Do employees really need equity
ownership to give you all they've got?
In the last year, some keen observers have suggested
that perhaps not all employees want the reward of ownership in your
growing advisory firm.
This is a novel viewpoint. First, because as advisory firms grow and
garner more interest from research firms, a common wisdom is developing
to the effect that equity ownership is what all employees ultimately
need if owners want to retain them. Second, it's novel because it
considers the human element in economic incentive mechanisms-something
all too frequently overlooked.
Essentially, the issue is whether or not there
exists two types of employees: those who are by nature entrepreneurial,
even though not presently running their own firms, and those who will
make a strong commitment to you, if properly motivated, but don't want
the risks that accompany ownership. And without conducting a
scientifically designed study, it seems self-evident that this should
be so.
Therefore, from a practice management standpoint the
question is, are advisors recognizing this dichotomy? Eric Hehman, who
wanted and got a minority (and growing) equity interest in Austin,
Texas-based Austin Asset Management says, "There are definitely
employees who have made it clear that ownership is not a motivating
factor for them and that they really don't want the responsibility or
risk of being a partner. Employees who aren't motivated by potential
ownership really value their participation on the team more than the
opportunity to set the direction of the firm." Therefore, says Hehman,
an owner must reward these employees with incentive compensation tied
to their team-based efforts.
However, he notes of the other "personality" found
in his firm, "Potential owners can never get enough insight into the
business and are almost starved for ways to make an impact." But
sometimes an employee's inclination isn't so easy to discern, which led
Don Patrick, managing director of Integrated Financial Group in
Atlanta, to devise a simple test to ferret out what he calls the
"entrepreneurs" vs. the "dedicated employees." "We offer new employees
either a fair-market salary or a small salary with the balance of the
compensation based upon [client acquisition] incentives. Obviously, the
few that choose the second option are the entrepreneurs."
But are incentives based upon client acquisition
enough? Not for some. Jeffrey Zures, now of Sanchez & Zures in
McLean, Va., says he and his partner had more than 14 combined years of
experience with the well-known northern Virginia firm of Sullivan,
Bruyette, Speros and Blayney Inc. Says Zures, "SBSB is an outstanding
firm, however we experienced no correlation between the firm's
profitability and our compensation," prompting Zures and Sanchez to
split off from SBSB to get the equity rewards they felt they needed.
Fortunately, says Zures, the separation has been amicable, and SBSB
even refers clients to him and his partner since their minimums are
lower.
It's my own hunch that some firms never have to deal
with this problem because they simply don't hire entrepreneurially
minded employees. For example, Ernest Hathaway with Financial
Strategies Institute in Midvale, Utah, says of his firm's four
advisor/producers and nine-person staff, "We've found that equity and
other long-term rewards are not as appealing to our employees. Most of
them simply want an opportunity to share in the profits."
At the other extreme, Bart Boyer's Parsec Financial Management Inc. in
Ashville, N.C., gives all its employees the opportunity to purchase
company stock. "My plan," says Boyer, "is to spread ownership broadly
enough so that the firm does not have to be sold when I retire, and I
can simply keep most of my shares. Ideally this should be started at
least 15 years before an advisor plans to retire." Boyer's plan points
out how succession planning can influence a firm's hiring tendencies
and ownership policies.
But, says Alan Gappinger, chairman of Heartland
Institute of Financial Education in Aurora, Colo., "It's important for
a firm's owners to recognize the value of both types of employees. A
program that provides profit-sharing, bonuses and deferred compensation
agreements supports the non-entrepreneurial folks, while a stock
arrangement or partnership, which may be based on results and/or
contributions, helps to encourage and motivate the entrepreneurs."
By now, you should have a clearer idea of where your
firm falls between a heavy emphasis on shared ownership (and employees
who require equity) vs. a heavy emphasis on team players who prefer to
subordinate themselves to a firm's owner, as well as the middle ground
where firms employ both types. Now, you just need a blueprint for how
to best motivate each employee.
Rewarding Entrepreneurs
If yours is a smaller firm, you'll probably want to
extend equity ownership to only one, or a couple, of key employees.
Perhaps that person is someone you're grooming to succeed you as the
sole owner of your firm. There are various ways to do it.
Joel Shaps, president of Bedrock Capital Management
Inc. in Los Altos, Calif., is initially selling 20% of his firm to Eric
Lewis, one of his four employees. Shaps hired Lewis, a Harvard grad,
with the understanding on both sides that equity ownership would occur
fairly quickly. And Lewis can afford to buy in, "a luxury not everyone
has," notes Shaps.
Perhaps it's due to Shaps' earlier experience with
extending equity ownership to employees that he didn't hesitate to do
it for Lewis. "In a former consulting business," he says, "I shared
profits and then equity with employees, which was to their benefit when
I sold the company. I'm very willing to share the success of my company
with my staff."
Boyer's system is slightly more complex in order to
accommodate a large staff of potential owners. "All employees have the
option to invest up to 20% of their annual income for the previous year
in company stock. Whatever they put up we match at 50 cents on the
dollar. Employees pay for their stock through payroll deductions," he
says.
The company's stock valuation is kept very simple,
and is easily calculated at any time. "We price it at a lofty ten times
earnings or two times revenues, whichever is higher." Boyer estimates
that an employee buying $10,000 of stock each year, assuming 15% annual
appreciation in the stock price, would, after 15 years, have invested
$475,000 and own stock worth $1.83 million. Furthermore, they will have
received approximately $745,000 in dividends along the way. That should
be plenty of motivation for any employee even moderately inclined
toward ownership.
Considering offering equity to your employees? David
Lewis, president of Resource Advisory Services Inc. in Knoxville,
Tenn., offers one cautionary note about extending equity in the form of
minority interests: "I have been a minority shareholder in a closely
held corporation without a clear way to liquidate my interest. Feeling
backed into a corner, I caused a great deal of trouble for that company
until I finally received cash for my shares. I have always felt I
didn't get a fair deal, and they have probably always felt I got way
more than I deserved."
Rewarding Dedicated Employees (Non-Owners)
What do employees not inclined to ownership want?
The question implies more options than does ownership. For example, Pat
Hinds' firm of Granite Financial Inc. in St. Cloud, Minn., successfully
rewards employees not with profit sharing but with benefits. "Over the
years, we've gone from just a retirement plan benefit to a full range
of benefits including education reimbursement, health benefits and flex
plan, life and DI coverage, and we've also offered flexibility in the
work schedule of employees to allow them to meet family commitments."
Hinds has found that his employees value the security they find in the
form of benefits.
Hathaway, as noted earlier, has found his employees
are highly motivated by profit sharing. "Each quarter we establish a
production baseline, which is the average of the last quarters'
production. If we finish the quarter at 5% growth over the baseline,
qualified employees receive an additional 7.5% of their salary for that
quarter. Additional breakpoints are 10% growth resulting in a 15%
bonus, and 20% growth resulting in a 30% bonus. This is paid in cash
about 15 days after the end of the quarter, with lots of
congratulations and a little hoopla, so that everyone receives
immediate reinforcement of their contributions to the firm's goals."
Hathaway says he's been amazed at the positive
effect this has had on his firm. "Staff personnel are more eager to
help one another because they are contributing to a team goal with an
immediate tangible reward."
The lesson of this story, then, is to have a clear
vision of where you want to take your firm, including your own
succession plan; hire to meet that growth objective, determining
whether "dedicated" or entrepreneurial employees (or some combination
of the two) will get you there; and devise the appropriate incentives.
In the end, it may or may not be necessary to give employees equity to
make your plan a reality.
David J. Drucker, M.B.A., CFP, an
independent financial advisor since 1981, now writes, speaks and
consults with other advisors as president of Drucker Knowledge Systems.
Check out his practice management portal, Practice Lifecycle, at
www.practicelifecycle.com, and Virtual Office News, a practice
management/technology newsletter for financial advisors, at
www.virtualofficenews.com.