The Financial Planning Association's 2001 Compensation & Staffing Study will tell you that fewer than 20% of advisory firms offer equity-based compensation. What the report doesn't say is that sharing ownership is a growth strategy for the firm that can provide exit cash when the original proprietor ultimately calls it a career.

"If your goal is to build a transferable business, and you want to link staff to that future transfer-a buyer may say, 'I'm not just buying the book of business. I'm buying your organization'-then you need to seriously think about equity-based compensation," says Mark Tibergien, a financial services industry consultant and principal in the Seattle office of accounting firm Moss Adams LLP, which conducted the FPA study.

Why equity fosters growth is simple. "You're leveraging the capability of the firm through principals" who, it is hoped, have skills complementary to yours for the benefit of clients, says David Diesslin, a Fort Worth, Texas, financial advisor whose C corporation embarked on a phantom stock program four years ago (revenues have since doubled). The owner of Diesslin & Associates Inc. attests that sharing equity participation has lifted the weight of the world from his shoulders. "I can share [concerns with] candor with people who have similar vested interests. I can take a vacation and not worry because there are interested parties back [at the office]," Diesslin says.

Endowing a cadre of worthy employees with equity multiplies ownership, instantly creating a market for the shares-your shares. Dallas advisory firm Quest Capital Management Inc., with six stockholders currently, has extended equity-purchase offers (rights to buy shares from existing shareholders at current valuation) to two key players. "This has provided us a methodology to create value on the back end" of the career, says Quest co-founder Glenda D. Kemple, a CPA and CFP licensee.

There also is a defensive reason to use equity remuneration: retention of those who make it happen. The 2001 FPA Staff Satisfaction Survey (a companion to the Compensation & Staffing Study) quotes some advisory-firm workers as saying they would quit current positions for the chance to become part-owner elsewhere. Not all that glitters is gold, of course, and individuals who are candidates for equity but who have never been boss may need schooling in the risks of ownership--foibles like phantom income (pass-through taxable income from an S corporation, limited-liability company or partnership without an accompanying cash distribution to the owner) and cash calls (when the company till is empty on, say, payday). "They have to understand that even if they own 2%, they'll be expected to ante up," Kemple says. Some workers may not be willing to assume such risks.

For many an owner, the first step to offering equity is overcoming the natural reluctance to share what was born of toil and personal funds. "The important thing is not to be consumed by the blood, sweat and tears that you put into building the firm, but rather think about the future opportunity you can create," advises Tibergien. "When people are serious about sharing ownership, they are committing to trying to create a significantly growing enterprise. If you don't want that, think about other forms of compensation."

Of the half-dozen forms of equity-based pay found at advisory firms, one, phantom stock, is not true equity-hence the spectral moniker. A tracking vehicle that falls short of bona fide ownership (meaning the recipient sidesteps responsibilities like signing leases and loans), phantom stock gives an employee participation in the equity appreciation he or she helps create. Say your firm is valued at $500,000 (by a typical measurement of three to six times the firm's free cash flow, or 1 to 1.6 times gross revenues) and you reward three employees with phantom stock yielding each 10% of the growth going forward. If the firm's value rises to $600,000 next year, each is entitled to $10,000 (10% of the $100,000 appreciation in firm value), leaving the owner 70% of the growth.

At Diesslin & Associates, participants share in distributions that the owner takes, on the theory that if they were true owners, they, too, would receive distributions. A vesting schedule and other restrictions often are part of the program. "It's important how you arrange the golden handcuffs for key people, so that with vesting schedules, payout provisions and [valuation and distribution] formulas, the owner's career and their futures become more closely intertwined," says Diesslin, who sought advice from a lawyer and a human-resources consultant to develop his plan. "We spent a lot of time on this."

Done right, equity-participation rights create virtually the same psychological buy-in as actual ownership. "And by putting more gravity into our folks, this amazingly puts the interests of the client first," Diesslin says.

A disturbing finding of the industry study is that more than twice as many firms dole out equity bonuses on a discretionary basis than for achieving pre-specified goals under a formal plan. In fact, arbitrary bonuses of all types, not just equity, are more common at advisory firms than performance-based awards, the study reveals, and that's a serious mistake, Tibergien says. Arbitrary awards become "an entitlement" in the eyes of an employee, he says. Therefore, firms that can't afford bonuses in today's down market "have created resentment on the part of staff instead of having them think, 'If I achieve certain things, I would receive my incentive,' which could be equity."

Some forms of equity remuneration require cash on the barrelhead by the would-be business partner. In fact, offering the right to buy equity from current owners is the approach taken by nearly half of all advisory firms reporting equity-based compensation. Quest Capital's Kemple says, "By having to write the check, employees are really speaking with their pocketbooks that they believe there's value and that they want ownership." Which, of course, bodes well for the prospects of exit cash.

In Rockford, Ill., the two original owners of Savant Capital Management Inc. sold shares to a bank trust-department manager they were courting who insisted on equity. "But we didn't want to give up a significant amount of ownership before he proved himself," says Savant co-founder Brent R. Brodeski. So the new guy was sold a small percentage at the start of the relationship-"Rather than just give him the stock, we wanted him to incur some risk," Brodeski says-and a plan was devised (with the help of a consultant) granting additional equity-purchase rights as goals were met. That was three years ago.

"He was able to buy more of the firm when he brought in a certain volume of business," which he did, says Brodeski. "Now he's at the point of hitting a certain level of profitability that will trigger another sale at today's value-as the company has grown, the price has gone up." (This is essentially the difference between an equity-purchase right and a stock option; with the latter, the exercise price remains constant over time.) Brodeski says the arrangement "has worked out wonderfully," which speaks volumes for creating a well-conceived, performance-based plan on the front end. "We spent a lot of money on consulting fees, legal fees and accounting fees-we had the accountants test the model on the financials and pro formas-but it was worthwhile," Brodeski says. Don't take the cheap route, he advises.

A potential stumbling block with equity-purchase rights is the newbie's ability to pay for the shares. One solution is to finance the purchase with dividends. At Savant, dividends have grown along with the firm, allowing the new business partner to use distributions received on shares previously purchased to help pay for the next batch of stock. Another way to make an equity purchase doable is by increasing the new partner's salary over a period of years during which he or she forgos the raises as payment for the shares.

The price offered in an equity-purchase right typically is less than you'd demand from an outside acquirer and also may be lower than the price contemplated by any buy-sell agreement between existing shareholders, as is the case at Quest. "We're offering [two top employees] a bargain price to [encourage] them to buy," Kemple says. The price, which is based on a formula valuing the firm at 1 times annual gross revenues, is available for a year. "We're giving them the benefit of a trailing number, and if they don't opt to buy it at that (price), they'll pay more" if they buy in later, Kemple says.

Regardless of the form of equity-based pay offered to workers, keep in mind that just because you, in your magnanimity, think it's a benefit doesn't mean employees will, especially if they didn't pay for the ownership. Tibergien says, "Employees may have the perception that the only way they'll ever realize value from the equity is if the owner sells-and that the owner is going to die with his boots on."

Similarly, stock in your firm may not serve as the retention tool you intend. "Small firms give equity because they perceive it as a handcuff," says Tibergien, "but an employee might think, 'How much am I really leaving on the table if I walk from this place?'"

For equity-based pay to work for both employee and employer, clients must benefit, too, of course. And the benefit provided is continuity of the firm and of the client relationship, says Kemple, who, along with another Quest Capital shareholder, has undergone major surgery in recent years. "We've recognized that we're not bullet-proof," Kemple says. Therefore, part of the motivation for sharing equity, "is to be able to leave clients well taken care of with an established firm, as opposed to shipping them off to some unknown planner with unknown skills. We're creating a legacy of a firm that can carry forward our vision of providing a plan for life for the families that we serve."