The struggle to attract top talent in your field is one every business owner can relate to. We’ve seen this happen first-hand with our clients.
When they get a lot of business because of the effective marketing campaigns we run for them, they reject some because they don’t have the people to handle it.
Even when you find the right people, trying not to lose them to competitors for higher pay or more benefits causes headaches.
But you can attract and retain outstanding talent in the contractor business by offering equity. This way you can keep them committed to long-term business goals.
We’ll explain what it all means and how you can set up your own strategy to build a superb team of great employees, expand your business, and drive more profits.
What is Equity and Why Should You Offer It?
Equity, in this context, is a non-cash payment that you can offer employees. It is a slice of business ownership and comes in various forms: stock options, restricted stock, and performance shares.
For the past 50 years, tech companies and startups have used this method of offering pieces of ownership to employees as part of their compensation package to attract them and keep them invested in the success of the company.
Even though this is a common practice among tech startups, it’s still in the early adoption stage in other industries, including the trade industry.
Your business can definitely benefit from offering equity-based incentives. You can:
- Get employees to feel invested in the company’s success
- Encourage them to align with the long-term goals of the company, and
- Reward efforts and creativity that add long-term rewards to the company
That’s not all: Employees who own equity in the company, on average, work 8 more hours per week than those who don’t own equity.
Equity not only attracts and retains top talent, but gets them dedicated to putting in their best effort. And that’s because they feel a sense of ownership of the company. Its success becomes their success, literally. Their long-term financial goals, since they’ve invested in the value of the company, are aligned with the company’s goals.
Offering Stock Options to Attract Top Talent
For your plumbing, landscaping, HVAC, or other contractor businesses, these are some types of equity-based compensations you can offer to get and keep top-tier technicians:
Stock options allow an employee to buy shares in the company at a fixed price called the strike/exercise price. A strike or exercise price is the price at which you can buy or sell a share.
It is common practice to let stock options vest with time so that the employee only benefits from this after spending a certain amount of time at the company.
Vesting is withholding the right to buy the stock options until a period of time passes. This can protect a company from a bad hire. For instance, when the vesting period is 4 years, it can be split into a schedule like 5/10/40/45.
That means 5% vests in the first year, 10% in the second, and so on. It could also be 25/25/25/25, where a quarter of the stock options is vested every year.
The other important thing you need to know is the cliff date. Cliff date is the day you can exercise your stock options. That means, even if, technically, your options are vested before this day, you can’t do anything with them until the cliff date. For some companies, it is usually 1 year.
Let’s illustrate using the 25/25/25/25 vesting schedule with 1-year cliff:
4-year vesting schedule with 1-year cliff (Source: Esofund)
If you offer Stan 100 options at an exercise price of $1 when he joined your company XYZ Plumbing, after one year, 25% of that will be vested. That’s 25 options at $1 each = $25.
So Stan, on his first work anniversary, can now buy those shares by paying $25. This is where Stan benefits: Supposing the XYZ Plumbing is now worth 3 times more than when Stan started working there, his 25 options are now worth $75.
He profits $50.
But if he leaves before his first year, he leaves empty-handed.
- Encourages people to stay in the company for a longer time
- Protects the company from a bad hire
- You’re only giving the possibility of buying stocks, not actual stocks
- If the value of the company falls, employees may feel discouraged as their stock options reduce in value
- It is subject to tax
Employees with stock options are not stockholders and won’t be able to make decisions except it came with voting rights. Even if the options come with voting rights, the owner will most likely have the majority of shares and therefore, the final say on all decisions.
1. Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs)
ISOs give the employees the right to buy shares of the company stock at a discount. And it sometimes comes with tax breaks on the profit they make.
An NSO is a type of employee ISO where the employee only pays income tax on their profit. The profit is called “non-qualified” because they are not qualified to be ISOs by the Internal Revenue Code.
Employees gain when the price at which the stock was granted to them is lower than the market price of the stock.
2. Restricted Stock Units (RSU)
Restricted stock units are like the regular stock options we spoke about above. But in this case, the employee can only assume ownership along with other privileges (like voting) at the end of a vesting period.
3. Performance Shares
Performance shares are those that are given after certain performance metrics are met. Examples of such metrics are earnings per share (EPS) target or total return of the company’s stock compared to an index.
How to Design Your Own Equity Compensation Plan
Equity compensation is sensitive and quite complex to design. So, before you get started on this, it is advisable to consult a tax and securities attorney. You’ll need the input of an expert for securities, legal control, employment, and tax issues that might occur.
You can check out Buffer’s equity formula to get an idea of how it’s done before we break it down for you.
To get started on yours, first:
Ensure compliance with laws
When designing your equity plan, you want to be sure you’re on the right side of employment and taxations laws, as well as corporate governance standards.
Laws that apply here are:
- Pay Equity Laws
- State and Federal Tax Regulations
- State Corporate Law
- Federal and State Securities Law
- SEC regulations
Sometimes the federal and state laws may differ. For example, when the federal minimum wage is $8 and the state’s minimum is $15.
Here, the U.S. Department of Labor states that you should follow the law that provides the best protection to employees and the strictest standard for employers. So, you must work with the state’s minimum wage.
You can check out this equity compensation plan exhibit by the SEC to get an idea of what you should aim for. Here’s another one.
Consult with your securities attorney to know what lines you cannot cross. To find the right attorney to help you work on this, you can:
- Ask a lawyer you already know to refer you to someone specializing in tax and securities.
- Call bar associations and ask for a list of lawyers in your area. They usually offer a free initial consultation, or at least a discounted one.
- Check directories of attorneys like the Martindale-Hubbell® Law Directory or Best Lawyers.
If you want a simple way to create a draft of your equity incentive plan, you can use the free template by Rocket Lawyer.
Draft a strong employee agreement
This document will cover everything that could go wrong during your relationship with your workers. It will state what actions you or they can take in a wide range of events.
For full coverage and protection of all parties involved, your employee agreement should cover:
- Information about the job including job title, department, and who they report to
- Details about the compensation and benefits package, including stock options, 401(k) plan, medical, etc.
- A detailed explanation of the time-off policy, sick days, vacation policy
- Employee classification (employee or contractor) for tax and insurance compliance
- The work schedule and employment period
- Confidentiality agreement to protect sensitive information
- Termination terms and conditions
- Information about the severance or outplacement plan
- Requirements (such as restrictions or mandates on the employee) after termination
You can use a free online template to draft your employee agreement, or you can consult with your lawyer for a more thorough and customized document.
Think about situations that warrant cancellation
You will want to retain the right to cancel an employee’s stock option or buy back their shares. This will protect your company from abuse and other unfortunate events.
In this part of your equity compensation plan, work with your attorney to answer all questions that may arise when employees lose possession of their stock options. Or what happens when they cannot exercise it.
For instance, will their estate be allowed to exercise options or hold employee’s shares that they’ve already bought after termination?
Clarify the rules for cancellation because situations may arise when people will want to sue. Your employee contracts, equity compensation agreement, and stock option cancellation agreement will play vital roles in this scenario.
The “Amendment and Termination of the Plan” or “Clawback” clause in your equity compensation agreement sets the terms for the actions you take regarding the cancellation.
If you created your equity agreement yourself or with the help of a template, it simply makes perfect sense to allow an experienced attorney to look over it. Only after you’ve done that should you ask your employees to sign such a sensitive document.
Consider needs for adjustments
You’ll also want to think of instances when you want to modify the award agreement, such as accelerating the vesting period.
Another instance is how the grant price (the specific price you offered the employee for the stock options) will change when the market value of your company changes. Or when more people join the staff.
There are a few things you need to know before modifying your agreement:
- You may need shareholder approval (unless you’re accelerating vesting or adjusting performance targets). It all depends on your original compensation plan.
- If the changes require the employee to give up some rights, you will need their consent. For example, if you’re extending the cliff date from 1 year to 18 months.
- Most modifications come at a cost. For example, if you make performance targets easier to achieve, it will cost you the aggregate fair value (combined value of all outstanding stock) of the modified equity offer at the time of the modification.
It’s advisable to get accounting guidance when changing your equity plan to avoid making mistakes.
Here’s how to find an accountant for your equity compensation plan modifications:
- Get a referral from the attorney you’re working with, your bank, or a business partner, or
- Check the Society of Certified Public Accountants in your state.
Create your equity formula
This example is based on The Hub’s adaptation of Buffer’s public equity formula.
Decide what roles in your contractor business are the most important. Then assign them percentage values between 0 and 1. Let’s use XYZ Plumbing as an example here again. Your operations manager can be 0.6%.
The risk factor takes into consideration how likely a company is to fail. In the early stages with fewer employees, the risk factor is high. Over the years, as the workforce grows, the risk factor shrinks.
A company of 6 people has a risk factor of 2, 15 has a risk factor of 3, 30 has a risk factor of 4, and so on. If the operations manager of XYZ Plumbing joined when the company was 47 strong, his risk factor will be 5.
If you operate a hierarchical organizational structure, seniority is easily visible. At each level, you add 0.1. 0.1 for junior staff, 0.2 for mid-level management, and 0.3 for senior management.
The formula that The Hub works with is:
Role% / Risk factor + Seniority
In this case, our operations manager’s total equity =
0.6 / 5 + 0.3 = 0.42
Equity formula calculator
We’ve built an equity formula calculator based on The Hub’s adaptation of the Buffer formula. Check it out below!
Step 1: Select number of employees
How many employees to you want to give equity?
Monitor and adjust when needed
Your plan has to stay adaptable because it’s likely you won’t get it right the first time. Watch and observe if the plan is working as intended. Also, laws and competition will affect the plan. Be ready to adjust.
If you want to learn more about equity offerings and how you can start using them today to hire the best and keep them, Carta has a rich bank of easy-to-understand resources on the topic.
However, in this matter, we’ll advise that nothing beats sitting down with a qualified securities attorney to design your equity-based compensation plan.
Keep Your Team Aligned with Company Goals
It is not enough to set up an equity program, attract excellent employees, retain them, and relax your efforts.
You’re dealing with human beings, and sometimes motivation and vested interest may fade. Even with equity in their hands, you still have to do some work to retain their interests.
You need to develop a recurrent strategy to keep employees on track with your long-term business goals.
You can do that by rewarding them for their contribution to metrics that benefit the company in the long term. Metrics like customer retention rate and customer acquisition.
In a Nutshell
You can attract and retain top tradesmen by offering equity, which are slices of ownership of your company.
This will get them invested in the success of the company and keep them doing their best for a long time.
To get started, you need to understand what equity options you can offer—the most popular being stock options.
Then, using careful considerations with the help of a tax and securities expert, craft a rock-solid equity compensation plan to help you attract and keep the best talent in the contractor industry.
Do you know anyone who can benefit from offering equity to attract top talent? Consider sharing this post with them.
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