It is not unusual for owners to receive requests from current or prospective employees about owning stock or a membership interest in the owner’s company. Owners must engage in this discussion with their eyes wide open and be fully aware of the benefits and pitfalls of having minority shareholders. The immediate response to anyone who asks about becoming a minority shareholder should be “I’ll think about it.”
Allowing minority shareholders or members into your business can be a very emotional decision. The options available and the technicalities of each option also may make your head spin. This is why owners should get their business advisor, lawyer, and outside accountant involved early in the game.
In preparation, owners should ask themselves the following questions:
- Why does the employee want stock? 1
- Does the employee expect short-term or long-term gain?
- How might having a minority shareholder improve the company’s performance?
- Can you achieve the same outcomes with a solid, objective bonus plan?
- Does the employee expect some form of cash payout each year?
- How will other long-term and loyal employees react if they find out another employee has minority ownership? What will be your response?
- Would you expect different annual and long-term outcomes from a minority shareholder?
- What is the value of a minority interest in your business?
- Will the event be a stock award, stock grant, stock sale of existing/outstanding shares, new stock issue, stock options, phantom stock,
- Class A shares, or Class B shares? (Is your head spinning yet?)
- Are there performance measures involved?
- What is the appropriate vesting schedule?
- Many owners allow minority shareholders as an incentive to build the value of the company towards an equity event. Are you planning an equity event?
- Will the employee be required to pay for all, part, or none of the stock?
- What is the tax impact to the minority shareholder and the company under various scenarios?
- What if the employee leaves the company? What will be the buyout scenario?
For the most part, owners cannot answer these questions on their own. Therefore, involving experts early in the process is critical, especially before any promises are made—orally or in writing—to prospective minority shareholders.
If you or someone you know is facing any of the challenges noted above and could benefit from guidance on navigating through the minority ownership minefield, please give me a call at 603-620-7500, or write to email@example.com.
Next month’s topic: Minority interest (control) discounts and lack of marketability discounts. They’re not that complicated.
1 For purposes of this article, stock, membership interest, partner interest, etc. are used interchangeably. Be aware that different legal and tax rules apply for different forms of business structure.