The Equity Bonus Plan: Attract and Reward Your Talent

By Elma Levy and Dov Levy

Innovators & Entrepreneurs, November 2022

Many start-up companies have certain elements in common: Most are still developing a profitable, working business model, there is little to no hierarchy or management structure, and everyone is in it together. A typical challenge is the ability to retain and/or attract strong leaders due to lack of resources needed to compete in the higher compensated talent markets. So, what we often see is the distribution of equity in lieu of higher salaries, with the promise and expectation, of course, that the reward will come with the end game.

When we built our company, Dovel Technologies Group, Inc., we held on to full ownership for as long as possible, recognizing that the equity increases in value as the company grows, and that there isn’t an unlimited amount of equity to share before we would be so diluted as to find ourselves with a minority stake in our own company, losing the ability to control our destiny.
We, the two co-founders, owned 51/49%, and only when the time came to bring in a CEO to implement a change in growth strategy, did we decide to sell part of our equity. We established the value of our company with a valuation through an independent valuation firm and sold a percentage to the CEO and to a senior executive who was brought in by the CEO. They paid for the equity with promissory notes, which came due for payment at time of transaction, as well as at other possible events as outlined in the stock purchase agreement (SPA).

We came to this decision because we understood that these two executives would have significant decision-making powers due to their roles in the company, and they should be sufficiently rewarded and incentivized as well as made to sharing the risk by having “skin in the game.” The new leadership shared our philosophy about limited equity sharing, however, we needed a way to attract strong leaders, as well as retain and reward the top players on our team.

So, together with our legal counsel, we developed the Equity Bonus Plan (the EBU Plan). The EBU Plan consists of the following principles:

• The value of the plan is defined as “a percentage of the net proceeds of a ‘change of control’ transaction.” This percentage is determined at the time the plan is developed, and it does not change. We set the value at 10% and the triggering change of control (the amount of controlling ownership changing hands) at 70%. The ultimate financial value of the pool is totally dependent on the net value of the transaction.
• The pool existed initially of 100,000 Equity Bonus Units (EBUs). EBUs were awarded on a merit basis to existing team members as reward, or to incoming leaders to attract. There is no assigned value for each EBU until the time after a completed chance of control transaction.
• A benefit of this plan is that the awardee does not pay for receiving the EBUs, so there is no risk to them, however, because they did not pay and establish “basis,” upon pay-out the gain is taxed as regular income (as opposed to true equity, which is taxed as capital gains).
• This is not true equity ownership. The EBU holder is not a shareholder of the company, therefore they do not participate in earnings distributions nor (in an LLC or S-Corp) do they pay pass-through taxes. The EBUs are forfeited and returned to the pool when the employee leaves the company.
• The benefit to the company shareholders is that there is no dilution of equity, while it provides a method to reward/retain/attract talent.

Obviously, since this plan is designed by legal counsel and creates an obligation of the current equity shareholders to the EBU holders, there are multiple documents with lots of legalese language involved in its creation and initial implementation, but once established it is a very simple plan to manage. We decided that all EBU awards must be approved by the Board, and each awardee had the opportunity to sit for a one-on-one session with HR so they would fully understand the plan.

This plan, and the obligation that comes with it, does not create an impediment to attracting a buyer or major PE investor as it is the seller who has agreed to share 10% of their net earnings of the sale of their holding with the team via this EBU plan. The final calculation of the value of the pool, and the value of each EBU, occurs after the transaction has been completed.

At the time of our “change of control” transaction to a Private Equity firm in May 2019, in which the Dovel shareholders (at this time there were additional investors, but we, the two co-founders, still held majority) sold the controlling share of their holdings, there were a few dozen participants in the pool, with varying levels of EBU holdings. The pool value was significant enough to be impactful. The new owners not only allowed the participants to invest their post-tax earnings, but they also matched these investments to a significant degree. Three years later, the follow-up transaction more than doubled their investments, which was then taxed as Cap Gain. We heard from many plan participants about the life-changing impact the proceeds of this plan had on them and their families, such as finally being able to put a down payment on a house, or the security of fully funded college savings for their children, etc.

Lessons Learned

The intent of the EBU plan was to incentivize, reward and attract top talent for our growing company. Though we are very proud of what was accomplished with this plan, looking back, we believe that the main accomplishment was the reward of our top performers. Despite our in-person information session with each new participant, the benefit of the EBUs to the holders wasn’t always clear to them; the value was unknown until the very end, and many participants were stunned to learn of the payout after the transaction. It worked better as a way to attract senior leaders during the later phases of the organizational lifecycle, since there was a clearer vision of the pathway to the endgame as well as the approximate EBU value as part of the compensation conversation. We recognized that, for this plan to function as an incentive and retention tool, it would have been more helpful to hold regular one-on-one information sessions with each participant.

Regardless, looking back, we are so proud and grateful for the impact we were able to have on the lives of our team members and their families, while still preserving equity and avoiding dilution until the main transaction.

 Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.

Elma Levy and Dov Levy are coauthors of Partners in Work and Life: Finding Success Through a Partner Business (Routledge, 2022).

Elma Levy is an entrepreneur, investor, leadership coach, and public speaker. She is cofounder and principal (with her husband Dov) of The Eldov Group, LLC, a boutique investment and startup advisory in the Washington, D.C. area.

Dov Levy is an entrepreneur, investor, and leading expert in large-scale, mission-critical IT solutions. He cofounded Dovel Technologies and served as its chief technologist until the company's acquisition in 2019, remaining a dynamic leader at the forefront of technological innovations.