Business Ownership: Equity, Compensation & Role Considerations
If you own a business and you understand the difference between equity, compensation and role, then you can develop a business that can attract the best talent. Consequently, equity is probably one of the most misused business tools. It is a business tool that needs to be understood before being used in the foundational stages of your business.
When we hear people ask for equity they are typically not interested in the downside of business ownership, just the upside. So, if you own 35% of a business through a “gift” of equity, and the business requires $100,000 investment are you ready to come up with $35,000? When you put the topic in these terms most individuals will opt not to have ownership in a business. What they really want is some share in the profit of the business, and some portion of the sale of the business should it be sold.
These two issues can be handled without distributing equity. A profit sharing plan and phantom stock plan can provide most individuals who ask for equity what they really want. This is a critical decision for most lifestyle and growth businesses. Most hyper growth businesses will set up a stock option plan and guard equity like gold, providing key contributors stock options with a low strike price should the business meet future growth expectations. This concept of stock options is not right for all business, but the concept is critical for smaller businesses as well.
Once the ownership structure is in place what does it provide you? In the ideal situation, owning a business provides you dividends each year when profits are earned. Equity also provides you with a payout should your business ever be sold, typically in proportion to the amount of the business you own. What equity doesn’t provide you is a job in the business on a daily basis and an annual salary. We are talking about an “ideal” business in this case, so this is not how most businesses are run, but the concept is critical to building a healthy business.
When we look at a set of owners we ask a few key questions:
- Are the owners capable of leading this organization?
- Are the owners in the right roles for their skill set?
- Are the owners taking compensation based on their contribution to the business or because of their right to define income?
- Are the owners capable of taking the business to the next level?
If you are the owner of the business — believe you need to be the CEO, and don’t have the skills to do the job — you are reducing your chances of success. Do you own a business to feed your ego, or to meet the needs of your clients and your life? If you become clear about what you do and why, then ownership can lead to great results. If you don’t understand the laws of business, then you will be continually challenged in ways you might not enjoy.
Larry Kesslin is president of 4-Profit, an IT centric leadership development organization focused on helping solution providers and the manufacturers and distributors serving the IT Channel. For more information please visit www.4-profit.com. Read more 4-Profit blogs here.