“How does an offer of ‘equity’ from an employer work?”

Question: I am being made an offer from a company owned by a “Private Equity” firm. They have said the offer will include “equity” – which is new to me.

How does that work? What terms will that piece of the offer come in? How do you negotiate that?

Rochester, New York

Answer: Dear Marianne:   

Your question is a really good question, and an important one. However, there is simply so much to explain that I can only cover the very basics. This is one time I must start off by suggesting you consult with an employment attorney who is experienced in these matters.

That said, let me do my best:  

1. “Equity” refers to an ownership interest in a company. It can take many different forms. If the company is a corporation, the “equity” may be in stock, stock options, or other kinds of ownership interests. If the company is a limited liability company, the “equity” may be in membership units. No matter how a company is set up, or what they call the ownership units, they are all kinds of “equity.” “Equity” is a very broad concept, and may be affected by many different conditions, many different limitations, and entail many different obligations. Almost always, these different forms, different limitations and different obligations are determined by the terms, provisions and conditions set forth in a written “equity plan.”  

2. There are many different aspects of “equity” that have to be reviewed and analyzed in order to figure out what is really being offered, and how it can  be lost. They include, among others: (a) what percentage of the company’s ownership is being offered to the employee-group, and to each member of that group; (b) can that percentage be diminished or “diluted” making something that looks valuable now ending up being near worthless later; (c) what conditions must exist before the “equity” is deemed earned, sometimes called “vested”; (d) is there any purchase price, or investment, that must be made in order to acquire the “equity”; (e) are there any “preferences” or priorities in getting paid that might make the “equity” near worthless; (f) what happens to the employee’s “equity” if that employee is terminated; and (g) perhaps most importantly, will the Private Equity firm pay for the employee group to hire legal counsel to negotiate the terms of the “equity” grant. 

3. Offering “Equity” is a way to motivate and retain good employees. Most times “equity” is offered to employees, it is intended to motivate those employees, and retain them. The thought is this: “If you stay with us for a few years, not only will you get salary and benefits, but you will also become an owner of the company, and if we sell it you may make a lot of money.” This often induces people to work very hard and to remain with a company for a long time. For example, those earliest employees of Google who received equity early on have made tens of millions of dollars. One early Google employee who received stock, was the Company Massage Therapist. She now has her own charitable foundation.

Want to Ask for Equity from Private Equity or other Private Owners? Use our “Model Letter for Requesting Management Equity from Private Equity or Other Private Owners. Right words, sensitivity and professionalism. “What To Say, and How to Say It.”™ To obtain a copy just [ click here. ] Delivered by Email – Instantly!

4. “Private Equity” firms are in the business of buying, “improving” and selling companies. Private Equity firms invest “private equity,” meaning monies of very rich individuals and institutions, such as college endowments, pension funds and insurance company investments. The business plan of most so-called “Private Equity” firms is to buy a company, make it become (or seem to become) more profitable, and then sell the company between two and six years later, for a large profit. The “equity” they often promise employees represents a share of those profits. Sadly, many times Private Equity firms make companies seem more profitable by reducing benefits, reducing salaries, and reducing jobs.

Unfortunately, Private Equity firms often pride themselves on being able to make a lot of money, and they often do, but just as often they do so by hurting employees and entire communities who have devoted many years – sometimes their lives – to a company. I am being 100% frank in my view that, overall, Private Equity firms represent the worst there is in capitalism, and “commercial values run amuk.”

5. Unfortunately, in my years of dealing with Private Equity firms, so many do not fulfill promises related to “equity.” In my many years of representing employees, I have many times seen the “equity” offered to employees turn out to be minimal, or non-existent. This is because, as the saying goes “The large print giveth, and the small print taketh away.” It is uncanny how many different ways and different times I have seen employees – after working their backsides off, and accepting reduced salaries for years – cheated out of  the “equity” they believe they were promised by Private Equity firms. It has come to the point that I actually expect this to happen. This is hard to guard against, and quite tricky to negotiate. That is why the many factors listed in section 2, above, need to be carefully reviewed and analyzed.

I have written a newsletter on this subject entitled “Negotiating Employment with a Private Equity Firm – 7 Surprises to Expect.” To read it, simply [click here].

6. Be especially wary – and skeptical – if you are expected to invest your own money. Some Private Equity firms go so far as to ask employees of what they call their “portfolio companies” to invest their own money in the company. Be especially wary – and skeptical – if this is asked of you.

7. Watch out, especially, for (a) large borrowings on the company books used by the Private Equity to buy it, and (b) unfair calculations of “profit.” You can almost expect that the Private Equity firm will borrow a lot of money to buy the company, and then make the company, itself, pay it back. This serves to enable the Private Equity company to, in effect, buy the company for no money, and also hurt the company’s later profitability. You can also almost expect that, when all is said and done, the “profit” you will share will be quite a lot smaller than you had been led to believe it would be. Almost always this is accomplished by promising the employees millions of dollars, but putting words in the Equity Plan or Equity Agreement that says words to this effect: “Nothing outside this agreement counts. Any promise or representation made to you does not count.”  

Employer ask you to sign an agreement? Use our Model Letter to Request Legal Cost Reimbursement. Why Not? After all, it’s their agreement, their business, their request, and is needed for the business’s interests. “What to Say, and How to Say It.™ To obtain your copy, [ click here. ] Delivered by Email – Instantly!

8. In situations like these, I always recommend you consult, and possibly retain, legal counsel experienced in just such matters. It is because I find it especially tragic for an employee to live and work for years with false hope, only to be disappointed in the end because they were tricked, fooled or misled, that I always recommend employees consult with employment attorneys experienced in these matters.

Marianne, while what is in front of you may be an opportunity of a lifetime, I am always concerned that this might also represent the disappointment of a lifetime. As noted above, I cannot here provide all that is necessary to share with you about what is ahead of you. I hope this has been, at the least, helpful.

Asking for an Equity Ownership Interest in your employer’s company is a very delicate request. And, too, it is a bit complicated. Consider a Telephone Consultation with Al Sklover before you make your request, to ensure it is done right. Just [ click here. ] All of our Model Memos, Letters and Checklists are Delivered by Email – Instantly!

Good luck in your efforts. While my “warning,” above, may sound quite dire, it remains my hope that you will be rewarded with all you deserve.     

Al Sklover

© 2011 Alan L. Sklover, All Rights Reserved.

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