How to make your employees 'owners' without giving up a single share of stock
You hear a version of it almost everywhere you go. An owner wants to generate commitment. He wishes his employees would take more initiative -- to act as if they're owners, too. But he isn't prepared to give them equity. The fact is, he may never be prepared to give them equity, and therein lies the rub.
It can be a big problem. Good people want a stake in the business, and they may leave if they don't get it. Or they don't leave, which can be just as bad; they just lose their enthusiasm. But if you think about it, passing around equity isn't your only choice. Ask Bob Luddy.
Luddy, the founder and chief executive officer of Captive-Aire Systems Inc., has come up with an unusual approach to the ownership question, one that hasn't required parting with a single share of stock. Instead, he lets employees have shares in something else, something that's related to the business but is not the business itself. In his case, it's real estate.
Currently, 17 Captive-Aire employees own partnership units in a 24,000-square-foot production facility near the company's Raleigh, N.C., headquarters. And soon more than half of his 90-plus employees will be eligible to become part owners of a second plant. Someday, says Luddy, these investments may be worth a lot. "It's something that sets us apart," he explains. "It's our way of letting people share in the growth."
When Captive-Aire first got started in the kitchen ventilation equipment business back in 1979, its approach to rewarding nonsales employees was about as basic as they come. No bonuses, no profit sharing, just a paycheck and medical insurance. "It was a struggling, young company," Luddy explains without apology, "and our focus was on growth." But once the company was three or four years old and posting revenues of more than $1 million a year, the dynamic shifted. Several employees began asking about his plans for sharing equity, and Luddy didn't know what to say. He knew he needed to address the matter, and he wanted to create a feeling of long-term opportunity -- something beyond titles and paychecks. But was equity the only answer?
Control was a big issue for Luddy. He admits his feelings may have been more emotional than rational, but the thought of sharing control bothered him nonetheless. There was no doubt in his mind, for example, that the key to success in his industry was building market share. "We invested all of our profits," he notes, "and it was working." But would other shareholders agree that this was the right way to go, or would they second-guess his decisions instead? He looked into the possibility of an employee stock-ownership plan, thinking that might be a way to share equity without sharing control. But in light of his plans for growth, it didn't seem the right way to go. He'd have to give up a lot of stock, and then, a few years down the line, he'd have to give up more. Besides, he says, "an ESOP doesn't let you differentiate very much between people who deserve it and people who don't."
So Luddy and his chief financial officer, Bill Francis, began looking for alternatives. In Luddy's mind, the ideal solution would provide people an opportunity for growth and "ownership," while preserving his own freedom to set the direction of the business. And he wanted something that didn't require a lot of front-end cash. ("Remember," says Luddy, "we were already spending whatever cash we had developing the market.") Too much to hope for? Perhaps.
Then, in the fall of 1983 the production facility Captive-Aire had been leasing came up for sale. What if Luddy bought the plant and let employees be partners? Luddy and Francis played around with the details and put together a plan. In a nutshell, here's how it works: a limited partnership, called Bramer Investors, bought the plant for $410,000, arranged for a 100% mortgage for 10 years, and then leased it to Captive-Aire at a rate that covers the mortgage payments plus a small cushion. Every employee who'd been with Captive-Aire for more than a year got the right to buy a 0.5% share of the partnership for the modest sum of $250. Fourteen out of a potential 19 did. In keeping with Luddy's desire to recognize key people, some were offered multiple shares. Over the next two years employees were given additional opportunities to buy shares -- at higher prices -- while Luddy himself retained about 70% and was the general partner.
It's not the simplest arrangement in the world, but the basics are distilled into a four-page memo, which explains, among other things, how the share value is calculated and what the mechanisms are for cashing out. As the mortgage principal declines and the property appreciates, the partners stand to do quite well. But there are restrictions. To take full advantage of the opportunity, an employee has to work at Captive-Aire for at least 10 years. "It was designed," Luddy says, "as an inducement to stay with us." And if employees leave before then? Well, in all likelihood, they'd lose. They'd still get their original investment back, plus interest of 10% a year. But they'd forgo their full share of the equity and appreciation -- their piece of the rock.
There's a possibility, of course, that the value of the property won't appreciate much -- or that it may depreciate. Think of all that idle real estate in places like Texas. The way the deal is structured, however, those who hang in for at least 10 years should make out just fine. If the value weakens by 25%, for example, a $250 share would still be worth around $1,500 (thanks to all the leverage). That's six times the original investment. If the value holds steady and doesn't appreciate, a share would be worth about $2,000, an eightfold increase.
Nobody is sure what will happen when the mortgage is finally paid off in five and a half years. There are plenty of possibilities, Luddy says, but nothing definite has been decided. It depends on a variety of factors -- the value of the real estate, the interests of the partners, and the needs of the business. It could be that the partners will be content to continue leasing the property to Captive-Aire or to another tenant. In that case, they'd get monthly distributions. Or they may want to take the money and run, which would put him in the unusual position of having to take out a big, new mortgage to buy out his own employees. But Luddy's not worrying. "If the value of the property goes up, my own interest will be worth more, too," he says. "We'll all share in the benefit."
Now we're not talking about a huge sum of money for employees -- certainly not something a person could retire on or even send a child to college with. Under the best of circumstances, a unit might be worth $4,000 or $5,000, not $20,000. But this doesn't seem to diminish the plan in employees' eyes. While it hasn't kept everyone in the fold -- 7 of the original 14 partners, including one senior manager, have moved on -- those who've stayed are delighted with what it represents.
It isn't equity in the business, concedes senior accounting analyst Susan Pendleton, "but in a lot of ways, it feels like it. And it's not something you'd get at most other places." For many, it's more than an investment; it's a symbol that they're part of the team. "When I first heard about it, I was flattered and honored," says Judy Nunnenkamp, vice-president of administration and personnel. "It showed me that Bob Luddy wanted me to stay here and be part of a growing company."
Since the program was unveiled, Captive-Aire has introduced a host of other benefits. Among them, there's a 401(k) savings plan, fancier life insurance, and a tuition-reimbursement plan. Today, Captive-Aire is a $12-million company, and while Luddy doesn't pretend that the partnership program is the only driving force, he's convinced that it has made a difference. "People are working harder now than ever before," he says. "The program has helped us convey an attitude that we're willing to share the success -- that if the company does well, they will, too." And it's made it easier to recruit new people.
How far is Luddy willing to go with the program? As far as it can take him, he says. This winter, for instance, he is offering his employees shares in a brand-new $750,000 plant. "The idea is to keep on going. Over time, if we continue to grow and need new facilities, we'll do more of these deals," he says. "I'm not saying we'll make people rich. But in the end, it could really amount to something. It could be a substantial portion of a person's net worth."
You may have more opportunities to reward key employees than you think
Looking for an alternative to giving up equity? You could take a cue from Bob Luddy, of Captive-Aire Systems Inc., and let employees own interest in your company's real estate. But there are other approaches that may be more suited to your circumstances. Here are some possibilities to think about:
* Sharing the equipment. Although the 1986 elimination of the investment tax credit makes limited partnerships based on equipment less attractive, they're still worth considering, says Marv Chell, chairman of Viking Inc., a manufacturer of wooden-pallet-assembly systems in Fridley, Minn. In essence, you let employees be part owners in equipment that is leased to your business or to a third party. "If you set things up right," Chell says, "it provides an opportunity for people to participate and to make some money."
* Sharing a new venture. Like Luddy, you may want to avoid giving up equity in your primary business. But what about letting people have a piece of another business? Gary Nowicki, president of Northwood Carwash Systems Inc., a distributor of car-wash equipment in Mount Pleasant, Mich., has been doing this for the past two years. He owns 100% of Northwood and is also a general partner in newly built car washes. So he lets key employees invest their bonus checks in these ventures.
* Sharing the cash. Alternatively, there are interesting ways to simulate a feeling of ownership without getting into property or stock. At COPI (Computer Output Printing Inc.), in Houston, employees get their own share of revenues -- ranging anywhere from 0.1% to 0.5% (see Compensation: "A Company of Salespeople," June 1988). As people become more important to the business, they get to renegotiate their shares.