There are a myriad smart ways to reward key employees. Issuing company stock isn't one of them.
There are many great ways to reward a key employee :tickets to a sporting event, gift certificates, a bonus, a title, a company car, an exotic paid vacation, and just about anything else you can imagine. The one item that should not be on this list is company stock. Too often we deal with expensive legal problems because a business owner used stock to reward or motivate a key employee. Owners of start-up companies may give stock to some employees because they don’t feel that they can pay the employees what the employees are really worth. Sometimes, owners hope that ownership in the enterprise will engend era greater commitment or greater loyalty from their employees. Other times, business owners have thought ofthe transfer of stock as a “no-cost” form of reward because it takes no cash to issue a stock certificate. Occasionally, issuance of stock to a key employee is critical to the company’s long-term success. For example, some owners have made a key employee a co-owner in order to keep that key employee from becoming a competitor. However, more often than not, making employees minority owners creates problems. In nearly all states, even minority shareholders have a right to review the books and records of a corporation. This may give minority-shareholder employees access to sensitive information about the company, such as compensation of other employees, confidential business relationships, and the like. Additionally, many state courts recognize a fiduciary duty owed by majority owners to minority owners. This fiduciary duty maymake it difficult to terminate the employment of a minority shareholder and may allow a minority shareholder to challenge the reasonableness of compensation and fringe benefits provided to the majority owner. Beyond these big issues are myriad potential nuisance issues. For example, in order to assure that the stock is not transferred to a creditor of a minority shareholder or to some other third party, written agreements will be needed. If the minority-shareholder employee becomes involved in a divorce action, it may be necessary to disclose financial information concerning the company so that a court can determine the value of the shares. Moreover, minority shareholderscan make it difficult to sell a business. Before issuing shares to an employee ask yourself several questions. Is the employee’s commitment to your business as strong as your commitment? Is it conceivable that the business will outgrow the usefulness of your employee? Would your employee be willing to share financial risk with you as a minority shareholder? Would you be willing to have the employee as an equal partner? If not, why are you willing to have him or her as a minority partner? There are other ways of rewarding key employees and obtaining long-term commitments. You might consider some form of non-qualified deferred compensation or even a phantom stock plan. In a phantom stock plan, an employee has the opportunity to share in the economic rewards of ownership (for example, dividends or a share of the sale proceeds ifthe businesses sold) without having theactual rights of ownership. Consider these options before taking on a minority owner. In the mean time, tickets to this year’s Super Bowl might be reward enough.
Michael P. Coyne is a founding partner ofthe law firm, Waldheger Coyne, located inCleveland, Ohio. For more information onthe firm, visit www.healthlaw.com, or call440-835-0600.