a percentage of the company’s profits.
It’s a simple and straightforward model, which can adapt to more complex arrangements if necessary, and it requires minimal infrastructure to administer.
But here’s the thing – whether you choose to assign stock or share profits with your employees, these types of arrangements only work if your employees feel like they can make a real contribution to the success of your business.
If employees feel like the decisions that affect your company’s profitability or valuation are out of their control, then you’re not going to get the alignment that makes these schemes worthwhile. They need to be able to see the link between their hard work and the company’s performance.
And if you start making questionable decisions without their input that drive your numbers down, then not only will you be out of alignment, but you’ll soon have a full-blown mutiny on your hands.
Equity and equity-like compensation are powerful tools to incentivise and motivate your team – but at the end of the day, a culture built on communication and employee empowerment will still be the foundation for your success.
Need help setting up an ESOP or profit-sharing plan for your business? Reach out to us at SBO Financial!
