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Key Reasons to Consider
Anything you do now will likely have far-reaching consequences. For example, once you offer an employee stock, you have the potential to turn the organization’s reward system upside down. Employees want to know how they can become shareholders and an owner should be able to objectively answer the question. The following are some questions to consider:
- Why is stock ownership important to this employee?
- What are the employee’s long-term employment goals?
- Is this employee key to the company’s future?
- Are there other employee-retention programs that can be put into place for this employee?
- When do you want to exit your business and how? (Either through external sale or internal transfer)
Depending on the situation, you may find these questions difficult to answer. Also, you and your key employee may be reluctant to discuss this in an open and honest manner. If this is the case, you may want to consider hiring an outside consultant who can view the situation objectively.
Your Employee Might Want More ‘Say’ in the Company
Once a dialog has begun, do not be surprised if one of the key reasons the employee wants stock is because he wants more “say” in the business. This frequently occurs in privately held, owner-managed companies because the distinction between ownership and management is not always clear. Simply put, the employee may think that in order to have any influence in the direction of the business, he or she must have a share in ownership.
Owner and Manager Roles Should Differ
This is an erroneous conclusion, however. In properly run organizations, the role of an owner should be quite distinct from that of a manager. For example, I have an “ownership” share in Ford Motor Company but I cannot sit in Ford’s executive offices and tell the company how to manufacture their trucks. A construction organization should be no different. To further clarify this point, look at the various functions that fall under the roles of an owner and a manager:
Owner functions:
- Decisions about where to employ capital
- Securing management talent to engage capital
- Establishing strategic goals and management personnel accountability
- Determining management’s reward for success
- Conducting a periodic review of investment performance and deciding when to extract capital and deploy elsewhere.
Manager functions:
- Establishing an action plan to achieve goals
- Creating processes, procedures and structure for business execution
- Securing human and physical assets necessary for the business
- Tracking business performance and reporting routinely to shareholders.
In reality, the “say” power in a business should exist in the management role. By teaching employees this simple and appropriate distinction, they already have a “say” in the business.
Your Employee Might Want a Share in the Rewards
Some employees are interested in stock ownership because they would like to share in the company’s long-term financial rewards. This is a good scenario for three reasons:
- The employee truly understands the concept of ownership.
- This indicates that the employee wants to stay with the organization for the long term.
- The employee’s goals are aligned with those of current shareholders.
How and When Do You Want to Leave Your Company?
Another key question owners must answer is when and how they want to eventually exit their businesses.
If you are within 15 years of your projected retirement date, it is not too early to start considering whether to seek an external sale or make an internal transfer of ownership to management or family.
On average, it takes seven to 12 years to sell 100% of the stock in a closely held construction company, assuming it is normally capitalized and has average industry profitability. Therefore, the planning horizon for internal transition needs to be long.
If your goal is to exit the business via an external sale, you should be especially cautious about extending stock ownership. Down the road you may not want to inform your key employees that you are in discussions to sell the company, but if they are shareholders, you might not have that choice. Furthermore, your fellow shareholders may not want to sell the company, which could further complicate matters.
How Much Stock Do You Want to Extend?
Finally, if you decide to extend stock, you need to consider how much stock you want to extend.
There are no steadfast rules here. However, it is important that the amount of stock be “meaningful.” For example, extending 1% ownership in a company with shareholders’ equity of $1 million means that the employee has the equivalent of $10,000 of ownership value. This may not be a powerful motivator in the long run.
Conversely, if you extend 25% ownership in the same $1 million equity company, you may not be able to afford it. You also need to make sure that you have sufficient “extra” stock if you decide to extend it to other employees in the future.
Employees Should Pay a Portion of the Stock
You also need to consider how you want to extend the stock to employees. You can use a variety of methods, including issuing new stock as a stock bonus, selling some of your shares or using stock options. The most important aspect is that employees must pay for at least a portion of the stock out of their own resources. Simply “giving” stock without some sacrifice in return will diminish the implied value of ownership and consequently the stock may lose some effectiveness as a retention tool.
Once you have examined these questions and issues you should be able to determine whether or not you want to extend ownership.
William G. Hill is a senior associate with the FMI Mergers and Acquisitions Group. FMI Corporation provides strategic planning, organizational development, market research and other business consulting services to the construction industry. For more information, e-mail Hill or call him at 303-398-7237.
© 2004 FMI Corporation. This article originally appeared in the Winter 2004 edition of FMI’s Mergers and Acquisitions Advisor. Used by permission of FMI Corporation.
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