united-states, equity, value, s-corporationI’ve been struggling lately with a member who can’t seem to find time to actually get anything done. Originally, we had awarded them X%, despite them coming into the company about 6 months after we had got it started (which I get is still early).
The said employee’s equity seemed fair, until somehow, between personal problems and their schedule, they started getting busy. I just want to point out some of the facts in this situation.
They had formerly “held up their end” earning X equity, until about 2 weeks ago, when they stayed up late working, and then kind of fell off the grid.
My co-founder and I both hold about 2.5X equity, each. We are starting to believe this is part of the reason they are lazy - we worry they feel they can work 2.5 less and ‘get by.’ We aren’t okay with this.
At a week before our product launch we’ve scheduled out for months, we’ve had to delay by a few days because we just simply were behind because of their absence (and a lot of other things going wrong), and they doesn’t seem to care.
My partner and I do own over half the company (S-Corp, Delaware, operating Colorado).
If this situation continues to worsen, is it fair (from an ethics point) and legal to dilute their equity by issuing more shares? There are about six other people with equity - they don’t deserve this. The company doesn’t deserve it.
Well, I’d say it depends.
Legality
This is a tough one, without knowing some more details about your company and what shareholder agreement you had with the member. But given you have to ask, I’m going to take a guess that it’s not explicitly written out in any agreement with the offender. Given that presumption, I would be wary. I’m not personally aware of any precedent-setting cases that relate to this, but I do know that you could get sued for doing watering down your share values like this. Now, you might be able to get around that, I wouldn’t know how, but it seems like something that would have loopholes in it, but that becomes more an ethics question. Speaking purely from the legal standpoint, I would at least speak with an attorney who deals with contracts, let him or her read that over, and let you know of your options. It’s hard to read a brief question on a Q&A site and give legitimate legal advice. But yes, it is definitely risky and you should speak with an attorney first.
Ethics
Shocker, this one depends as well. Long story short, I’d say judge this aspect on intent. Obviously ethics are a fairly, well, subjective matter. And some people might disagree, and my answer here won’t be anything groundbreaking or definitive. But I’d say if your employee is acting maliciously, out of greed or a simple “I don’t really care about this, I’m tenured” type attitude, then your company “doesn’t deserve that” either, to quote your counter-argument to diluting his equity.
On the other hand, if he’s been a valuable asset to you over the last several months and just the last couple weeks he’s been a little distant, I would definitely give him a bit of time. We all have off-days, or even weeks, so while his behavior is certainly far from acceptable, particularly if you’ve spoken to him about this and he’s still delayed a launch, I’d give him a little time to figure himself out.
I think an important part, from the ethical standpoint, is just communicating with him. Does he know what he’s cost you in opportunities and grief? I know you commented that he might be reading his lower equity as an excuse to work less, but what if you give the benefit of the doubt to the same logic: maybe he takes his lower equity to mean he actually isn’t that important. Before you make any big decisions to effectively cut him out, just make sure you’re both on the same page about the role he plays, and the consequences of not playing that role. You might find that his morale is down, and that’s why he’s not contributing much, then you could work to find alternatives that would help him build up the desire to actually put in effort.
Inter-Office Relations
This one is a bit different, because it isn’t really concerned with legality or ethics as your question originally asked about. But think about what other implications a move like this could have.
I’m sure there are other aspects that I haven’t considered, but in essence make sure you’re viewing a decision like this from every available perspective. I certainly don’t mean this to discourage cutting the worth of his: I just want to make sure you’re thinking about the people it might have an emotional effect on, in addition to the directly quantifiable one.
A final, general note
I commented slightly on this in my closing remarks to ethics, but I think it deserves explicit commentary. So, a few notes:
Thus, my final conclusion, personally speaking: Your number one priority should be finding a way to get him excited again. If you can make that equity really worth something to him, you can probably get him to work more for you. This solution is a win-win for everyone, because he’ll be happy, your other employees will be happy, and you don’t even have to think about the ethics or legality of getting someone enthusiastic. But if you can’t do any of that, and he’s aware of the implications of his absence, then it’s time to speak with an attorney about your options.
Yes, there are almost always legal ways to dilute shares. Details differ based on jurisdictions and existing contracts, so to do it in a cost efficient and legal way, you always need a lawyer. Ideally you need the lawyer before you give the shares away in the first place, as that makes the situation even simpler and cheaper to resolve.
Morality and ethics are really not as relevant as consequences:
The person you wish to punish currently has something, and you wish to take it away from them. This sends a message to that person. It also sends a clear message to everyone else: You can take away their stuff if you’re not happy with them. You might want to send that message, but there’s a good chance it will destroy the company.
The slightly better option is to fire them and buy them out, assuming the company has the right to buy back shares from former employees (again, you need a lawyer).
And the best option is to do what a manager would do: talk to them and figure out what the problem is, then deal with the problem appropriately. If you’re not good at that, have someone who is better at it talk to them. It their dog sick? Did they start evening classes? Do they have a new girlfriend? Do they get mobbed by their coworkers? Was their mother diagnosed with cancer? Depending on the problem your response has to be different. Having occasional personal problems is normal. As is being less efficient at work because of it.
It sounds like you are talking about a situation where equity is the only form of compensation … and that you provided equity up-front, rather than putting in some sort of milestones to earn the equity portion in stages (hard to do that retroactively).
Did you provide a clause that will allow the company to purchase shares back? Did you provide the actual shares, or did you provide an option to purchase shares at a “valuation” price (one that requires you to re-value every so often)?
You should probably consider talking with your “other” folk to see what is driving their lack of 1000% commitment with only a hope for future compensation (after your company is able to go public, I assume … unless you are planning to provide dividends to shareholders out of future company profit).
Remember, punishment may simply change folk into completely absent shareholders at best and, at worst, trigger some distracting legal action on their part.
Go back to communicating (not demanding) and try to understand their point of view. If they were important enough for you to get started, then do think about what it would take to replace their future work contribution with other people.
Oh … and do remember that, in the end, a company is not a democracy so you do have the power to make changes with majority stockholder votes. Just consider the consequences. Punishment sounds like retribution, when you should be thinking about how to regain contribution.
No.
Short storey longer. Equity is about ownership not reward. That person owns ‘X%’ of your company just as if they handed over the cash to pay for the shares, and they will still own X% even if you fire them tomorrow. You can not dilute their ownership by issuing more shares since that dilutes everbody’s share equally.
As for your problem, you have a contract with him or her that say’s ‘if you do this we will do that’. That contract defines the only terms you can use to reward or coerce that employee. I suggest you read it carefully.
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