The juicier part, however, is what Lovejoy's lawyer has long-windedly dubbed the "equity equivalent participation rights agreement." It has a lot of the features of equity -- like the opportunity for capital appreciation -- without some of the legal strings. Lovejoy considered making his managers conventional shareholders, but he worried about the possibility of interference if for any reason the business had to be sold. Under the system he came up with, he and Lorie hold 100% of the stock, but two key managers (Franklin and Clifton) get to share in the increase in the book value of the business between the end of 1988 and the time they cash out. The way the plan is written, each has 2%, and they can get their money whenever Lovejoy Medical is sold or when they leave -- even if they're fired. If they quit or are fired, the company can take up to 18 months to come up with the cash.
So how do people feel about this? Has it made any difference in the way the managers approach their jobs? Well, it's a little early to tell -- the plan is less than a year old -- but Clifton and Franklin are pleased. "It gives me reason to hustle a little more," says Clifton. "As the company grows, I stand to make a nice chunk of change."
Setting up a program like Lovejoy's has its risks. One is that you'll alienate employees who aren't included. And as the value of the participation rights increase, there's the danger that you could be creating an incentive for key people to leave.
Lovejoy believes the first risk is unavoidable. "As an owner, you have to make choices." Although he has no specific plans, he says, there's no reason why he can't add new people or give current participants larger shares. The longer-term risk, that the program might encourage people to leave, he considers both speculative and amusing. "If the company does well over the next several years, it's a bridge I might have to cross." As it is, the 18-month payout is designed to discourage people from leaving on a whim.
While Lovejoy admits that there may be some unanswered questions, nothing has dampened his enthusiasm for his program. At many companies, he offers, even the most critical people have very little upside. "They see it simply as a job. I'm lucky to have people who know the business inside and out. They contribute to our success, and they'll share in it. I think they'll think twice before leaving for something else."
PARTICIPATION RIGHTS
The anatomy of a nonstock deal
The idea of sharing actual ownership with employees gives a lot of business owners pause. Even when minority owners hold a small number of shares, the fear is that one day they'll exercise -- or try to exercise -- a bigger voice. A nonequity solution mollifies that worry. You hold the stock; employees get some of the benefits. Here are some questions Matthew Lovejoy of Lovejoy Medical Ltd. answered when designing his "participation rights" program:
* Who participates? Lovejoy has a number of extremely dedicated employees at his 27-person business. But only 2 were employees he depended on to carry the ball. "They were part of the fabric of the business," he says. "I would entrust the business with them if I were disabled or unable to be there for other reasons. If they left, my business life would be miserable."
* What's the value tied to? Rather than relying on outside appraisals, the participation rights are tied to the growth in the company's book value (assets minus liabilities) over a base level that was set when the program began; in the event the business is sold, the value is tied to the sale price (minus the base book value). If Matthew Lovejoy or cofounder Lorie Lovejoy take compensation or perks greater than agreed-upon levels, the amount is added back in when profit is calculated. Participants get to see monthly financials.
* How big are the shares that people get? To some degree, Lovejoy concedes, the 2% shares he offered each of his managers was purely arbitrary. "Your gut tells you what is fair." Over time he may include other people in the program or offer bigger shares to the current participants.
* When can they cash out? Lovejoy's lawyer wanted to limit the opportunities in which individuals could become liquid to the sale of the company or a participant's disability, retirement, or death. Lovejoy rejected his advice. "I decided I would pay them regardless of the circumstance of their departure -- even if I fired them." In his view, the value is built up over time, so it would be unfair to deny people rights to what they've earned. To reduce the incentive for quitting in order to raise cash, the company can take up to 18 months to buy out shares.
