Managing Hired Guns

A piece of the action for your top people may cost you peace of mind.

By Patricia A. Frishkoff

Jeannette, the owner of a family business, knew her key nonfamily manager had helped her through many recent business setbacks. Now that the company was back on track, Jeannette wanted to make sure this manager felt that she valued his work and commitment to the company. Her two children, who bad been working their way up for several years, were about to ascend to management positions, and Jeannette was worried that her hired gun might feel threatened. She didn't want to lose him. Now that she could afford to be generous, she decided to give him a piece of the action — just 1.5 percent of the closely held stock.

That decision turned out to be a serious mistake. It wasn't long before this manager began to act like more of an owner than Jeannette had intended. Suddenly he suggested opening a new facility in another town that he would then manage. Jeannette was even more surprised when he asked to see all the financial and legal information she had always kept strictly to herself. Then he began planting hints about bigger and better perks he felt entitled to. The last straw was when he casually mentioned that he wanted to hire his son, who was just out of business school, to fill a new marketing position.

When owners dole out shares of the business to a key executive, they often unwittingly shift the manager's sense of entitlement. Ownership comes with real and perceived benefits, many of which the family never intended as part of the deal. That's why I believe that business owners should not blur the boundaries by giving or selling to hired guns even fractional shares of the company.

There's nothing wrong with trying to give key managers a sense of security and attachment to the business, or with trying to enhance their long-term commitment to the company. But once you give away a bite-size piece of your company, you alter forever your relationship with the new minority owners. You may be legally obliged to open the books to them. You inadvertently create role ambiguity, as new minority owners begin to think of themselves as partners, not subordinates. One question you should consider: If something happens to you, do your spouse and kids want to be in partnership with the nonfamily manager?

Stock ownership creates more problems than it solves. The benefits are mostly perceptual, not real. For one thing, owning closely held stock is a teaser, partly because without a market for those shares, they provide no immediate liquidity. Because so few private businesses pay dividends, the stake provides no real ongoing income either. Unless your legal documents restrict it, minority owners could walk away from employment, but retain their ownership intact.

Another problem with minority ownership is that once you give someone 1 percent of your stock, they are likely to wonder when they will get the next 1 percent, and then the next. When reality hits that they are not destined to acquire increasing stakes in the company, you may have done more harm than good.

Nonfamily minority owner-managers may also assume they cannot be fired, regardless of their performance. That's not true. People can be fired if they own as much as 49 percent of the stock.

Management gurus tell us employers should make all employees, not just key managers, feel like owners. But they don't mean you should let them own stock. They usually recommend sharing selected strategic and financial information, increasing authority at lower levels, and soliciting ideas and feedback. They are talking about improving motivation and commitment, not taking on new partners.

You can instill pride and loyalty in your top managers without giving away pieces of your company. Probably the best alternative is to negotiate a broad, generous compensation package. The centerpiece of a good package should be a market-based salary — plus a bit more, to cover the greater risk hired guns face in a family business of being replaced by an owner's relative. A solid profit-sharing and pension plan is essential. You also should consider offering phantom stock, which is not real equity. Because its price shadows that of common shares in the company, it gives nonfamily members a chance to reap appreciation, especially if you may eventually sell the business. Also consider including top managers in a new outside venture: jointly purchasing real estate or investing in a new business.

If you are worried that key employees may leave if they don't get a stake in the business, don't think that fractional shares will keep them. One key executive lobbied for stock in a thriving enterprise. When the family refused, he left, opened his own establishment, and became a formidable competitor. This executive wasn't asking for a few token shares; he wanted a major stake. He was itching to do his own thing, and my guess is he would have left even if he'd snatched up some stock.

Unless you genuinely want a partnership with someone, stock is not the answer. And even then, you should do it in a meaningful way — with a significant chunk of equity — or not at all.

If you decide to go ahead and give hired guns fractional or substantial shares, be sure that everyone's expectations are crystal clear. You should also immediately install a buy-sell agreement to manage the messiest possible situation that may arise.

Whatever you do, realize that at best, token gestures of appreciation are ineffective, and at worst, they can backfire.

 

Patricia A. Frishkoff is director of Oregon State University's Family Business Program in Corvallis, Oregon.