If you can’t afford to pay top-notch salaries to your employees, company stock may win them over. But while issuing equity appears to be a fairly low-cost option, it can cost you down the road, and it also carries a host of disadvantages for employees.
Employee Ownership Basics
C corporations and S corporations can both issue company stock to employees, although S corporations are limited to 100 shareholders. LLCs can’t issue shares of stock, which means that they can’t implement employee stock ownership plans or any type of stock options. However, LLCs can grant a membership interest to employees that represents ownership in the company.
Partnerships can choose to make employees limited partners, meaning that they own part of the company but can’t take an active role in managing the company. However, the National Center for Employee Ownership notes that the legal treatment of partnerships make employee ownership more complicated. Because of this, the Center only advises employee ownership in a partnership when there are a few key employees that have a close working relationship.
Pros of Issuing Equity
- It Creates a Stronger Commitment: Stock gives employees an incentive to see the company succeed and profits rise. It helps staff maintain a long-term mindset and it gives in-demand employees a reason to stick around.
- It Helps You Succeed: The Center for Employee Ownership notes that multiple studies have shown that employee-owned businesses with employee participation perform better than their business counterparts.
- It Keeps You Lean: Offering some stock as compensation means that you don’t have to spend as much on salaries and payroll taxes today. This helps keeps your expenses low in the startup stage and allows you to reinvest cash back into the business.
Cons of Issuing Equity
- It Make Your Business More Complex: Distributing equity is a complex process and you’ll need to pay your attorney to make sure you get it right. The Society for Human Resource Management points out corporations that add too many shareholders could be automatically converted into publicly traded companies under U.S. securities law, which you don’t want to jump into accidentally.
- Employees May Not Value It: If your company is never acquired and stays privately held, employees may not have many opportunities to cash out their stock. Employees that remember Enron and other recent accounting scandals may not as be enchanted with stock as a form of compensation. Lower income employees may prefer cash in hand today over more valuable ownership that could pay off down the road.
- It Messes With Employee Portfolios: Investors should have diverse portfolios and it’s not usually a good idea to maintain an investment in a large amount of a single stock. Owning your employer’s stock makes the risk even bigger — if the company goes under, employees lose both income and the value of their stock investment.
- You Lose Equity: Stock may feel like a cheap way to compensate employees now, but you may be losing your autonomy along with a share of company profits. When an employee owns company stock, they also take on the rights and responsibilities of ownership. If employee-owners have different opinions about significant business decisions or management style, it could become difficult to run the company.
Stock can be a powerful motivational tool but come with a lot of complexity and downsides. If issuing equity doesn’t feel right for your business, consider creative ways to reward your employees and offer customizable employee incentives as a way to retain talented staff.