The Small Business Owner Thinks Big on Equity Compensation
January 2009
Early in my consulting career, I came to the realization that when a business leader uses the term “small business” as in, ‘I run a small business,’ it is purely a state of mind. And, when it comes to developing compensation approaches to drive growth, the generally poor economy is bringing out the most innovative and optimistic instincts of the small business leader.
I was reminded of my small business epiphany during a recent meeting with a CEO to consider a recommendation that would increase 2009 cash compensation by 3%. His reaction was “we can’t possibly afford that type of increase in this environment. We are just a small business after all”. This is not an exact quote as the CEO included some language that cannot be reprinted in a family business publication. But the point is that this CEO led a company with $250 million in revenue and 750 employees. And, like all “small business” owners this CEO was so close to how his organization makes and spends money that he felt like a small business owner with all the uncertainty, risk and tough trade-offs that implies.
I have commented previously on one characteristic of the small business owner. They can get stuck in a zero-sum way of thinking about compensation along the lines of ‘If I increase Joe Salesman’s commission by 5% that is 5% out of my pocket’ as opposed to the possibility that a well designed 5% increase in a commission might increase sales and net profit by 20%. No doubt about it, it is hard to resist the zero-sum thinking in a poor economy.
But the current economic environment has also brought out what I consider the best characteristics of the small business owner – the creativity and adaptability forced upon them by the perceived or real constraints they face. Many are reaching for any way they can to keep their key talent and poach on their slower moving competitors. They want to be prepared to come out swinging when the recovery comes.
While some small business owners remain reluctant to give up any share of ownership, many recognize that equity-type approaches to compensation are the best way to attract and keep talent during this economic environment when cash flow is at a premium.
This involves working through the pros and cons of a number of issues; and, as with many compensation issues, there is little in the way of best practice to turn to. Instead, every business has its own requirements, priorities and objectives.
For starters, what are the objectives of an equity program and what employees are being targeted? Am I trying to attract new talent, retain employees who might leave without a big pay increase or motivate employees to achieve particular goals? No one compensation program can ideally meet all three. A common mistake is trying to use one compensation program to achieve too many objectives or meet the objectives of too broad an employee base. The result is often an overly complex program or one that is not particularly transparent to the participant. An equity program that is overly complex or opaque is a waste of money.
Other considerations include:
- What percentage of ownership, profits, revenue, etc should be distributed?
- Should I use shares or options?
- How do I value the share price?
- Compliance with Federal and State Security laws and regulations (or preferably, identifying the appropriate exceptions).
- How do I divide up shares among the targeted employees?
- What kinds of restrictions or vesting should I put in place?
- What is the impact on a potential transaction?
- Should I add performance criteria to the equity grants?
- What is the cash Flow/accounting impact under various business scenarios?
- What is the time period for the grants?
The bang-for-the-buck of a well-crafted and communicated equity plan is tremendous. Designed correctly, it can replace the use of scare cash, send a positive message to employees and create a a compensation platform to grow on. Even a small business owner has to love this.
