One of the most difficult parts of owning a business is finding great employees. Successful business owners know they cannot be everywhere at once and therefore must rely on their key employees. Sometimes retaining key employees becomes vital not only for day-to-day operations but also for the future success of the business.
This drives many Wisconsin business owners to ask: Should I let my key employees buy into my business? This is a loaded question. Not only do business owners need to assess whether the individual is a true “partner” and someone to help with all matters big and small, but they also need to examine whether it makes sense from a legal and practical standpoint.
This article discusses some of the issues you will need to understand if you are considering offering a valued employee a piece of your business.
Buying In
First, consider how the ownership will be transferred. Sometimes ownership can be transferred in consideration of past services as an employee. Most often employees pay for their ownership in cash or through delivery of a promissory note. How the ownership is purchased will also determine what taxes the transfer will be subject to. You may also want to consider whether an 83(b) election is appropriate. Always consult your accountant or tax professional about what the best sale structure is from a tax perspective.
Second, merely determining the value of the ownership percentage (in the case of an LLC or partnership) or shares (in the case of a corporation) is also necessary. Companies sometimes run into a valuation issue when determining what the company is worth. This is where third-party valuations and appraisals may be necessary. Business owners need to be careful about overvaluing or undervaluing the ownership interests. Misvaluing an ownership interest could expose you and your business to unintended repercussions and penalties.
Last, as mentioned above, an employee may be able to buy into the company in cash or, if the employee is not able to pay the entire purchase price in one lump sum, some kind of promissory note may be executed. A promissory note requires the parties to negotiate terms for interest, payment installments, missed payments, and security provided for the note.
After the Buy In
Business owners also need to think about operations after the buy-in is finalized. This means drafting or amending the company’s operating agreement, partnership agreement, or shareholder agreement to set forth in writing how the parties will conduct business together.
What decision-making authority does each owner have, or what type of decisions may you, as the founder, maintain complete control over? What happens if, after the employee becomes an owner, they decide to leave employment? What if they are fired? Is their ownership contingent upon being an employee? Does the founder have buy-back rights? What if the employee has an accident, becomes disabled, and can no longer work?
Making sure all owners are party to a contract in writing—setting forth how the company will operate—is essential to your business.
Alternatives
Many business owners decide that offering ownership to their employees is too complex and opt to incentivize the employee in other ways. There are alternatives to offering valued employees ownership that do not involve outright joint ownership of your business. Examples include compensatory ownership as stock options or restricted stock, bonus agreements, commission agreements, and deferred compensation plans. Each of these also have their own legal and tax implications—including Employee Retirement Income Security Act (ERISA) considerations—that would need to be assessed by your legal counsel and accountants.
The business attorneys at Axley are a great resource to assess ways to reward or motivate your key employees. Good business owners recognize and value their employees who are committed to helping their businesses grow. Wanting to reward these employees and keep them motivated is a great mindset to have.
Kathleen M. Bodenbach is an attorney with Axley LLP in Waukesha, Wisconsin, and can be reached at kbodenbach@axley.com or 262-409-2286.