When it comes to equity, there is no one-size-fits-all. It is something that is customized to a company’s situation. Today’s guest co-founded a company dedicated to helping others in this area. Jon Burg of Infinite Equity joins the forum to take us into the world of equity and how he got into it doing what he does. He talks about equity plans, expanding the concept of using equity as compensation to employees, sharing ownership, and attracting quality talent through it. Jon also shares his insights on how to lower voluntary turnover and helps you understand the many tax implications involved. Join this conversation and learn more about the equity world.
We are a mastermind of leaders dedicated to creating workplaces where people thrive, employees reward, and customers love. We usually have a whole host of people here. Jules, unfortunately, is having some connectivity issues. It looks like she is not going to be able to be with us, and either is Char. Char is down in Mexico and setting up her workspace down there. She doesn’t have connectivity.
We are lucky enough here to have Sumit Singla with us once again. Sumit is an expert in people strategy out of India. If you have joined the forum here before, Sumit is a wealth of global knowledge of people strategy across the world. He brings that global perspective to us here at the show. Me, myself, and I, I am Sam Reeve.
I’m a compensation and rewards expert. I’m also an expert in talent management. I’m here to sponsor these forums with the CompTeam. I’m happy to have you here every week. A little bit about the forum is that we are multicasting across several channels. We are on LinkedIn, YouTube, Facebook and Twitter.
Let’s go ahead and introduce our guest. Jon Burg is the Cofounder of Infinite Equity. He is also a partner of our CompTeam. We are fortunate enough to use Infinite Equity services in a lot of our clients. They are a trusted partner. The important part of what Jon and his team do is help companies and their leaders make the right decisions when they are dealing with those equity questions as far as their stock pool and how much they have to spend. There’s no one size fits all. Equity is something that’s customized in a company situation and why it’s quite an important topic.
To kick things off, Jon, can you tell us a little bit about yourself and how you’ve got into the equity world and doing what you do?
First off, thanks for having me. This might be my first debut on some of those platforms you listed off there. I’m very excited to be here for this conversation. A little bit of background, I used to refer to myself as a recovering pension actuary because I told a lot of the story. Since it has been years since I was a certified actuary, it has gotten a little stale. I started my career doing pension work. I’ve got involved in only determining the liabilities but gaining an appreciation for some of the employee behavior that underlined how you develop the liabilities for a massive set of people covered under a pension arrangement.
It was interesting to work but I was always looking for a way out. I’m looking for that greener side. It lucked out that in about 2004, the exposure draft related to stock-based comp for accounting purposes didn’t so much rewrite the rules because largely, what they were taking is the accounting standard and moving it from a proforma basis into the income statement. It shined us a giant light on, “These numbers start to become more real. It’s not stock options because it’s free. We’ve got to run-up to the income statement.”
I was able to leverage my actuarial background and apply it directly to equity. Needless to say that being many years ago, it set off a fire and passion more broadly about concepts of using equity as compensation to employees. As we will get into some of the nuances in this conversation, even more broadly than specifically equity, is this idea of sharing the ownership of the entity that employees are building.
Fast forward along the way, we left a large consulting firm and launched Infinite Equity to double down on this passion and work with a much wider range of companies, which has brought us into private companies, LLCs and family businesses. It’s some of the stuff that we will get in and try and dissect for those that are thinking about how it applies to their own situation.
Equity is quite an important part of compensation. I know a lot of our readers are probably wondering, “Can I even have equity or a long-term incentive program at my company?” First of all, can you tell us the different forms of long-term incentives that small private companies might entertain?
This is probably a good way to level-set the concepts because when we refer to equity, we might think of it as the universal umbrella but it’s specific to what corporations can provide to their employees. Sometimes it gets a little bit lost in translation when an LLC is thinking about what they can do in terms of sharing. I like how you framed it in terms of, “Let’s think about this as long-term incentives. How are we taking this idea of providing compensation or even benefits in some forms to our employees but doing it in a way that it’s also sharing an ownership concept?”
We use LTI in ownership more as the umbrella and then get into, whether it’s equity, profits interes, or phantom awards because a lot of that corporate structure as well as what you are trying to achieve helps you down that path. Let’s look at it from corporations, whether it’s designated as a corporation or an S corp pass through, this is an opportunity where you can use real equity.
Typically, the way to think about it is that you have an idea of an appreciation vehicle of what we commonly think of as stock options. The idea being the value conveyed is based on increasing the value of the company. We also have the concept of shares. Those are the two predominant vehicles available for corporations.
From there, you get into, “What do we want to buy with this equity? Are we looking for retention and sharing in the upside? Are we looking for more specific performance milestones?” You get into all of these different flavors, which can get confusing. If you take a step back, the two vehicles are this idea of an appreciation for the full-value share. That’s corporations. The good news is most of those same concepts translate into other forms of corporate identity or tax situation.
Let’s look at LLCs as a segment. Here, you are not using equity per se. You are using membership units within the organization but the concept of the value conveyed in appreciation is the same as a stock option. It’s just a little bit different mechanics and how you write it up. Are you using full units very similar to what you see in corporations? Even though there are all these different flavors, when you get down to deciding what you want to do, starting with the philosophy helps determine how you are going to make the decision later on.
The third category is this idea of phantom or cash-based LTI. There are lots of different reasons. This is a little bit agnostic to what corporate structure you have, where you might form or develop an LTI program but with the intent, for it to be fully denominated in cash. We see this sometimes as long-term cash. When you hear the term phantom, it’s still cash-based but the idea is it’s intended to replicate the economic benefits as if it was real equity or real units. I’m going to repeat them because I threw a lot. You have got real equity appreciation or full units. LLC is the same concept. It’s just a different tax structure. You have a third category, which is cash-based.
I often find that a lot of the confusion on this is lost in translation with the terms. The bottom line is, whether you are a public company or a private company, you can have vehicles that perform very much the same. They are named differently in the different environments, right?
That’s exactly right. As I know, you spent a lot of time with your clients. Part of avoiding some of that confusion is spending time upfront and helping them develop what their compensation philosophy is. Even more specifically, what are the objectives you are trying to get out of here? A lot of times, we will get the question. We want to provide equity or an ownership opportunity to employees but it’s a little bit of a blank slate.
Having clearly defined objectives and a compensation philosophy almost works as a North Star to that company. When you get further down the line and start deciding on things like vesting, liquidity, and some of the other challenging things that are important to think through and have a myriad of decisions later on, having that North Star to go back to and check it against, “How well does this decision align with those objectives?” It certainly makes the rest of the design process easier.
I have had several clients. Some will say, “We want to create an ownership culture where everybody is an owner.” We have other clients that go, “I don’t want to give up or dilute my ownership but I want people to think like owners.” They have different types of philosophies on how they want to run their business. The nice thing is that there’s a solution for each one of those strategies, right?Having clearly defined objectives and a compensation philosophy almost works as a north star to a company. Click To Tweet
There absolutely is, and you said it really well. Regardless of what the fact pattern is or the objectives of the owners or founders, there is a solution that’s going to align with those. It’s also important to point out there are a lot of solutions that they could end up with that don’t align very well with some of those objectives.
That’s why it’s important to have some agreements to guide them to the point where they best align with those decisions. A lot of times, we are getting involved in a pre-IPO company and having to go back and look at some of the decisions made 5 or 10 years before. There’s oftentimes a lot of areas you can point back to and raise the question, “Why did you do this? You clearly hadn’t thought about some of the downstream implications.”
Before we get into the details of the strategy around this, let’s stay on the topic of communication and understanding. One of the big problems with equity programs or long-term incentive programs is that they are confusing the people, whether you are an owner, leader or employee. Let’s cut to the chase. I don’t know how many executives I have spoken to who are supposed to know equity plans, but then they secretly don’t know about how they operate. They themselves are also intimidated.
As far as these plans, I find that one of the most important things is the perceived value. Somebody is not going to value a plan or compensation component unless they understand because when I talk to employees, I go, “There’s some equity. Tell me what do you think it’s worth.” They go, “It’s something between $0 and $1 million. I don’t consider it part of my comp. It’s like a lottery ticket. I might become rich someday or something but I focus more on my cash.” Do you ever come across that in your practice?
We come across that a lot. I was hoping you were going to give me the magic formula for how you convey that understanding in perceived value because I don’t think we are going to solve it in this. We could probably share some tips that we think work well in that communication. I’m going to answer it in two ways. One is the transparency aspect. Here, there are a lot of things that companies can do but I understand why there are some limitations.
First and foremost, you go through a lot of time and effort to develop a plan, have it adopted and determine how much to give people, what features to put on those awards, how to come back and refresh it. Where I don’t think we spend enough time is one on the communication but it’s providing some of the transparency and the things that will help them understand what they have. Through that, we develop a greater appreciation.
The simplest thing is to get a cap table and an equity management system, which allows your employees to go in there and see their awards. There are no more spreadsheets. There are lots of solutions out there that can align well. It doesn’t matter if it’s real equity, these units, or even cash-based. Most of them have the flexibility. Start there.
Also, there’s some shyness with companies in terms of providing transparency on what the 409A value is with the company. If they are given options, they will see the strike price. That conveys the starting point. They don’t necessarily have visibility to the rest of the cap table. They may not know the total value of the company to the extent that the owners are comfortable providing more direct transparency or an understanding as to what those aspects are.
More importantly, as the future 409A values are determined, convey that. It’s still a paper gain. There still may not be liquidity for a number of years, and you want to get that across. Start to build some of the understanding of, “We are growing this entity together. How does that translate into this promise you gave me through this equity instrument?” That transparency is number one in terms of areas for improvement that can happen.
We get into classic communication and education. I would like to get your thoughts as well. There are two elements of psychology that we try to tap into when we are rolling out a new plan or doing education on existing awards. The first is when we are getting into what you have in the terms and everything else, we do find that if we can associate it by analogy to something that we think they have a pretty good understanding if we can do that first, then that helps to draw a connection between what may be a new term and something that already exists.
We do this in a stock purchase plan. Sometimes, we are matching schemes to the extent we can associate that. You save money into your 401(k). We match it with some dollars or profits. You have similar opportunities in share purchase plans where you are saving purchasing shares. Being able to draw that connection is key. There are similar parallels, which we don’t need to get into with the different types of instruments as well.
The second principle that we try to tap into is to help them appreciate what they can do with the money. This may be segmented by different generations. If you have a younger workforce, it’s helping them understand that this can pay off some student debt in the future. It may help towards being able to plan your route in terms of the downpayment. Get them thinking, not just in this instrument that I have but what it might mean in the future.Somebody is not going to value a plan or a compensation component unless they understand. Click To Tweet
I see one of my longtime friends in the audience there, Emily Cervino. I’m going to call her out. Emily is at Fidelity. She always tells the story of the first ESPP she participated in. Thanks for those purchases, she built a deck off of her house. This was years ago. I heard her say this in a speech. It stuck with me that long. That’s what built the appreciation, and her love for ESPP is what she was able to do with that money.
I try to encourage clients, don’t be afraid to plant some of those seeds in terms of what this might mean. Instead of thinking it’s that lottery ticket of $0 to $1 million, get them thinking about something that’s more tangible, paying off my debt, putting a down payment, helping with some other expenses, savings, and wealth generation. Any one of those is fair. Those are the two psychological things related to something they know, and then get them thinking about what they can do with it. Sam or Sumit, what things have you learned there over the years to build appreciation?
That is all those things you mentioned there as far as communicating value and making sure that there’s regular communication of how the company is doing and how that translates into the different plans. Sumit, I would love to hear your impression on how equity and long-term incentive plans are perceived in different places around the globe. What do you typically see in India?
Jon hit the nail right on the head by saying they are not communicated well enough. Usually, it’s a lot of jargon and complicated language. I wish there could be a lemonade stand version of what an equity plan is all about. Also, it’s what you could do with the money. It’s an example like the one from Emily. I see that she has put in a comment saying she has added a second story to her first home. Thanks to an ESPP. They would understand it, especially some of the younger generation who have not maybe understood financial markets, shares, and trading in so much detail. It will help them to get into wealth creation.
Also, the demographic context in India and Asia is a little different. Children or teenagers don’t pick up jobs as such. You are dependent on your parents until you finish your undergrad course. That’s when you start working and start being a little more financially independent. People get financial prudence a little later in life age-wise.
It will help to maybe have a simple version of an equity plan explained in the onboarding itself and maybe even before. If you are trying to attract quality talent, you can build it into your employer value proposition itself and say, “We believe in creating owners, not employees. Once you join us, this is the value you will add to yourself in addition to your salary.”
It’s having that strong communication planning. Communication is typically where I see equity fail in companies. If they don’t have it well-communicated, it’s going to be undervalued. When we are thinking about some small companies that are out there or startups that are mom-and-pop shops, they are thinking, “Equity is too complicated. Maybe I can go by my cash comp and deal with a cash comp?” What are some of the reasons that you hear that small companies don’t have equity plans?
I want to call out Sam and Sumit. I thought it was fantastic before answering this question and moving on. Don’t forget it’s a marketing opportunity for the employees. Selling the reason why you are giving the equity, we said, “We are trying to shift the mindset from employees to owners.” I thought it was crystal clear. It’s something that you would communicate in terms of purpose that could be beneficial to the long-term appreciation.
Maybe that’s a good segue to your question, Sam. We picked out companies that don’t want to do it. The litany of reasons, some are very valid, and some are probably not. The laundry list is going to be pretty long. You hit on a few of them, complicated cost, “Do we get the real benefit of it or not?” A whole host of other reasons are some of the things that we hear.
Many of them are going to be spot-on valid for the situation or for the way they are looking at it but it could be a situation where if you shift the lens or strategy in terms of what you would be doing to extend the ownership, some of those might go away. For example, let’s take a family-owned business. It’s one that has built a nice profitable business. It has paid employees well with competitive salaries and cash incentives. It’s probably a good 401(k) and has done well up until this point.
We have run into a handful of these as we have been concentrating more on this market. What they are finding is they are still maybe not as competitive to some public or even private corporations that offer equity as part of the mix. That’s at least driving some of the consideration on ownership into losing some people that they think they otherwise might have been able to retain.
It gets them thinking like, “Could we do ownership conceivable and we are not on a growth trajectory to go public?” When we think about an exit strategy, staying private is one of those paths. Oftentimes, we only think of trade sales and going public as the exit strategies but permanently private or private for the foreseeable future is something that should be thought of as an exit strategy.
They are on this permanently private exit strategy. They want to be more competitive for ownership but they don’t want to give away ownership or deal with some of the hassles. That is a legitimate burden to overcome but this is where shifting the lens in terms of what the strategy is can still strike the right balance. This is where the fact pattern comes into play, where phantom equity might make a lot of sense.
Here now, you are going through the same design consideration as if you were going to give out the stock option. You are allocating a certain percentage and ultimately implementing a phantom cash plan, where the liquidity through cash and profit is going to mimic as if someone received stock options and exercised at a specific time later. It can be done. It does introduce a couple of new variables, which you should have a way of valuing both the company as well as the underlying phantom units that you are giving out.
This is commonly done through multiple EBITDA. Typically, when you are in this situation, it’s a profitable business because you do need to be able to ensure you have got the cashflow later. Multiple EBITDA is a fantastic way to drive this. You have got an equity or ownership strategy. You have a formula in which to convey value. Dole it out, provide some transparency and communication. You can accomplish the ownership objectives even without providing real ownership.
Have you heard the argument, “My employees don’t stay that long anyway. We are lucky if we keep them for 2 or 3 years, and then they move on?” What do you do in situations like that?
The first is to take stock on whether that’s a problem or not, “What type of business is it? Is that turnover part of the business you are running? Is a lot of that excess turnover or unnecessary turnover that you would cut down?” If that’s the case, then having equity or a long-term incentive that spans multiple years is proven to reduce some of that unwanted turnover.
Further, we have seen some good evidence that employees will choose an employer that offers an ownership or equity stake over one that doesn’t. We see 2/3 roughly, as well as in other surveys that 3/4 of employees would rather work for a company that has employee ownership, whereas fully employee-owned.
We know there’s a lot of good data on attraction, retention, reducing turnover, and use of equity. If we were to encounter that situation, I would turn it around and ask more questions along the lines of, “Why not?” We try to drill in to see if there’s an ownership formula or strategy, which would address the underlying concern that they are losing people every couple of years. I realized it’s easier said than done but it’s where the process is just as important as the outcome.
Understanding your employee demographic is key in the reasons why people are leaving. That was one thing that we are seeing in this environment that we are in now. There are people who have been leaving companies at a higher rate. They dubbed it the Great Resignation. There have been a lot of thoughts of, “Perhaps we should have a plan that keeps people here long-term.”
This sounds like there are several types of vehicles. Let’s talk about the reasons why you would choose a different vehicle. You mentioned one. If you are going to stay private, you are going to be closely held. Maybe that’s a family business, and there’s a way to have a program there. What are other situations where companies deal with that might call for a different type of plan?
I touched on this a little bit at the beginning part of this conversation. There are some things that will point you towards a certain vehicle or not. With corporate structure, it’s corporations versus LLCs. That’s a clear delineation in terms of what you are able to give in terms of an instrument. There are real tax implications in terms of giving them. Particularly with LLCs, it does change the employee-employer relationship for those receiving it.
If we put LLCs aside because of some of the tax implications, it’s much easier to take a step back and think about, “We want to convey an ownership opportunity,” and then ask the question, “What do we want in return for that?” The answer, as you can imagine, is that each company is going to be a little bit different. Even within companies, key stakeholders may answer some of these questions differently. Some of this is a synthesis of different views into concrete objectives in that compensation philosophy.
What you are looking for is if the pendulum is swinging more towards motivation, sharing in the growth of what we are building, and incenting for specific performance, it probably means you are looking to do something more in this appreciation vehicle stock option concept. It may even be explicit performance triggers tied to the achievement of strategic milestones or growth values. In all of those situations, it probably means stock options or something synthetic to a stock option, where value is derived through growth from that point of time that you give the ownership when liquidity is provided.If they don't have it well communicated, it's going to be undervalued. Click To Tweet
If you are looking more towards a retention concept, how do we lower that voluntary turnover? How do we convey an ownership culture? You may not tie it necessarily to growing the company. You may tie it more towards, “You are an important part of this team. We are going to give you this stake of shares here but we are going to have you earn it over the next 3 or 4-year period.” In some cases, in full-value awards, it can even be tied to a liquidity event. Some of the reasons there are getting to some of the tax nuances, which maybe we will cover a little bit later here.
At a high level, what we are looking for is retention versus growth and some cellar qualities in terms of determining which of those two types of vehicles. It’s not to fully rehash it. If there are any concerns around giving real ownership or concerns over the complications of real equity, the tax treatment, and we are okay settling in cash, that’s the reason why. Even though you may create it in a phantom situation, if you intend to settle in cash or you don’t want to give away ownership, then you are going to be on this cash denominator to a phantom stock side of the equation.
You did mention tax a few times. We can’t give tax advice or anything like that. That is one thing to consider, depending on tax and regulation and where you are issuing your grants. If it’s outside the US, there may be things that need to be considered. Can you tell us a little bit about that?
Taxes are very important as well as the knowing aspect of ownership opportunities, whether it’s real equity or phantom. It’s further complicated by a couple of factors like, “Where is the company itself domiciled? Where are the employees from a local jurisdiction?” If you start with tax implications and you haven’t done the legwork up in the beginning in terms of whatever you are trying to do, you can often find yourself going down a path of letting the tax drive your decision.
The first cautionary element is to know the tax treatment, the regimes, and sometimes even the Securities Laws. Have a good understanding of that but don’t immediately jump down the path of designing something to align with the specific tax treatment. Particularly for global workforces, being able to convey a unifying benefit, this ownership plan is pretty important, and then coming back and explaining some of the tax nuances. That’s the first part of it, even though I have said that as a caveat, it’s important to know the tax requirements.
If there’s an opportunity to make something more tax-favorable to the employee, explore that. There are a handful of countries where there are qualified opportunities for tax benefits. Usually, it means qualifying the gain for better treatment than ordinary income taxes. In some countries, there are very few tax reporting implications. Clearly, there are too many different jurisdictions to get into. What the two parts leave you with is, don’t let the tax regime drive the design but be aware of it and take opportunities where you can.
The big message is if you have employees outside the country or in different locations, consider the tax impact and their cashflow or disposable income. Are they going to be more burdened in certain areas versus others? Also, back to the meaningfulness of equity, is that something that’s meaningful in their culture?
To talk about Americans, we can be a little US-centric at times, thinking that, “Equity, everybody should value that,” but it’s not quite true. In some cultures, it’s simply not as important. We need to make sure that we take that into consideration. You were telling me a situation about how you are seeing companies do equity differently or emerge with different ideas. I would like to explore that in this next segment about what is happening new in the marketplace. Sumit, can you tell us a little bit about what you found?
One of the most interesting ones was an Indian company that was in the news. The company is into meat and seafood. They have created a program where they say, “Everyday vesting, anytime liquidation.” During the year, you can liquidate your equity at any point in time. They don’t hold you to the longer-term duration of vesting. It’s also an outcome of the fact that they have quadrupled in size in the last several years. They do know that there’s hypergrowth that’s happening. They are not tempted to cash out and leave quickly.
Most of their people have been with the company since the start. They are hiring aggressively as well. The message that’s going out in the market is the fact that this is a good stable company with more than double-digit growth. That’s likely to continue for the next 5 or 10 years. Even without trying to lock people in, not everyone might be happy with the everyday vesting formula. I can sense a lot of experts criticizing it but it does work for these people.
Also, for the larger companies, I know Pepsi used to do this. They used to have cash compensation but it was deferred cash. You have the option of collecting 100% of your bonus at the end of year one or you could say, “I don’t want 100% of it now. I’m willing to park some percentage of it until next year, when I will get an additional amount for it. If it’s supposed to be $100 at the end of year one, I will only collect $80 now. That $20 will become $30 or $40 at the end of year two.”
By the time when that bonus is ready, you are already in line for your year-two bonus as well. It’s a cycle that keeps ongoing. I don’t know if this is a US-centric practice as well in discounting our equity shares. The way companies in India started marketing this one is the exchange rate. The dollar is a strong currency. The price of the Indian rupee versus a dollar has only been going one way for the last many years.
As the exchange rate fluctuates and the dollar grows stronger, even if the share price stays still, you will still be making money. With a growing company, you end up making a lot more. On top of it, you get a 10% or 15% discount on the market price of the shares. Even on day one, you are already making money, and that’s lucrative.
Similar to what Jon was talking about, companies like Adobe, this might be a global plan that they have. You can take your performance pay in cash or terms of equity shares as well. They are fine with that. You can take it in different ratios. You don’t necessarily have to convert all of it into shares. You can say, “I will take 50% cash and 50% shares.” These are some of the practices that I came across, which are pretty popular among the younger generation as well.
Are you seeing a change in how the demographics perceived equity and how that plan design is for the future, Jon?
To me, it hit on a couple of things that are interesting to dive into. We don’t have the full answers. Netflix has been doing this for a while with cash comp, trading in for equity stakes with a little bit of enhancer. What you are offering is a choice. While it’s still a minority practice in US companies that we work with, we have seen this growing in interest and different applications.
When we think about choice, oftentimes, it’s stock versus options. There are plenty of those examples out there. We have seen an increasing number of ones where it’s cash or bonus in exchange for a choice for options as well as when you think about the broader concept of an employee stock purchase plan. It’s what Sumit was talking about that is growing in popularity in terms of Indian-based employees.
We have seen a real dramatic increase, both in the adoption of plans but also with all of the new IPO and direct listings. The number of companies, including an ESPP, is in near 90% prevalence. At its heart, it’s very much a choice or an offer to employees as well, “Do you want to participate or do you not?” The choice is, “Do you want to use some of your own capital to buy into our company?” We will give you an additional benefit on that. Typically, it’s a discount, lookback or sometimes a match.
To me, it’s a compelling offer. It says a lot about the psychology of the employee’s interest in both the company as well as the broader concept of an ownership culture. Unlike giving our issues or stock options, this is an offer that they need to assess on their own terms and determine if it’s a good offer for themselves. In that respect, this is where my actuarial mindset of mine gets excited. There’s human behavior that you can go and measure.
When we break down some of the impacts, they are bifurcated between those participating and those not participating. We have seen some discernible benefits. It’s lower voluntary turnover among those participating in purchase plans, higher performance ratings, and then higher engagement scores. This is on a small subset of companies where we have been able to dig underneath the hood. Starting with the hypothesis that ESPPs are great and employees that are participating in them are more engaged with their company and their day-to-day jobs, it’s nice to see some of that data bear out.
Those are a couple of the things I liked. With equity, there are so many different decisions you can make. That gives an opportunity that you might do something a little bit out of the norm. You might be criticized for it but it might make perfect sense as to why you are doing it for your employees. I think of Pinterest years ago still as a private company that said, “We are not going to truncate your exercise window if you leave the company.”
Typically, what happens is once you vest in options, you have until the contractual period as long as you remain an employee. If you leave, oftentimes, that window chops down to 1 to 3 months. Pinterest said, “We are going to give you the whole term. If you were here and you earned these options, we are going to still allow you to enjoy the benefits of future growth even after you left.” It certainly made some news at that time. It probably got more criticism from other companies because they didn’t want that to become the new trend but for them, they felt like it worked.One that has built a nice profitable business has paid employees. Click To Tweet
It aligned with their ethos in terms of, “We are giving you this compensation for the services but it’s yours at that point. Even if you leave us, we want you to continue sharing in the growth that you have built beyond that. We don’t want to handcuff you particularly while it’s a private company.” There are a handful of other examples that we could pull out. The idea of, “Don’t be afraid to experiment but make sure it works for you,” is a good guideline to follow.
As you mentioned, the vast majority are still doing the plain vanilla approaches that have been tried and true over time. Let’s say that some of the leaders are saying, “This sounds interesting. Maybe I should consider getting started in a plan.” What are some of the first steps that they should be doing? I know we talked a little bit about comp philosophy. If you were to give them a list of the first things to think about, what would that be?
The first thing to think about or at least take stock of is, “What type of company are you?” It’s because that does have some real tax and employee relationship considerations. Beyond that, what you want to take the time to do is think about, “Is there a problem that you are trying to solve? What are the other why reasons you are considering extending ownership to the employees?” Get that out and jot them down. It’s helpful to see them react to them, particularly if there’s more than one person involved in making these decisions.
Number two on that is to think about, “What it is you are trying to get from your employees in terms of extending this ownership.” I don’t like the term buy. In some respects, if it’s compensation or benefits, it’s always this employer-employee relationship. You want something out of them. Is it a longer service? Is it more loyalty? Is it a feeling that their day-to-day job impacts the growth of the company but also directly the value of their stake? Get some of those elements out as well in terms of what you want from extending this.
The third aspect is to be clear to yourself. This doesn’t have to fully be communicated broadly. What is the longer-term strategy of the corporation or the company? This gets into the time horizon and the exit strategy. It may be a balance that, “We are growing this company. We think we can get it easier. We might become appealing to a competitor. A trade sale is quite possible if things go well. We have got good momentum and backing potentially at the public event.”
You don’t have to be right on that but have a clear understanding of what you are guiding to and how long that might take, recognizing everything as a moving target. The reason those are important is that depending on what type of ownership vehicle you are going to use and how you are going to design it, you do need to think about time horizon and liquidity.
Particularly more so now than many years ago is that the permanently private or the longer period to going public has changed. Even with a ten-year stock option, there may still be a need to provide liquidity to employees because there isn’t going to be liquidity through an IPO that you might have seen with companies many years ago. As a reminder, the three things are, “Why are you doing this? What are you trying to get from it? It’s corporate strategy time horizon.”
Jon, I want to say thank you for joining us and sharing your wisdom here. How can people reach you if they want to learn more about equity and install a plan into their organization?
Our website is the best place because it has my number and a generic email to it, InfiniteEquity.com. You can also follow us on LinkedIn, @InfiniteEquity is our company page. Directly to me, it’s [email protected]. It does look like Michael Lackey had a question here. Michael and I go back as coworkers many years ago for a brief stint. He was going back to the idea of using multiple EBITDA as the value of the currency. He brought up a question, “What about using external valuation firms to establish the share or the enterprise value, commonly referred to as 409A values?” It’s a great question.
Multiple EBITDA is a concept. It’s predominantly only going to be used in that family-owned business or phantom-stock-only strategy. It’s all going to be cash denominated. It’s a profitable business because you have got to be able to provide that liquidity at the settlement date. Multiple EBITDA tends to be a pretty easy one because it’s fully within the company’s control. It doesn’t trigger additional external costs of getting the business valuation.
It’s a little bit of a unique situation. It doesn’t mean corporations can’t use multiple EBITDA but it does tend to be unique to phantom stock plans. If you are not doing a phantom stock plan, then going and getting the external valuation is the predominant practice. That’s the 409A. The frequency is once a year in the early stages. If you are leading up to the liquidity event, that’s where more frequent valuations are usually warranted.
Going out to an external valuation firm to that 409A, how does a company go about doing this? Do you typically have some recommendations? Where do they go to start this process?
The simplest thing is to type 409A into a search bar. You are going to get a laundry list of companies and business valuation specialists that provide it. Also, be aware of some of the cap table inequity management software does have built into the service in your subscription. You may be entitled to a 409A valuation through that subscription. There may be that opportunity there as well that you are not even aware of.
Generally, there are a lot of companies depending on your complexity. If you are simpler, then you are going to aim for one that maybe is simple on the name and easy. If you are getting to the later stage and you have a complex cap table, then you are going to look for more of the household names. It’s the larger firms that have dozens or hundreds of business valuation specialists. I’m happy to provide referrals in terms of companies we have worked with, referred, and trust really well. There are a lot of choices out there and price points to fit budgets.
That was our last question. I want to say thank you once again for sharing your knowledge. I appreciate the conversation. For those readers out there, if you need help, please reach out to Jon and Infinite Equity. They are an excellent resource. We love working with them. Thanks once again, Jon.
Thank you so much for having me.
Everybody, have a great week. We will talk to you in the next episode.
Jon found comfort in employee equity compensation programs. He has over 20 years of experience designing, valuing and implementing employee equity compensation programs. He also leverages actuarial background in analyzing employee behavior, developing assumptions, and performing complex valuation modeling, to apply added rigor and discipline to the world of employee equity compensation. He has a proven track record of guiding companies from ideas to full execution with the ability to measure success (ROI) of equity programs.