Employees can buy out the boss

Like many entrepreneurs, Bruce Powell struggled with whether to offer employees equity in his company. Prior to co-founding Toronto-based recruitment firm IQ Partners Inc. (No. 166 on this year’s PROFIT 200) in 2001, he had worked for companies at which staff ownership was offered, but never fully delivered. He’d listened as fellow business owners urged him to cling tight to his equity. He’d heard horror stories of intra-company spats that erupted when employee owners disagreed with their bosses.

But the way Powell saw it, employee share ownership plans (ESOPs) failed only when they were poorly planned and managed. So, he built what he believed would be a dysfunction-free program, open to all revenue-driving employees who meet specific performance benchmarks and giving them equal say in company matters. Powell implemented his ESOP on IQ Partners’ first day in business 10 years ago. Since then, it has been a “key driver” of the firm’s growth—which topped 255% over the past five years.

Some 40% of Canada’s Fastest-Growing Companies offer some form of employee ownership, spurring higher levels of creativity, employee engagement and organizational alignment—which can lead to higher productivity, profitability and company valuations. But Powell and other PROFIT 200 leaders know that an effective ESOP is built on savvy planning, consistent communication and, yes, money—up to $50,000, depending on the complexity of the program. Before giving employees skin in the game, you need to know the rules.

Determine if it’s right for you

Most entrepreneurs aren’t ready to cede even the small degree of ownership and control that an ESOP entails. But Bruno Cloutier had no qualms about sharing equity when he launched an ESOP at his IT implementation firm. “I’m happy to sell a lot of shares,” says the president of Quebec City-based Momentum Technologies inc. (No. 139).

“The way I see it, the shares I have left will have more value, because there will be new energy put into the company.”

Employees must also be interested in an ESOP for one to work. Cloutier knew the time was right when employees started asking about ownership. Not all workers are so proactive, so some PROFIT 200 companies conduct surveys and all-staff meetings on the subject of employee ownership not only to gauge interest in ownership, but to estimate its motivational power. Demographics matter, too: ESOPs tend to be longterm propositions and, as such, are often ineffective retention tools for Gen Y staffers, who gravitate toward more immediate benefits.

Choose a model

You can offer up a large chunk of the company through an ESOP, or retain the vast majority of shares for you and your existing shareholders. You can grant equity in addition to or in lieu of other benefits, ask employees to buy into the program, or top up their contributions as an added perk. You can issue options to buy shares later at a predetermined price. You can even offer different equity classes, say, shares with no voting rights.

Jeff Smith liked the idea of offering employees equity, but he didn’t like the idea of sharing decision-making abilities as his company matured. So, when the president of Ottawa-based Allphase Clinical Research Services Inc. (No. 173) implemented an ESOP in 2008, he attached a few strings. Every year, employees are given share options based on their tenure, salary and role. The catch is, they can’t exercise their options till 2018. At that time, their options are convertible into an equivalent number of shares at $1 each— or cash. Employees won’t get the right to vote on company business until they convert their options to shares, which means Smith won’t have to deal with unwanted advice about the course of the business until then.

In the meantime, employees are motivated by the clear end-date to convert—even though it’s a long way out. They are proactively devising ways to make the company more profitable, Smith says, and are less likely to leave for a competitor: “People know that if they stay with the company, they’ll get value for it.”

Decide who can participate

Marla Schwartz, president of Benecaid Health Benefit Solutions Inc. (No. 103), considered opening her ESOP program to all the employees of her Toronto-based provider of health-benefits plans. But after some investigation, she learned that many simply weren’t interested in equity. So, she limits her firm’s ESOP to specific personnel who have met unique objectives. “We looked at it in terms of who we thought would help us drive value as an organization,” says Schwartz. “We wanted to give those individuals a further incentive to reward them for their efforts.”

Perry Phillips would appreciate Schwartz’s approach. The president of Toronto-based ESOP Builders Inc. says that restricting participation to your most important staff gives them a valued and exclusive benefi t that’s “a good way to lock these people in.” However, he adds, about 70% of entrepreneurs opt for all-in programs, because these build a sense of teamwork and reinforce that everyone in an organization is valued.

Get some outside advice

Before launching an ESOP at Ottawa-based web business consultancy ThinkWrap Solutions Inc. (No. 76), CEO Steve Byrne did his homework—in concert with his legal team. They mapped out a wide array of obligations and potential scenarios, from when to make dividend payments to how to handle a major shareholder who becomes sick and can no longer contribute to the company. “We really thought of every scenario so that the company is protected,” says Byrne. “Taking the time to do it right has been very important to our plan’s success.” Good tax advice is also crucial. Be aware that some provinces give tax credits to participants in eligible ESOPs—offering staff an added incentive to join a plan.

Communicate the plan

For an ESOP to work, employees need to understand their agency in increasing shareholder value and their place in the ownership structure. Facilitating that understanding can take some effort when your employees don’t come from financial backgrounds.

Smith gets it done with clear and consistent communication. Once a year, he sends participating employees a letter explaining their current tally of options. Then he addresses them at an all-staff meeting and explains the ways in which their efforts are building the company and increasing its value. In the meeting, Smith also addresses any questions or comments his staff might have. “It’s a matter of keeping people informed,” he says. If you’re questioning whether it’s worth undergoing all this effort only to end up with a smaller stake in your own firm, consider Powell’s experience. “If people have an idea about what might make us grow further, they bring it forward, because they’re thinking like owners,” he says. “It aligns everyone’s interests in the growth of the business.”

This article originally appeared in PROFIT Magazine.