An expert put it well perhaps three decades ago: “Every business sells just one thing: people. And every business succeeds or fails predicated on just one thing: people. It does not matter how good your product or how good your idea if your people are not good enough to make it work. In that sense, every company’s most important inventory item is its employees.”
Keeping a good employee is a difficult task. Most employees know if they are good and know that skill is a valuable commodity in any market place. Loyalty to an employer or even an industry is no longer a fact of life in most employment markets and many employers find themselves in a dilemma: the better the employee and the more one trains them to be excellent, the greater the chance that they will leave for a competitor who will pay them more and utilize the training it took your company years to complete.
The alternative…a bidding war by which you and your competitor increase salaries to keep valuable employees…can be economically impossible for the company who faces the unpleasant prospect of seeing its best people soon join competitors…or having to pay most of the profits to the employees to keep them.
In California a non compete clauses in an employment agreement is usually illegal except in unique circumstances discussed below. See The Employment Non Compete Clause in California. As such, more subtle methods are required to maintain employees without having to pay them massive sums or seek to rely on contractual prohibitions.
Such methods are euphemistically called “Golden Chains” in that they are benefits (thus “gold”) but they tend to keep the employee “chained” to a particular job. They do exist and they can work.
Those methods are the topic of this Article.
The Problem: Keeping the Employee Without Losing Your Shirt.
The obvious solution to keeping employees-paying them more money than others in the market-will often work but has the draw back that one is soon in a bidding war with competitors and at some point the cost benefit does not justify the increasing cost of the employee.
Further, most studies indicate that most employees are NOT primarily interested in a mere pay check. Studies demonstrate that employees care far more about working conditions, status within the company, employee-employer compatibility and, above all, a feeling that one controls one’s own working life.
That latter wish of employees is almost universal and was initially a shock when the studies indicated the high degree of preference for that particular benefit of employment. Actually, that desire mirrors what most psychologists, both in and out of the work place, advise is the results of their own studies: that most people’s greatest goal is to be in control of one’s own destiny and the cause of the highest stress both in life and in the work place (after death of a spouse) is a feeling that one’s life is out of control or controlled by others who may not have one’s own interest at heart.
In short, throwing money at an employee, which is what most companies do, is seldom enough minus truly significant sums far in excess of what competitors can offer. Instead, what works is a combination of desirable working conditions and that necessarily includes fringe benefits that are not easily quantified by monetary terms. Money is vital. It is seldom enough.
The 1990’s saw a flurry of such fringe benefits available to the young work force, with cash rich and product poor companies building gyms, offering free dinners and sleeping quarters, home offices and the like…and, above all, options to purchase stock…but expecting the employees to work sixty or more hours a week. That program lasted with increasing employee dissatisfaction for about five years as the glamour of the fringes faded before the massive hours and energy actually demanded by the companies. As one employee put it, they were building “sweat shops with chrome.” When the options became useless due to the changes in the economy the entire structure collapsed.
The facade of that structure was the image that the employee was an “owner” due to the options and could work at home or enjoy a homelike atmosphere at work, thus was in control of his or her own life. In reality, the ownership was ultimately worth little, the hours worked made the home office a burden more than a benefit, and the efficiency of such organizations dropped drastically as the years passed.
But what is vital to note from the point of view of this article is that the model itself did attract the best and the brightest for many years. The combination of image of ownership and a company providing alternative means to work resulted in relatively lower turnover until the companies, themselves, self destructed for reasons not relevant to this article.
But what are the lessons here?
1. It was not just salaries that brought and held the people but a piece of the action.
2. Smart people want to feel that their needs are taken into account by the company.
3. Working conditions can make up for long hours but not forever.
4. But all that will not supplant good, solid business planning of cost benefit.
Ownership as the Solution?
Some companies concluded that granting of stock options or, indeed, outright ownership would create the type of loyalty needed without having to distribute cash to the employees. This was particularly true of start up publicly traded companies which enjoyed massive appreciation of the stock.
The problem faced was that the cost was real in terms of value transferred from the corporation to its employees (ownership) but was not accounted for as an expense (explaining why the stocks collapsed so quickly since the companies were thus overvalued…and this benefit became an illusion to the anger and disappointment of the employees.) That incentive vanished overnight when the company decreased in value and is seldom entirely trusted as worthy of high value by sophisticated employees today.
For a privately traded company the problems can be even more severe. Ownership is power. While it is true that in California the person owning fifty one percent of the stock has effective control of the corporation in most instances, certain fiduciary obligations flow to minority stock holders which can restrict the freedom of the company to act. See our articles on Fiduciary Duty; Corporations, Who Has Power When Push Comes to Shove?; and Corporate Opportunity Doctrine. Further, in a small company even a small amount of stock can be the tie breaker vote and employees may find themselves with far more power than the employer wishes.
But there are tremendous advantages to use such ownership to gain loyalty IF the correct structure is created and carefully implement.
First, non compete clauses ARE enforceable in California if and only if the employee sells all of his or her interest upon leaving the company and the non compete is part of the stock sale agreement and reasonable in scope.
Second, the employee does have a stake in the company and may have incentive far greater than the more narrow view of bonuses or salary raises.
Third, the status of owning stock means a great deal to many employees. To be an owner, no matter how small, can radically alter their view of their role within the company.
Fourth, unlike salaries and bonuses, the value of this benefit only increases if the wealth of the overall company increases. The employee’s ownership may go up faster than the offered salary of a competitor yet only go up in conformity with the ability of the company to pay since the value goes up as the company’s value goes up.
Fifth, it is a benefit whose value may be tax deferred for the employee. Appreciation of ownership value will only be taxable once the stock is sold.
Sixth, it allows creation of a Stock Repurchase Agreement (as part of the ownership package) by which the employee can be made to agree to ancillary terms of value to the company
Seventh, many of the employment laws are relaxed when the employee is also an owner.
Eighth, it allows the original owners to perhaps create a vehicle for having themselves bought out for a fair price in the future. See our article on Wills and Trusts and Corporate Buy Sell Agreement.
But few owners wish to share ownership with employees. It is their business, their family business quite often, and they do not want to have to worry about the various duties, power dynamics, and egos that ownership granted to an employee can entail. And, as one owner put it, “I have put everything into this business for twenty years and it is taking off…twenty years of sacrifice. Now, when I at last get it going…I should give it away to someone who was in grade school when I was going without lunches?”
What many owners do not understand is that it is possible to overcome many of these potential draw backs in granting ownership:
1. The danger of control can be eliminated by issuing non voting stock.
2. The cost of the buy back can be adjusted based on the circumstances of how the employee leaves the employer, (e.g. can be a long term buy out with only ten percent or so down and five or ten years to pay the rest and with a valuation formula predicated on how long the employee remains in employ, if reasonable.) Further, this type of buy out is an incentive for the employee not to violate the non compete since the owner can stop payments if the employee violates the non compete.
3. The employee can be forced to sell the stock when leaving along the above lines, thus ensuring that only working employees are owners of stock.
4. The fiduciary duties are neither particularly onerous nor unreasonable.
5. And the value of what is given is dependent on the value of the company itself and will only appreciate if the company appreciates.
Again, the key is appropriate structural planning and requirement of certain agreements being in place concurrent with the bonusing or sale of stock.
Above all, a major benefit is a fully enforceable non compete which can restrict the employee from immediately going to another company upon termination of employment. The value of the stock must be more than token and the non-compete must be reasonable in scope and time: but the very fact that it exists radically increases the cost to the employee of leaving and is significant incentive to remain.
“Shadow Stock” and Its Uses.
There is no shadow and there is no stock, but the phrase refers to a compensation program that rewards an employee as if he or she owned stock. It is normally memorialized in a written employment agreement and provides that if the company is sold there will be a bonus to the employee as if he or she owned X shares and if there is a dividend or some other owner distribution, the employee will receive a bonus at that time as well.
The argument is made that it gives the employee the economic benefits of ownership without the control issues that issuance of stock would entail and that is certainly true. It can make an employee feel an “ownership” type interest in the future of the company based on pure economics but there are significant downsides:
1. There is no legal way to make that into a valid non compete exception. Since there would be no sale of stock the non compete clause would remain illegal in California.
2. Taxation of the income to the Employee would remain regular income, not capital gains.
3. Assuming the company is not sold or dividends declared, there is no payment to the employee. Since it is unlikely to have sale of the company and most private companies use compensation to reward owners rather than dividends, the practical benefits of this shadow stock are remote.
4. And the sophisticated employee will soon realize that many of the “perks” that an owner gets such as paid meals and lodging for business trips, auto allowances, club memberships, etc. (which are, after all, a primary benefit of ownership) do not necessarily flow from shadow stock.
Nevertheless, such stock does eliminate the fear of many employees that all their efforts to help the company and increase its value will go unrewarded since the owners will merely sell the company for its increased value with no benefit to the employee. One employee commented that at least he knew he would get something back if the boss’s son sold out the minute the boss died.
However, since nonvoting shares allow non competes and avoid the danger of control issues, there are clear advantages to stock ownership methods rather than shadow stock.
Fringe Benefits as Chains.
It has long been a mantra at the larger companies that it is their generous package of fringe benefits that keep their employees loyal. Such fringes as good vacation and sick pay programs; maternity leaves; medical coverage; dental coverage; company retreats, etc. are often touted as fringes that smaller companies can never match.
Many employees remain in unpleasant jobs for the medical or dental benefits available for them or their families. A close friend of the writer, with a daughter with cystic fibrosis, could never afford insurance that could be life and death for his daughter if he did not work for a very large company which can afford the broad insurance coverage he requires. Other benefits such as sabbaticals, remarkable advanced training, home offices allowed or even created, generous matched pension plans, are all inducements that can be incentives to remain.
The problem with such benefits is that they are expensive, often increasingly unavailable to the small company, and often undervalued by employees. Many companies spend much time and money seeking to convince employees of the economic value of such benefits and these educational programs do seem to have some effect. Nevertheless, a recent study indicated that when given the choice of cash in hand or fringe benefits, almost all employees opted for cash: whether this will alter in today’s world of rising health insurance premiums is another matter.
In smaller companies one finds that such fringes can still exist though they differ. Access to the owner’s vacation home or recreational vehicle, flexible hours, generous contribution for life insurance, etc. can be the small company equivalent to the large company fringe program.
Ultimately, the problem with using fringes to retain company personnel is that they are NOT exclusive to the company and, like salary, can be matched by any competitor and are expensive. Put simply, it is simply another form as compensation and no more “chain-like” than a high salary.
Working Conditions and Employee Loyalty
An elderly but successful business man once commented that the only golden chain he ever needed was the working atmosphere in his plant. “I pay them less and can’t afford to pay them more but they know I care about them and the customers and will break my back to keep this business going.”
The relationship with management does have a direct effect on morale and loyalty of workers and so long as the money is not significantly lower than the competitors, a good atmosphere will keep most employees from jumping ship to another stranger company.
But, as stated at the beginning of the article, what seems to matter most to employees is a feeling that they are valued, that their efforts make a difference, and that if they perform they will be recognized and rewarded.
The latter is a vital part of any compensation package. For an employee to know that if certain criteria are met the employee may receive some bonus may not result in the criteria being met…most employees are not entrepreneurs after all…but will inevitably result in a feeling in the employee that such extra money is certainly within his or her own control: if he or she performs, she can get it and not merely be depending on the discretion of the boss.
Thus many companies that seek to retain such employees create individual incentive plans that accrue over time and which have no top limit. The employee knows that if tremendous effort is put in, there is reward in it and to that extent, salary is dependent on some type of objective performance criteria.
What is important to understand is that bonus incentives do not necessarily lead to increased performance. People are neither logical not necessarily driven to perform. The thrust of the method is not merely to have that level reached but to give the employee the feeling that the employee can control his or her own paycheck.
Equally vital is a method by which employees can create input as to methods and procedures This is a topic for a completely different article since only proper methodology can avoid bitter confrontations within an office, but it should be noted that input is a way not only to get good ideas but to create a feeling of “ownership” within a company that can create long term loyalty.
Indirect Threats: Confidential Information Contracts: Non Solicitation Contracts
As discussed in our article on Non Compete clauses in contracts, while California prohibits restrictions on competition absent purchase of all of the employee’s stock, one can impose strict limits on use of confidential information and can require the employee not to solicit employees while employed. See Soliciting Employees Away From a Business. Practically speaking, such clauses can cause the employee some nervousness when seeking to change jobs since both the employee and the potential employer may worry that there will be allegations that the employee (and the new employer) are wrongfully using confidential information or improperly solicited other employees and thus are subject to later litigation.
This is a definite chilling factor on both the employee and potential employer and if the company has a reputation for strictly enforcing confidentiality agreements, can make the switch to another competing company a dangerous and unlikely event for the employee.
A key is to make sure the employee executes an appropriate written confidentiality agreement (providing for arbitration of the dispute) and that any potential employers and all the employees are aware that these contracts are strictly enforced. One client spent close to a hundred thousand dollars enforcing one such contract yet only collected twenty five thousand dollars from the bankrupt employee. “It was well worth it. It was a message to the world…and, even more, to my other employees. Saved me millions.”
While that position is extreme, these “Golden Chains” are actually not incentive of gold so much as disincentives of steel: but when combined with incentives to stay, can tip the balance in favor of loyalty to the company.
Remember, few employees have the resources to engage in prolonged litigation with an outraged former employer and few new companies will risk that danger. A typical application form used by many companies specifically asked if the prospective employee executed confidentiality agreement. Clearly it is and should be a concern for future employers.
Courts do not like to enforce confidentially agreements too broadly, especially if the result is to make an employee entirely unemployable. Care must be taken to keep the terms reasonable and careful analysis of cost benefit should be made before entering the legal system to enforce such a contract. The point being made here is that the very existence of this agreement may make a difference in determining choices the employee makes before deciding to leave.
If there is no “trade secret” information, then this method is of less value but note that customer lists, vendor lists, business methods, etc, can all be trade secrets if kept confidential by the company and if part of the agreement. Careful advance planning is required to create and maintain credible trade secret categories of information.
It is apparent that the various tools available to maximize the incentive to lock an employee in must be carefully considered and the right mix created to conform to the requirements of the company, the economics of the situation, and the ethos of the industry. It is far from impossible to maintain long term employment incentives (and disincentives to leave) but the underlying element is a willingness to plan the matter long in advance and to create and implement an entire strategic plan to achieve that end.
It will not always work; what it can do is maximize the odds of the employee remaining.
What will not work is a scramble after the fact to try to reclaim a departing employee or impose restrictions without prior careful structuring. This is one of those areas of business planning in which advance consideration is essential.
And, perhaps, it is important to remember what John Ruskin wrote two hundred years ago;
In order that people may be happy in their work these three things are needed: They must be fit for it; They must not do too much of it: And they must have a sense of success in it.