I always give away equity in my companies this is why Ep 317

Summary Notes


In the podcast, the host discusses the strategic use of phantom equity as a tool for incentivizing employees without granting them actual company shares. The host, drawing from personal experience and lessons learned from business magnates like Sam Walton, emphasizes the importance of aligning employees' interests with the company's growth by offering them a stake in potential wealth through phantom equity. This method fosters owner-like behavior and engagement, as it is tied to specific events like company sales or changes in ownership, without the tax liabilities associated with traditional equity. The host also distinguishes between profit sharing and equity, suggesting that the best employees, those who are confident in their ability to contribute to the company's success, often seek a share in the upside, which phantom equity can provide. The overall message is that by sharing wealth with employees who contribute to the business, owners can actually enhance their own wealth and the company's value.

Summary Notes

Introduction to Phantom Equity

  • Phantom equity is a mechanism to incentivize employees without giving away actual equity.
  • It is one of many vehicles for aligning employee interests with business growth.
  • Speaker A introduces the concept of phantom equity based on personal experience and its utility in business.

What I want to introduce you is just one of the many vehicles that exist to incentivize employees, and it's called phantom equity.

This quote introduces the main topic of the conversation, which is phantom equity, a tool for incentivizing employees.

The Game of Business

  • Speaker B sets the context of the discussion focusing on customer acquisition, maximizing profit per customer, customer retention, and learning from failures.
  • The podcast aims to provide valuable insights and lessons to its audience.

Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way. I hope you enjoy and subscribe.

Speaker B provides an overview of the podcast's themes, which revolve around business strategies and learning from past experiences.

Equity and Performance Relationships in Business

  • Speaker A recounts a conversation with a newer business owner about incentivizing a marketing employee.
  • The discussion leads to the realization that performance-based relationships are preferable to giving up equity in some cases.
  • However, for certain positions, offering equity can be beneficial for business growth.

So I was having a conversation with a newer business owner, and he was talking about how he had this person who was good at marketing and he wanted to give them a percentage of his business, but not the whole business, in order to do his marketing.

This quote describes a real-life business scenario where a business owner considers using equity as an incentive for a marketing employee.

Wealth Creation Through Employee Incentives

  • Speaker A discusses the philosophy of growing personal wealth by facilitating the wealth growth of others, including employees.
  • The concept of leveraging business as a vehicle for mutual wealth generation is emphasized.
  • Speaker A shares personal insights on wealth creation and the importance of incentivizing employees.

Because I have realized over time is that in order to grow my slice of the pie, it's better to get a bigger pie and have more people get wealthy.

Speaker A explains the rationale behind sharing wealth with employees, which is to grow the overall wealth for everyone involved, including the business owner.

Sam Walton's Influence on Employee Incentives

  • Speaker A references Sam Walton's book "Made in America" and the impact of Walmart's employee stock option program on the company's growth.
  • The success of Walmart's incentive program is highlighted as a model for other businesses to consider.
  • Speaker A expresses a desire to transfer learned lessons to the audience more efficiently.

Sam Walton even talked about this in his book made in America, how he said one of the biggest things that influenced Walmart's growth is when they created their employee stock option program.

This quote points to the historical example of Walmart's successful implementation of employee stock options and its positive impact on the company's growth.

Personal Experience with Phantom Equity

  • Speaker A shares a personal anecdote of being offered phantom equity as an affiliate for a software company.
  • The experience with phantom equity from the affiliate perspective led to its adoption in Speaker A's own businesses.
  • Speaker A plans to explain phantom equity from both the employee's and the owner's perspectives.

Believe it or not, I've used Phantom equity to incentivize high level employees in just about every company.

Speaker A attests to the widespread use of phantom equity in their own businesses, underscoring its effectiveness as an incentive tool.

Phantom Equity: Definition and Vesting

  • Phantom equity represents a form of non-vested equity with specific events that can trigger vesting.
  • Vesting determines whether the equity is owned and in control of the employee.
  • Phantom equity typically vests upon a sale or change in company liquidity.

"Phantom equity is, simply put, equity that is not vested, but has events that can trigger its vesting."

This quote defines phantom equity and introduces the concept of vesting as contingent upon certain events.

Phantom Equity: Triggers and Clauses

  • Vesting of phantom equity can be triggered by changes in ownership, such as a majority sale.
  • The inclusion of such clauses is negotiable and can be tailored to protect the owner or to allow employees to participate in ownership changes.
  • Clauses can specify limits on how much equity employees can liquidate.

"Phantom equity vests, or you are able to participate in a transaction of the company if ownership changes, if majority ownership changes."

This quote provides an example of a trigger event for phantom equity vesting, emphasizing the negotiability of such terms.

Phantom Equity: Purpose and Strategy

  • The goal of phantom equity is to foster owner-like thinking and engagement among non-majority employees.
  • Phantom equity aligns employees with the company's success without giving away substantial equity stakes.
  • It is used to incentivize and attract high-performing employees who want to share in the company's growth.

"The objective of phantom equity is to get owner like thinking and owner like engagement, owner like behavior among people who are not majority owners of the business."

This quote explains the strategic purpose of phantom equity in promoting an ownership mentality among employees.

Phantom Equity: Employee Incentives and Wealth Building

  • Phantom equity allows employees to build wealth alongside the company's success.
  • It is a tool for incentivizing employees by giving them a stake in the company's upside.
  • The speaker reflects on their past experiences with equity distribution and the balance they've found.

"The best people want a stake because winners win and they know they're going to win. So they want to be able to participate in the upside."

This quote highlights the motivational aspect of phantom equity for high-achieving employees who are confident in their and the company's success.

Phantom Equity: Tax Implications

  • Phantom equity is tax-free until the vesting event occurs, aligning the interests of the owner and employee.
  • It is preferred over normal equity because it does not expose the employee to the potential downsides of ownership.
  • The tax benefits make phantom equity an attractive option for both parties.

"And the beauty of that, that it's entirely tax free."

This quote emphasizes the tax advantage of phantom equity for employees, as it does not incur taxes until vesting events.

Phantom Equity

  • Phantom equity is a financial incentive mechanism that does not involve actual stock but provides benefits similar to having equity.
  • It avoids tax implications for the employee at the time of issuance since it's not a direct transfer of equity.
  • Phantom equity is contingent on certain triggers, preventing immediate vesting and taxation.
  • The structure of phantom equity is designed to benefit both the employee and the employer by deferring taxes and encouraging long-term employment.

"It's good because the employee doesn't have to buy the equity because normally if you actually have an equity transfer, a true transfer, then what happens? They actually have to pay tax on it because they're getting, can't just, Zuckerberg can't just give all of his shares to Facebook to somebody. They have to pay taxes on it, right? And so that is a taxable event when you transfer equity. So you make it phantom equity because it doesn't technically vest unless a trigger occurs. And so what that does is it means that they don't have to get taxed on it, which is beneficial for the employee."

This quote explains that phantom equity is a favorable alternative to actual equity transfer because it circumvents the immediate tax liability that would occur if equity were truly transferred. This arrangement benefits the employee by deferring taxation until certain conditions are met.

Vesting Schedule and Cliffs

  • The vesting schedule dictates the timeline over which phantom equity awards become available to the employee.
  • A common structure is a percentage-based vesting over a set number of years.
  • Cliffs can be included to delay any vesting until a certain period has passed, after which vesting can occur incrementally.

"So, for example, you could say, I want to give you 5% of this company, and I want to give it to you over five years, which means you get 1% a year for the next five years. And you could say, hey, I want to create a cliff. Which means that after the first year, the entire first percent vest, and then after that, every quarter, another zero point 25% vest after that. So that means that at month nine, there's still zero vesting. And then at month 13, they'll have 1% that will have vested in its entirety."

The quote outlines a hypothetical vesting schedule for phantom equity, demonstrating how an employer might structure the gradual release of equity benefits over time, with a cliff to ensure that the employee stays with the company for at least a year before any equity vests.

Employee Retention and Protection

  • Phantom equity agreements can include clauses that revoke unvested equity if an employee leaves the company, incentivizing them to stay longer.
  • The structure of phantom equity protects the business owner by retaining talent and safeguarding against premature equity loss.
  • Phantom equity also protects employees from personal liability in case of business failure.

"Now, one of the benefits to this, and this protects the owner, is what if you say someone comes in, they're a hotshot, they're smooth-talking, and they're like, yeah, man, I want phantom equity, whatever. And you're like, sure, I'm going to give you 5% over the next five years. Right? And let's say they leave within X period of time. Now, a, upon the termination of the employee, you can have them not get those. And you can also write that in the original agreement, which means that if you leave, you lose your phantom equity, which also gets people to stick with it over the longer term, which is why companies employ the structure. It's to incentivize people to stay and continue to grow the business."

This quote discusses the strategic advantage of including terms in a phantom equity agreement that protect the company's interests by discouraging employees from leaving prematurely. The loss of potential equity serves as a retention tool.

Book Promotion

  • Speaker C promotes their book, "100 million dollar offers," available on Amazon with high reviews, as a resource for the podcast community.
  • The promotion is framed as a gift to the audience and an investment in future business partnerships.

"Hey guys, real quick, if you're new to the podcast, I have a book on Amazon. It's called 100 million dollar offers. At over 8005 star reviews, it has almost a perfect score. You can get it for Kindle. The reason I bring it up is that I put over 1000 hours into writing that book and it's my biggest give to our community. So it's my very shameless way of trying to get you to like me more and ultimately make more dollars so that later on in your business career I can potentially partner with you. So that's my give. Go check it out, Amazon and back."

Speaker C uses this quote to promote their book as a valuable resource, highlighting the effort put into its creation and the positive reception it has received. The promotion serves dual purposes: to provide value to the listener and to lay the groundwork for potential future collaborations.

Equity vs. Profit Distributions

  • Equity ownership does not guarantee participation in profit distributions.
  • Profit distribution can occur without equity ownership.
  • These concepts are often conflated but are distinct variables in negotiations.

"You can be an equity owner and not participate in profit distributions. You can also participate in profit distributions and not be an equity owner."

This quote clarifies the misconception that equity ownership and profit distributions are inherently linked, highlighting their independence in business arrangements.

Phantom Equity

  • Phantom equity is dependent on the value of the business.
  • Senior leadership positions may receive between 0.5% to 2% phantom equity.
  • True executives can receive 3% to 5%, depending on their contribution and role.
  • Phantom equity is an alternative to other incentive programs like bonuses or ESOPs (Employee Stock Ownership Programs).
  • It aligns employee incentives with the company's success.

"So somebody who's like on the executive track, they might get between half a percent to 2%, depending again on the value of the business, their seniority, their experience, et cetera."

The quote provides a guideline for allocating phantom equity based on position, value of the business, and individual experience.

Employee Wealth Growth

  • The speaker prefers profit sharing as a means to help employees grow their wealth.
  • Employees who understand the business's videos and strategies can think in terms of enterprise value.
  • Aligning team members' life outcomes with the owner's leads to a unified direction and faster progress.

"I love the fact that my employees can grow their wealth alongside me because they hear the same videos that you guys watch."

This quote emphasizes the importance of employee wealth growth as part of the company culture, where they are educated on the business strategies and outcomes.

Building Employee Wealth

  • The speaker is focused on creating wealth for employees as a top priority.
  • Finding creative ways to build employee wealth is essential without risking the business's foundation.
  • The speaker advocates for sharing the benefits with those who contribute to the business's success.

"And so building my employees wealth is something that is something top of mind for me and trying to find new ways and creative ways to build wealth without necessarily sacrificing what we've built and risked to get here."

The quote reflects the speaker's commitment to rewarding employees' contributions to the business by exploring innovative methods of wealth creation that do not compromise the business's achievements.

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