How to give a staff member equity in your business

How to give a staff member equity in your business

Do you have a key member of staff that you'd like to bring 'to the table' by sharing some equity with them? If so, read on as we'll be discussing (almost!) everything you need to know when it comes to inviting staff to become shareholders in your business.

Before you start issuing shares to staff members it's usually wise to exhaust all other avenues first. Why? Because once issued, equity can be a tricky thing to take back, so to avoid drama where possible we'd suggest looking at other options first before taking the equity route.

What other options are there?

There are a few and we'll look at the main ones in order of preference (i.e. try number one first, number two second, ...).

  1. Performance bonuses. Option numero uno is to reward the staff member over and above their salary with a bonus tied to their individual performance. This shows that they are capable of going beyond their basic duties and then rewarding them accordingly. Make sure the targets are realistic and clearly defined otherwise it may act as a deincentive.
  2. Profit share. If you've got member of your management team that is integral to the running of the business it might be time to start sharing some of the spoils with them. Start small and work your way up and remember that the bottom line isn't usually what you've actually got available to share as there is tax to pay as well as outgoing cash on assets that may not have any impact on the profit and loss. It's also important here to note their involvement with the management of the business - profit share to someone with no control over said profit doesn't always work as they have no control over the bonus.
  3. Phantom equity. Also known as shadow equity, this is a way of getting a key staff member's interests keenly aligned with those of the business without actually issuing any real equity to them. How's that? Phantom equity is effectively a bonus scheme whereby if the owners receive a dividend the staff member will receive a bonus (i.e. including tax and super) in some proportion to the dividend paid. And if the business is sold typically these arrangements will afford some kind of exit bonus to the staff member so they are rewarded for helping increase the value of the business. These arrangements can act as a great incentive and they are simple to implement (and undo), but note the tax consequences on the faux dividends and capital gains aren't as good as the real deal, so expect push back from a well-advised team member.

How should we structure this?

Once you've exhausted your other options it's time to talk equity with your star team member. Our advice is usually to start slowly, offer a small percentage of the company each year up to a certain cap that gives the team member enough skin in the game to be motivated, but not so much that the existing owners are demotivated.

Usually these deals involve the shares being purchased from the owner unless the business needs cash for some reason, in which case the shares may be bought directly from the company. This is good news for the existing owner as the cash received allows them to realise some of the goodwill they've built up in their business and it'll be taxed favourably given the 50% CGT discount and the small business CGT concession (assuming they are available).

The purchase funding is usually the concern of the staff member, but if they are struggling you could look at vendor financing where the company loans the money to the staff member to make the purchase from the existing owners. If you're doing this be wary of any possible FBT or Division 7A tax issues.

Alternatively, you might decide to simply gift the shares (or part of them) to the staff member. In that instance you should be aware of the Employee Share Scheme rules which, broadly speaking, look to tax the staff member on any discounts received on shares in their employer company. This can result in some pretty hefty tax bills, so what appears to be a generous offer may actually be a costly one. 

As with any business deal make sure you get tax advice and a solid legal agreement in place. In this instance it'll be a shareholders agreement which will deal with all kinds of matters including dividends, what happens if someone gets made an offer to sell, how extra shareholders can be brought into the mix, what happens if you get into a fight, etc.

What next?

Your best first step will be to speak with your accountant. They will be able to advise you of all your options and the ramifications - for you personally, for the staff member and for your business. Get this advice before speaking with the staff member to help ensure you don't right cheques that you can't cash.

If you're keen on bringing a staff member into the fold by giving them equity then why not get in touch? We've helped countless owners grow their businesses by bringing key team members into the mix and we'd love to help you do the same. Get in touch today!

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