Offering Stock to Your Employees: 5 Key Financial Considerations

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Most small businesses hire employees, pay them, and offer them benefits. But at the end of the day, those employees aren't closely tied to the company. Whether or not things go well, they'll receive their paychecks. However, that isn't the only option available to small business owners. You can choose to make your employees more involved with your business' future by offering them stock in the company.

It's not a decision to be made lightly, of course. By offering stock, you're offering part ownership of your company, as well as a share in the proceeds. But the benefits can be worth it. An employee who holds stock in the business he works for has an incentive to go all-out when it comes to earning money for the company. If you're comfortable with the considerations that go with a decision like offering stock, it's an option worth exploring.

1. Do you need to tie your employees to your company?

Holding stock in a company can give an employee a reason to ignore job offers from your competitors, a fact that led Alex Moazed to offer stock to his employees. He found that it also helped to bring his employees on board for the business' future development. Moazed says that his employees like the stock program, which has been in place for about a year. "They have responded positively. It makes sense on their end and on my end. They have more motivation and devotion to the company and its goals."

Moazed notes that he does not offer identical stock options to each of his employees. The details for each employee vary, based on what the employee wants and what Moazed is able to offer.

2. How will you change your employees' compensation?

For an employee, the first question is likely to be how a stock deal will change his take home pay. If you're thinking of lowering your employees' immediate income in exchange for offering stock, be prepared to encounter resistance. The problem is that you don't want to put yourself in an awkward financial position by unbalancing the compensation you offer your employees. However, offering stock in place of a raise or a bonus can help you maintain the balance.

Bibby Gignilliat is the founder of Parties That Cook. She chose to offer stock as a bonus for her staff: "In a down economy last year (when I could not give bonuses and raises), I chose to award my staff with equity compensation."

3. How comfortable are you with your employees?

You have to have a certain comfort level with any employee you are considering offering stock to. After all, you don't want to be in a position where you've given stock to an employee who then leaves your company. There are approaches that can reduce risk, but it's important to realize that you're going to have ties to anyone you provide stock to and avoiding creating knots is important.

There are some companies that offer stock plans to new employees right off the bat. Doing so is certainly an option, but it does require even more care when setting up the paperwork to ensure that the offer won't backfire.

4. What sort of stock do you want to offer?

There are a variety of types of stock you can offer, depending on your business structure. The particular types that you may choose can serve different purposes. Gignilliat used two different approaches to create incentives for her staff, who are spread out over three cities. "I awarded staff who were in jobs that involved growth (like city managers), with Stock Appreciation Rights and I awarded staff who I wanted to make sure to retain over the long haul, with Phantom Stock...I chose Phantom Stock for the employees who have been with me the longest and whom I wanted to receive value on the day Phantom Stock was offered. And I choose to offer Stock Appreciation Rights to newer staff members and members who were in high growth jobs so that they would be motivated to grow the business (but the value of their pie would be based on the delta of the starting value to the future value)."

The response to both options has been positive, says Gignilliat: "All of the employees to whom I gave the equity compensation are still with the company. They still treat the company as their own and seem even more invested than before. It is motivating to the staff — they are even more invested in growing the business as much as possible (like I am) to create value for their piece of the pie."

5. Are you comfortable with the paperwork?

You may have a good idea of the terms of the stock deal you want to offer your employees, as Moazed did: "I knew the terms of the plan, but consulted with my lawyer and accountant to set everything up properly." The paperwork involved with transferring stock to your employees requires some careful consideration. You may need to draw up new contracts with your employees, make some changes to your tax paperwork and — depending on your business' structure — make sure that your business is set up in such a way that you can simply transfer stock.

There are companies that will handle the process of setting up a stock plan, such as the one used by Gignilliat: "I decided to hire Tony as a consultant to help me determine what to offer my staff. Over a few months, he helped me structure the whole program and view financial scenarios to see the impact that the plan would have on my business in the long term. Having been through a difficult partnership, I did not want to give away any ownership...We used a legal advisor to review all of the documents that Tony drafted for us. We got a special price from Tony given our connection with Pacific Community Ventures. We also hired a consultant to value the business. Given the down economy, we were able to bargain quite a bit. The whole package cost us about $6000 to implement."