Ownership, equity, a slice of the pie. It's one of the best vehicles for creating wealth. It's also one of the best tools for aligning interests and motivating employees. But these facts are often underappreciated by people on both sides of the table. Let's explore how sharing the pie can increase profits and well-being for both would-be and existing equity-holders.
For Employees
I'll start with a quick anecdote. Early in my career, I took a position as the Controller of a start-up hedge fund. A year or two in, one of the firm's Partners was buying a house. His loan officer requested his K-1s (the tax form for owners of a partnership) and the business's tax returns since the inception of the business, so the Partner connected him with me to provide whatever he needed. In the following days and weeks, the loan officer came back again and again with additional questions about every detail of the business. Finally, the Partner grew frustrated and requested a phone call to address all of the loan officer's questions, once and for all. When the Partner asked, "what exactly is the problem; why is this taking so long?" the loan officer replied, "Well, sir, since you're self-employed, we have to make sure the business is profitable and sustainable to ensure you're capable of repaying the loan."
The business was quite profitable, the Partner received substantial distributions of those profits each quarter, and the loan officer eventually realized that he was well-qualified for the loan. But here's the thing: I had just purchased my first home, and my loan officer looked at my W-2s (the tax form for salaried employees) and said "Based on your salary, you are well-qualified for this loan." He saw that number on the form, clearly stated and rounded off to a nice even thousand-dollar increment, and never questioned it. But in what way was I not subject to the same risks as the Partner? How often do layoffs start at the top? If the business turned unprofitable, my salary was no more guaranteed than the Partner's distributions. And furthermore, as an at-will employee, I was subject to the additional risk of being fired for poor performance or simply not getting along with the owners (though the Partner and I are still great friends!).
As the Founder of GatePass Capital, frequently I speak with talented Financial Advisors that I would be happy to have join us as a partner. However, despite their extensive financial knowledge, they often are guilty of the same error as the loan officers. Many of them earn substantial profits for their firms, but take home a fraction of those profits in salary and bonus and/or modest commissions. They stand to earn substantially more under GatePass's employee-owned model, but, at least initially, they tend to be fearful of the perceived risks. There's nothing wrong with being risk averse; that's human nature. But, as the anecdote above highlights, any employee weighing the uncertainty of equity ownership needs to make sure they're weighing it against the full uncertainty of at-will employment, which is often hidden behind the illusory security those W-2s provide. Here are the facts:
There can also be significant tax advantages to being a business owner. Everyone talks about the dreaded self-employment tax, but again, that "disadvantage" is mostly illusory. As an employee, your employer was already paying that tax as part of the overall cost of your labor and could have paid you the additional 7.65% if not for their share of Social Security and Medicare taxes – just because you don't see it deducted from your paycheck doesn't mean you weren't paying it all along. On the other hand, however, business owners enjoy greater flexibility and opportunities for tax structuring, as well additional deductions such as accelerated/bonus depreciation and state-level programs like Ohio's Business Income Deduction, which exempts the first $250,000 of business income (for single and married filing jointly returns) and then charges a flat rate on all other business income of 3%, compared to the current top marginal income tax rate of 3.75%. Most importantly, business owners can enjoy a top long-term capital gains tax rate of 20% (23.8% when including the net investment income tax) at the federal level, compared to the current top marginal income tax rate of 37%, when they sell their equity in retirement.
If you have the opportunity to start a business, obtain equity ownership in your current company, or participate in an Employee Stock Ownership Plan (ESOP), I would strongly urge you to consider it. Hopefully this blog post gives you some ideas to help you accurately weigh the benefits and risks. If you need help analyzing a particular opportunity, schedule a call with a member of our team.
For Business Owners
What if you've already won the game? You're an owner of a profitable business, and you're enjoying all of the benefits discussed above. What now? It's time to share the pie with your employees.
No, I'm not saying you should redistribute your wealth for the sake of income equality. I know first hand how hard you've had to work to build your business, and you deserve the fruits of your labor too. You're not doing this for the employees, you're doing it for you. Connecting employee compensation to equity returns aligns incentives and encourages employees to focus on how their jobs affect the bottom line. It also gives you a lot more flexibility in down years – it's much harder to rescind last year's raise than it is to show your employee-owners why net income was down and how they can help you bring it back up. Employee ownership also increases job satisfaction, so you'll also spend less time and money on employee turnover and training. Here are the facts:
Many of the small business owners we talk to have no succession plan for their business and run the risk of being left with no residual value from the business when they retire. Implementing an ESOP may be a great way to attract and retain talent, and ensure the business will survive (and pay you proceeds) when you retire. If you'd like to explore your options, schedule a call with a member of our team.
The Bottom Line
Both owners and employees can win when you share the pie. At GatePass, we're proud to work every day with our partners, each of us committed to our clients', and in turn our firm's, success. Let us know how we can help or if you'd like to join us!
Unless otherwise indicated, commentary on this site reflects the personal opinions, viewpoints and analyses of the author and should not be regarded as a description of services provided by GatePass Capital or its affiliates. The opinions expressed here are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual on any security or advisory service. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. While all information presented, including from independent sources, is believed to be accurate, we make no representation or warranty as to accuracy or completeness. We reserve the right to change any part of these materials without notice and assume no obligation to provide updates. Nothing on this site constitutes investment advice, performance data or a recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Investing involves the risk of loss of some or all of an investment. Past performance is no guarantee of future results.
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