employee-compensation, equity, value, s-corporationI recently had to handle a bit of an office episode that occurred due to an employee having a bit of a breakdown that we didn’t think she was valuable to the company.
My co-founder and I had recently decided to give her a relatively small amount of equity, less than 3%, when going through our documentation to file our S-Corp. Incidentally, I had been arguing that she had done far less than .01 or .005 (half-to-1-percent) of the total work in the company. I thought 3% was extremely generous.
Reality is, she felt like, because her number was low, that we were not valuing her as part of our team, and this came to us as quite a shock. We have been working on this startup for 18 months, and she had done nothing to contribute until maybe 6-8 months ago.
Without going into further detail, I was amazed to realize how unsure I was of how to handle this decision. Clearly we never increased the equity we gave her, but we had to convince her that her equity had nothing to do with her value to the company, but that it was just a measurement of risk, that some of us had taken far more risk than others (I had barely scraped through my senior year of college, amassing 6-figure loans, and turned down an offer at Google - my business partner dropped out entirely).
But, come to think of it, was I misleading her? Clearly she had not contributed as much, but should I have tried to relate that she was not as valuable as she had somehow thought?
She’s clearly a person, and we think she’s great. She just has been working jobs and living comfortably while the rest of us eat ramen :) and I’m unsure of how I handled this situation.
I’d say, and obviously this question is inherently opinion-based (although as @connor has suggested, not in a bad way), that you were right to describe the share of equity as being a description of accumulated risk.
It’s kind of–well, more than kind of–like pay: the eternal question is what’s fair between paying your employees and paying yourself. Obviously this has all had a pretty negative connotation associated with it, and I don’t mean to make this political, but realistically the 99% movement of a couple years ago is just evidence that you’re far from alone in making the call that someone who’s involved in a less–I’m struggling to phrase this to sound as I want it to so bear with me–pertinent way, should receive less of the company and its profits than someone in management.
Without sounding too condescending to the lifeblood of our corporate world, the fact is, compensation is a way to keep people around. It isn’t a gift that polite managers give out to employees. You pay someone because you believe they are benefiting you more than the money independently would. Obviously some employers are more generous than others, and I certainly have no issue with that whatsoever. But that’s the idea. It’s compensation for coming into work and getting what you need to done, and it’s an assurance that no other companies will steal your employees to join their own workforce. If your competitors were sending her better offers, then she would have a good bargaining chip to get more from you, but as it stands, that’s what the industry seems to consider her worth.
Three percent is a pretty big portion of a company to give to someone, as you said. By giving her three percent, you’re effectively telling her that she brings to the table more than that three percent would otherwise invested. That’s a pretty big deal. For someone who’s only been around for six months of a lifecycle worthy of dropping out of school for, I’m impressed that your company considered her worthy of that.
So how, then, can we measure how much someone brings to the table? I think, as I started off saying, you’re right to assess it based on risk. The fact is, presumably, if you hadn’t scraped by your senior year of college, the company wouldn’t be around today. Thus, it follows pretty logically that you’ve brought more to the company than someone who recently joined on.
To a point, it doesn’t matter how valuable she is now, because you clearly managed up until six months ago without her. And furthermore, I’d make the guess that if she hadn’t applied or you hadn’t recruited her, you’d be saying this all about someone else. On the other hand, if you were originally uninterested in the business, it might not even have started in the first place. It’s her job now to earn her wage as time progresses, and as she receives the bonuses and pay (each of which might include equity in the company) that she seems to think her worth is worthy of, she’ll begin to increase her power in the company. That’s how businesses are meant to work.
So, all in all, yes, I think you were misleading her a bit. Speaking in extremes, if she felt she deserved 50% of the company, then that would be completely frivolous because she just hasn’t put in enough to earn that. She probably isn’t as valuable as she thinks she is. But, from a managerial perspective, I think you were right to describe that value in terms of risk. I don’t think you were wrong to mislead her. Realistically, her believing that her presence is extremely important is good for you all, so long as she doesn’t try for more than she deserves as a result, and if she does, you can deal with that then. But for now, I think you were best to just leave it as a matter of risk assumption. Explaining the whole capitalistic system to someone who overvalues herself isn’t going to be productive, and it will just hurt feelings unnecessarily.
I can certainly see how this comes about and have dealt in similar situations.
Risk is certainly the main factor here. You are all working hard and contributing greatly. However taking on risk is what brings rewards and sometimes that is hard for someone who has been an employee all their life to understand.
I believe you certainly handled it in the right way discussing risk, it is the factor determining equity, unless they brought something along with them (e.g. Money or IP).
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