Caution! Employee dressed as Shareholder
The Employee vs Shareholder debate – the Pirate Brigade
The following discussion would generally apply to service type private businesses where an employee could easily move to either a competitor or start her/his own competing business.
A shareholder/CEO of a private business with seven shareholders, all of whom received equity positions due to good performance and/ or by virtue of “this is the way it is done in our industry”, sadly described a few of his co shareholders as “pirates”. At the end of the year, the Pirates would attack and pile onto the mothership, pull out as much gold as possible for themselves (in the form of dividends) and then sail off only to return next year end for a new haul. A somewhat dramatic viewpoint, but there is truth and pain behind it.
While having a great employee and team player is fantastic for the company, those attributes may not necessarily be enough to earn a seat at the annual shareholders meeting. Should there possibly be much more currency attached to the invitation?
Bringing on new shareholders is often critical to the success of the corporation. The ideal private company shareholder has expertise, industry knowledge, contacts, leadership skills, relationships, money – just some of the many attributes necessary in exchange for that seat.
Some of the responsibilities of being an employee may include:
- Understanding and executing job duties and responsibilities to the best of their abilities,
- Exhibiting leadership, as necessary,
- Protecting the company assets,
- Going the extra mile as necessary, and
- Generally, being loyal to your employer and to yourself.
Some of the more obvious responsibilities and risks of being a private company shareholder may include:
- Constantly upholding the company’s reputation and values while having your credibility and integrity under constant scrutiny,
- Making difficult or unpopular, but necessary, corporate decisions,
- Investing personal capital and/ or lending further personal capital and possibly putting up personal guarantees,
- Often being paid last after employees, creditors and taxes are paid (even bonuses may not happen as they did when being an employee), and
- Understanding and adhering to legal, tax, environmental, labour and other regulations/ laws (even the ones you didn’t know you needed to know).
So why did my CEO friend call his co shareholders pirates? What went wrong? Shareholder responsibilities are not to be taken lightly. Herein lies the potential issue – taking in a shareholder who expects only the rewards, but fails to understand the associated responsibilities and risks.
When new shareholders are being considered, we recommend a process whereby the board performs formal interviews with the candidate. The objective is to understand why that person wants to become a shareholder, outline the rights, responsibilities, risks and lastly, to gauge their overall suitability. Will that great employee be an equally great shareholder?
More specifically, assuming the employee can afford to purchase the shares, would they also be prepared to contribute additional funds to the company, if necessary? Could they afford a reduced or no salary for extended periods of time, if necessary? Can they read financial statements and understand finance? How comfortable are they with corporate and personal debt, personal guarantees and funding growth? is the valuation formula on the way in and out clear?
We often find ego can be a strong reason – “I am a shareholder now”! How well will they fit in with the existing shareholder base – will they play well in the sandbox? What else of value can they bring to the shareholder table?
While there are ways for the board to address the above questions for the right shareholder, we believe it is essential to understand if the person has the entrepreneurial sprit and if both sides understand and are prepared to accept the associated risks. The candidate’s financial advisor should be part of the risk conversation as well as even the candidate’s spouse. We believe that having the above discussions may simply enlighten the employee to risks they and their families may take on as well as the rewards.
The last perspective to consider is that of “can we afford not to take this person in as a shareholder?” There is often a big risk that an employee will leave specifically because there is no possibility of becoming a shareholder. Perhaps there are other ways to keep that employee engaged. While a topic of another discussion, the board would be well advised to be fully comfortable that the company is doing all the other things financially and culturally necessary to retain their teams.
Not withstanding all of the above, it is important to not lose sight of the benefits of being a shareholder to both the individual and the company. A strong base of aligned minds pushing the company forward. The group enjoys and celebrates the satisfaction of building a great business, strong relationships and the returns provided in exchange for the risk taken. This is the reason for the due diligence we recommend when bringing new shareholders in.
In a private company, having shareholders who think like shareholders is a marvellous achievement. Having shareholders who think like employees is not a good long-term strategy. Therefore, private companies must ensure all shareholders are both clear and accept their responsibilities. Thus, avoiding the purge of the pirates.
Brian McGill, CPA, CA – Partner with Stawowski McGill