The Road to Employee Ownership

Dealerships are facing challenges everyday with competitors looking to poach their key employees including sales, finance and general managers. What are ways to ensure your best and brightest employees want to stay with your dealership?  

For many employees, the factors that will motivate them may be different, but in many cases part of the solution will revolve around compensation. 

Something for you as a business owner to consider is if you want to share more of your profits or share some ownership and future growth of the dealership with your key employees.

There are a number of options you can consider that will achieve the objectives for both the dealership and the employees. These include:

• Profit sharing plans
• Employee stock option plans
• A share freeze

Profit Sharing Plans

At times, a periodic bonus tied to employee performance may be sufficient to achieve the objectives of both the employee and the dealership. If the employee hits certain targets, then they get a cash bonus taxable to them as employment income and deductible to the dealership. 

If you go with a bonus tied to targets, make sure the targets are well defined so both you and the employee understand them. And also to ensure you are motivating the employee to do what’s good for the whole business as opposed to simply motivating them to do what’s best for them. 

Employee Stock Option Plans (ESOP)

For employees you are confident would make a good owner, an ESOP can be both a great motivating tool and an attractive and effective retention tool. 

An ESOP allows you to set the terms on the shares available to the key employee(s) including the timing, the number and percentage of shares you want to make available to them to acquire and the price they will pay for the shares. 

You will need to consider what happens if the employee passes away, quits, is fired, becomes disabled, etc. The terms covering off most of these issues will be found in the ESOP agreement along with the unanimous shareholder agreement.

Your key employee(s) will benefit from an ESOP by providing them with a direct link to the benefits of being an owner including sharing in the annual profits via growth in the equity of the business as well as in the increase in the share value. 

If set up correctly, the employee will not be taxed until they actually dispose of the shares they receive under the stock option plan. 

There are also other plans that do not involve direct ownership but do allow the key employees to effectively benefit from the growth of the business. These are often known as phantom stock option plans.

Share Freeze

Another way to include employees into ownership is to execute a freeze of your dealership. This will be done on a tax-free basis for you as the owner: you lock in the value of your common growth shares into fixed value preferred shares that no longer grow in value. 

From there, you can then issue new common growth shares for $1 per share in any percentage you want to you as the principal dealer as well as to one or two (or more) of your key employees. At this stage, the new common shareholders (including the employees) are only participating in the future growth of the company.

Be aware some of the benefit of share ownership that comes from feeling like an owner by investing into a business may be muted if the employee does not invest a meaningful amount of their own funds for the shares. You, as the owner, must balance this issue knowing many of key employees may not have access to capital to invest. You need to ask yourself if it is more important to retain the employee or more important for them to pay fair value for their shares.

For many, the answer lies somewhere in between. If you’re concerned a key employee may not feel like an owner because they haven’t actually paid for any of their shares, you can always have them invest a smaller percentage into the dealership so they have skin in the game.

Similar to the ESOP, a significant benefit of this option is that the employee now gets immediate ownership and will be able to see the fruits of their labour - not only in the annual profits of the business, but also in the appreciation in the value of their shares. 

One of the keys to ensuring a successful implementation of a freeze is to have a clear dialogue with the key employee(s) so they understand what it is they are getting as a result of the freeze. You will also want to make sure you have a robust unanimous shareholder agreement in place prior to the execution of the freeze all new shareholders must agree to prior to being allowed to acquire shares of the dealership. Essentially, you dictate the terms of the agreement all new shareholders are governed by.

Conclusion

There is no one model that works best in all scenarios. It is essential to understand first what you want to achieve but also to understand what will motivate your key employees. Some employees may only be motivated by money and may not make great owners. For other employees, the idea being an owner may drive them to act like one, as they can now directly see the benefit of their efforts in the bottom line of the dealership.

Contact Jeff Henkelman, CPA, CA, at 306.664.8361 or [email protected]