How can a business owner incentivize without giving up equity?
This question has been asked by thousands, if not millions of business owners. We all have that key employee, the one that if we lost them, the business would falter, even possibly fail, without their influence and activity in our business. This makes us very vulnerable and sometimes a little desperate to show our love.
The usual answer is to give them a piece of the pie—but that is like marriage, and we all know how most marriages end up. Giving just one percent of an ongoing business gives the new shareholder the right to harass, interfere, and annoy the majority business owner endlessly. So why do it?
Introducing the phantom buy sell. Instead of giving away real equity through a buy sell agreement, try having the legal contract effect the following: Give away participation in the percent change in the profit of a company from year to year and the change in value.
For example, John is my key employee who has been pushing for recognition that he is valuable through ownership and money. I decide to give John a 50 percent interest in the profit and change in business value, calculated every two years. The first step is to quantify the value of the business through a third party valuation. This is a tax deductible expense that can be used for estate planning or sale of the business at some point in the future. Let’s say the value is set at $5,000,000. The profit from 2010 was $500,000. In 2012 the company is evaluated again (much quicker and cheaper this time) and the value is $5,400,000. John now has value of $200,000 plus half of two years’ profit. He is actively participating in the growth, has more money, and is recognized for his importance in the business and I retain total and complete control of my business. Everyone wins!