By Corey Rosen. Closely held companies often call us to ask questions about how to set up and run an equity compensation plan for employees. One of the first questions they ask is how much equity they should share. When I ask them what they have in mind, almost invariably they say 10%. Somehow, it just sounds like the right number. And they have heard that is what other companies do, so it must make sense. Of course, if people share 10% because they hear other companies share 10%, it becomes a self-fulfilling trend.
But 10% of one company—say one with a few years under its belt, some solid products, and profits or their near-term prospect, is a very different company than a start-up or a well-established company with steady earnings. Ten percent of one produces a very different value than 10% of another.
Other companies base their models on what surveys show typical employees at various levels get in terms of a percentage of a company. This method creates the same problem – x% of one company not being the same as x% of another – but just makes it more granular and seemingly scientific.
From the employee perspective, no one really cares about absolute percentages. People care about what the grants are actually worth. So why not start there? Figure out how much value you want to provide to employees, then figure out if you can afford it and make adjustments.
An even better approach, I think, is to use a dynamic approach. Each year, set one or more targets that are critical to what employees need to do to add value to the company. If the company meets that target, share a percentage of the value created over and above it in the form of equity. If your target is profits, you can estimate how much added profits add to equity value and give some percentage of that number. Other targets may require a more intuitive judgment, such as how much added market penetration or revenue will add to value, but your accountant (or better, an appraiser) can help you assess that.
In this model, if companies do really well, they will give up a higher percentage of equity; if they don’t meet their targets, they don’t give up any. But if companies do give up a higher percentage, so what? The amount held by owners grows even more. Would owners be happier with 90% of less or 80% of a lot more? Once you determine the pool, now you can work backwards to determine who should get what and whether that is enough or too much. You can then make adjustments as needed.
The grants should made annually, providing a regular incentive that employees can specifically link to their collective efforts. By doing this, you convert equity grants from an entitlement to a jointly shared and earned reward.
Corey Rosen is the founder of the National Center for Employee Ownership and author of The Decision-Makers Guide to Equity Compensation. The NCEO is holding a seminar, cosponsored by Certent, on Equity Compensation for Companies Staying Privately Owned in Santa Clara March 8.