1
00:00:05.800 –> 00:00:07.949
Julia Sexton: Hello, and welcome, everyone.

2
00:00:08.220 –> 00:00:10.239
Julia Sexton: Thanks for joining today.

3
00:00:10.730 –> 00:00:14.850
Julia Sexton: I will let everyone settle in.

4
00:00:15.340 –> 00:00:20.190
Julia Sexton: stall for a minute or two. I know it takes everyone a second to…

5
00:00:20.560 –> 00:00:39.150
Julia Sexton: get their cameras and screens straightened out, but we’re pretty excited to spend some time today talking through one of the hottest topics, or we like to think, and most important, strategic conversations, that advisory firms are having right now, and that’s how to share equity.

6
00:00:40.220 –> 00:00:50.520
Julia Sexton: So, maybe you are tuning in today thinking about how to build better retention strategies, or how to kickstart succession planning for your firm.

7
00:00:50.700 –> 00:01:06.179
Julia Sexton: Maybe you’re thinking about how to reward your future leaders better, or just create some better long-term enterprise value. But, lucky you’re here, because equity sharing plays a major role in helping you accomplish any and all of these goals.

8
00:01:07.830 –> 00:01:20.560
Julia Sexton: My name is Julia Sexton, I am the Director of Strategic Organizational Planning here at SRG, and I will be your host for today’s webinar and conversation all about equity.

9
00:01:21.660 –> 00:01:25.480
Julia Sexton: Supporting today’s topic is my colleague.

10
00:01:25.510 –> 00:01:41.939
Julia Sexton: An industry expert, Nicole Fry. Nicole is SRG’s Director of Team Solutions, and she brings a wealth of knowledge and experience, leading all things to do with operating entities. So, that includes strategy development, the initial setup.

11
00:01:42.090 –> 00:01:46.819
Julia Sexton: Restructuring, formalizing of partnership governance.

12
00:01:46.920 –> 00:01:49.800
Julia Sexton: Merging major operations, you name it.

13
00:01:50.150 –> 00:01:59.740
Julia Sexton: But Nicole and I work closely together, helping teams build equity-sharing plans, and setting up the right foundation to support

14
00:01:59.970 –> 00:02:02.109
Julia Sexton: Teams Equity Sharing Goals.

15
00:02:02.440 –> 00:02:13.849
Julia Sexton: So, our goal today is to make this topic maybe a bit more approachable, practical, and hopefully give you some ideas, and strategies that you can apply to your own business.

16
00:02:14.640 –> 00:02:32.000
Julia Sexton: So, we will try to keep this topic as light as possible. Nicole and I were just joking before we jumped on. There’s a lot of technical material to cover when it comes to equity sharing and entity structuring or building those foundations for equity sharing.

17
00:02:32.040 –> 00:02:48.700
Julia Sexton: So, feel free to send some questions into the Q&A chat throughout the presentation. We’ll do our best to address them either throughout, or maybe we’ll have some time reserved at the end. If you’re not comfortable with

18
00:02:48.780 –> 00:03:00.050
Julia Sexton: Dropping your questions into the chat. Feel free to send any questions in through the survey that we’ll launch at the end of the presentation, and we’ll be happy to get back to you.

19
00:03:00.350 –> 00:03:02.300
Julia Sexton: So we will be…

20
00:03:02.450 –> 00:03:16.140
Julia Sexton: sharing our slide deck, after the presentation as well, so no need to whip out your phones for pictures or screenshots, as good as I know our decks are. Just check your email inbox within 24 hours of today’s session.

21
00:03:20.160 –> 00:03:39.110
Julia Sexton: Before we get into it, we do have some upcoming webinars in June, and July, as you can see. So if you would like the links to register, we will send those in the chat. Those will be available on our website as well, and check social medias, including LinkedIn.

22
00:03:39.270 –> 00:03:56.280
Julia Sexton: But please make sure you register for those. Next month’s is co-hosted by myself, and my colleague Parker, and then in July, we have our president and founder, David, leading a presentation on PE value.

23
00:03:59.330 –> 00:04:11.590
Julia Sexton: Before we get into content today, for those listening that maybe aren’t as familiar with who we are, or maybe you just need a good reminder of all the things that we offer and where our expertise is focused.

24
00:04:11.660 –> 00:04:27.769
Julia Sexton: We have been guiding advisors in the independent space, both broker-dealer affiliated and RIAs of various sizes over the past 14 years. And our team brings together professionals who specialize in everything from valuations and value building.

25
00:04:27.770 –> 00:04:32.390
Julia Sexton: Initiatives, like equity sharing and compensation design.

26
00:04:32.570 –> 00:04:40.100
Julia Sexton: To things like equity planning and entity strategy and planning, as well as maintenance on those topics.

27
00:04:40.570 –> 00:04:47.450
Julia Sexton: And we’ve completed several thousands of valuations and M&A deals, hundreds of succession plans.

28
00:04:49.360 –> 00:04:59.419
Julia Sexton: And we’re here to help you make informed decisions about your own business, because at the end of the day, our goal is pretty simple. We want to help you build a strong and lasting business.

29
00:05:01.300 –> 00:05:04.410
Julia Sexton: So, we just launched a couple of poll questions.

30
00:05:05.030 –> 00:05:07.949
Julia Sexton: As we continue to let people…

31
00:05:08.190 –> 00:05:18.899
Julia Sexton: trickle in here, briefly introducing a little bit of a bit more about myself, and Nicole in terms of, you know, why we are leading today’s conversation.

32
00:05:19.190 –> 00:05:33.669
Julia Sexton: I am leading today’s conversation, frankly, because I sit in the seat across from so many advisors and business leaders who are building for the first time, or maybe unwinding and rebuilding a more effective equity sharing plan.

33
00:05:34.460 –> 00:05:47.360
Julia Sexton: On the SRG team, I focus primarily on organizational planning activities, hence my title. But what that means is it includes things like equity sharing and ownership strategy development.

34
00:05:47.360 –> 00:05:58.640
Julia Sexton: As well as the plan implementation, and a focus on career pathing, compensation design, which are all very closely related to today’s conversation.

35
00:05:59.140 –> 00:06:05.020
Julia Sexton: There are other services and topics that I primarily focus on, but again, less,

36
00:06:05.350 –> 00:06:08.800
Julia Sexton: connected to today’s conversation, so we’ll focus on these ones.

37
00:06:09.430 –> 00:06:29.409
Julia Sexton: And then as I mentioned, Nicole is joining the conversation because she focuses heavily on operational structure and strategy, again, as well as the implementation and ongoing maintenance of entities and governance. So, she’s here to shed some light on the importance of your operational structure as the foundation for equity sharing.

38
00:06:29.750 –> 00:06:32.380
Julia Sexton: Because we can’t talk about one without the other.

39
00:06:35.800 –> 00:06:51.980
Julia Sexton: So today, we’ll start with the foundation, starting with, what is equity? What does it actually mean, and why are firms choosing to share it? Then we’ll talk about the key foundational elements to address before, or maybe while you’re building your equity sharing plan.

40
00:06:52.340 –> 00:06:59.729
Julia Sexton: From there, we’ll talk about strategies, comparing phantom equity and true ownership equity plans.

41
00:07:00.090 –> 00:07:03.690
Julia Sexton: And then Nicole will help us understand…

42
00:07:04.440 –> 00:07:16.809
Julia Sexton: The importance of organizational structure considerations, because again, your entity structure and your governance absolutely matter when implementing any equity sharing plan.

43
00:07:17.120 –> 00:07:22.280
Julia Sexton: And lastly, we’ll wrap up with some implementation tips and best practices.

44
00:07:24.840 –> 00:07:38.689
Julia Sexton: So, as we kick things off, launch in just a couple poll questions to get a better idea from those tuning in today. If you already have an equity sharing plan, if you’re interested in setting one up, for the first time, or maybe a new one.

45
00:07:40.150 –> 00:07:50.689
Julia Sexton: Or maybe you’re just here for the knowledge of it. Also, get a better idea of maybe what your primary motivations and objectives are when thinking about designing an equity sharing plan.

46
00:07:51.230 –> 00:07:53.090
Julia Sexton: So, would love to hear from you all.

47
00:07:53.840 –> 00:08:00.150
Julia Sexton: But I will kick things off as you answer those couple of questions, and we wait for results. And that is with…

48
00:08:00.280 –> 00:08:05.730
Julia Sexton: What is… Equity. What do we mean when we say or use the word equity?

49
00:08:06.100 –> 00:08:13.560
Julia Sexton: Most people often immediately think ownership, but equity sharing can really mean a few different things.

50
00:08:13.950 –> 00:08:23.500
Julia Sexton: At its core, equity is an economic reward. It’s a retention tool, and in some cases, it is actual ownership and sharing of control.

51
00:08:23.810 –> 00:08:36.070
Julia Sexton: But one of the biggest misconceptions that we see is firms assuming they have to immediately give away ownership in order to create incentives, but that’s definitely not true.

52
00:08:36.669 –> 00:08:44.189
Julia Sexton: There are ways to create financial participation without giving up control, and that distinction

53
00:08:44.340 –> 00:08:49.480
Julia Sexton: Becomes really important depending on what your motivations and goals are.

54
00:08:50.260 –> 00:08:55.789
Julia Sexton: For example, if your primary goal is retention and creating performance initiatives.

55
00:08:55.990 –> 00:08:59.009
Julia Sexton: A phantom Equity Plan may be a perfect solution.

56
00:08:59.630 –> 00:09:10.719
Julia Sexton: If your goal, rather, is focused on future ownership, offloading and succession planning, then maybe a true equity ownership plan will make more sense.

57
00:09:10.890 –> 00:09:26.310
Julia Sexton: So, obviously today, I want to help you think through those differences, and again, hopefully walk away with a better understanding of what not only your options are, but what the best options are based on your goals and motivations.

58
00:09:31.460 –> 00:09:42.839
Julia Sexton: So, before you start implementing a plan, you have to ask yourself why and who as it relates to equity sharing, because if these aren’t clear.

59
00:09:42.980 –> 00:09:55.919
Julia Sexton: The plans usually become, or the creation of the plans can become messy, and strategy and structure really do work best when it’s aligned with your actual long-term goals for the firm.

60
00:09:57.710 –> 00:10:04.660
Julia Sexton: So the first step in creating an effective equity sharing plan is determining your why.

61
00:10:04.990 –> 00:10:19.850
Julia Sexton: Once you know why you are doing this, or can answer that question, it becomes a lot easier to identify who should participate, what plan of your options make sense, and then how that plan should ultimately be implemented.

62
00:10:21.120 –> 00:10:27.939
Julia Sexton: We also encourage firms to think about things like employee career tracks and building those out more intentionally.

63
00:10:28.060 –> 00:10:34.719
Julia Sexton: your organizational structure. So again, making sure that that is set up in a way to support your why.

64
00:10:35.120 –> 00:10:46.270
Julia Sexton: Your valuation, having an idea of what you actually are sharing as that valuation relates to or establishes what that equity is, and long-term… your long-term business goals.

65
00:10:46.820 –> 00:10:50.229
Julia Sexton: So because all of these things work together.

66
00:10:50.310 –> 00:11:07.119
Julia Sexton: what we see pretty frequently is firms jumping directly into a plan design before they’ve clarified that bigger picture, or again, considered their why, and the long-term effects of how those align or not. So we really want to make sure that you’re thinking about

67
00:11:07.330 –> 00:11:17.280
Julia Sexton: the mapping, of what your long-term objectives are before we jump right into that plan. So, again, spending time on the foundation really does matter.

68
00:11:22.430 –> 00:11:34.569
Julia Sexton: There are usually 3 primary reasons that firms explore equity sharing, so those motivations, and those are the three on screen here. First, internal succession planning.

69
00:11:34.960 –> 00:11:40.510
Julia Sexton: Also, creating performance incentives. And then retention.

70
00:11:41.030 –> 00:11:47.399
Julia Sexton: For a lot of firms, it’s actually honestly a combination of all three of these, or they play a role collectively.

71
00:11:47.980 –> 00:11:50.219
Julia Sexton: Internal succession planning.

72
00:11:51.080 –> 00:11:57.510
Julia Sexton: Hot topic, because it’s so important to think about and start mapping well in advance.

73
00:11:57.600 –> 00:12:11.429
Julia Sexton: of a founder’s transition, of their ownership for their retirement. So ideally, this happens very intentionally, well in advance. Maybe, like, 10 to 15 years would be ideal to start mapping this out.

74
00:12:11.810 –> 00:12:17.619
Julia Sexton: So, it does come up pretty early on, in, I’ll say, a business’s life cycle, or at least for founders.

75
00:12:18.480 –> 00:12:29.960
Julia Sexton: Performance incentives are another major driver, as firms want employees thinking and acting like owners to build the horsepower behind company growth and the overall success.

76
00:12:32.570 –> 00:12:34.279
Julia Sexton: And then, of course, there’s retention.

77
00:12:34.500 –> 00:12:46.549
Julia Sexton: We jokingly refer to equity sometimes as golden handcuffs, but there is truth to that. Equity sharing can create a powerful long-term incentive for key people to stay invested in the business.

78
00:12:53.190 –> 00:12:58.050
Julia Sexton: I’m sorry, as you can tell, I have a little bit of a tickle in my throat, so I’ll mute myself so you don’t have to hear this.

79
00:13:03.430 –> 00:13:04.969
Julia Sexton: Alright, bought me some time.

80
00:13:05.760 –> 00:13:11.340
Julia Sexton: One of the top reasons that… Arguably, I would say…

81
00:13:11.710 –> 00:13:18.650
Julia Sexton: Most firms should be interested in equity sharing, and understanding the right way to structure and share equity.

82
00:13:18.930 –> 00:13:26.229
Julia Sexton: It’s because of the impact that it has, on enterprise value and value retention. So, your long-term mechanism.

83
00:13:30.040 –> 00:13:30.880
Julia Sexton: Sorry.

84
00:13:30.990 –> 00:13:40.139
Julia Sexton: This is a… Critical consideration and motivation for aligning your equity sharing strategies with your long-term goals.

85
00:13:40.730 –> 00:13:47.029
Julia Sexton: To ensure that you’re building a plan that creates a pathway to achieve your goals, rather than fight them.

86
00:13:47.870 –> 00:13:55.740
Julia Sexton: For example, a lot of businesses historically have shared equity in the form of client relationships, or group of clients.

87
00:13:56.220 –> 00:14:03.249
Julia Sexton: That’s easy to understand, it’s easy to implement, because there really isn’t anything to implement. And it’s easy to track.

88
00:14:03.370 –> 00:14:16.910
Julia Sexton: However, sharing equity in the form of client relationships significantly impacts business value, and honestly, the viability of many long-term exit strategies, probably more than you think.

89
00:14:18.160 –> 00:14:25.030
Julia Sexton: So let me walk you through the example, the financial example that’s on screen here, for the numbers people in the group.

90
00:14:25.850 –> 00:14:32.020
Julia Sexton: On the left side, we are looking at a scenario where equity is shared in client relationships.

91
00:14:32.200 –> 00:14:35.460
Julia Sexton: And on the right side, we’re looking at equity shared in the overall company.

92
00:14:36.230 –> 00:14:40.450
Julia Sexton: In both cases, we’re starting with a million dollars in revenue.

93
00:14:40.880 –> 00:14:44.310
Julia Sexton: And assuming a 3 times value.

94
00:14:45.140 –> 00:14:46.500
Julia Sexton: Over time.

95
00:14:47.160 –> 00:15:01.090
Julia Sexton: Revenue grows, and in the first example, when the employee leaves after 5 years, so on the left here, they take associated clients, or the clients that they have ownership with, and the revenue that comes along with those clients.

96
00:15:01.400 –> 00:15:08.890
Julia Sexton: That means the company permanently loses that revenue when the employee leaves, and therefore permanently losing a portion of the value.

97
00:15:09.650 –> 00:15:21.039
Julia Sexton: The impact of sharing equity in client groups is honestly equivalent of paying advisors production splits. It’s essentially a cost right off the top that directly detracts from your overall company value.

98
00:15:21.650 –> 00:15:31.550
Julia Sexton: This is really a book-building strategy for a siloed business model, not a strategy to support internal succession planning or long-term value building.

99
00:15:33.320 –> 00:15:46.109
Julia Sexton: On the right side, the employee still participates economically, however, through ownership in the company. And here, the clients and the revenue remain centralized within the business.

100
00:15:46.300 –> 00:16:00.889
Julia Sexton: So over time, that difference becomes pretty significant, and results in almost a million dollar difference in company value by the end of 10 years, which is probably a pretty realistic retirement timeline for a lot of the listeners today.

101
00:16:02.480 –> 00:16:15.769
Julia Sexton: This is why it is an important mind shift. A lot of firms, as I mentioned, historically have rewarded advisors by carving out pieces of client relationships, or giving them what they’ve sourced.

102
00:16:16.280 –> 00:16:31.410
Julia Sexton: However, more firms today are trying to build a team-based or ensemble-based business structure, because this is what’s creating that true enterprise value that survives well beyond any one individual advisor.

103
00:16:41.550 –> 00:16:48.830
Julia Sexton: Sorry, the slides were a little glitchy here. Okay, so once you understand your why, whatever your why is.

104
00:16:49.740 –> 00:17:07.479
Julia Sexton: The next question becomes, who should participate? Most commonly, firms are sharing these plans with key employees, the first one on the list here. So think individuals who are driving growth, leadership, efficiencies, or long-term value.

105
00:17:08.069 –> 00:17:16.430
Julia Sexton: However, some firms make plans available to most or all employees, and that can absolutely work.

106
00:17:16.890 –> 00:17:25.090
Julia Sexton: But it’s important to think about the, again, long-term alignment of that plan as it relates to your goals.

107
00:17:25.200 –> 00:17:29.120
Julia Sexton: Especially if the long-term goal is internal succession.

108
00:17:29.620 –> 00:17:31.020
Julia Sexton: This is because…

109
00:17:31.300 –> 00:17:46.269
Julia Sexton: What we’ve seen in situations where equity is shared with most or all is that future owners, or your next gen internally, can become frustrated if equity is being broadly shared with individuals who

110
00:17:46.270 –> 00:17:55.279
Julia Sexton: Don’t necessarily carry ownership-level responsibilities like maybe they do, but get to participate in the economic benefits.

111
00:17:56.440 –> 00:18:02.910
Julia Sexton: This is where defining culture matters a lot, because every firm defines key employee a little bit differently.

112
00:18:03.070 –> 00:18:18.530
Julia Sexton: Some firms focus heavily on revenue producers as key employees, others prioritize operational leaders, or culture builders, or a combination of. So, there are a lot of common pathways, but rarely one right answer.

113
00:18:19.880 –> 00:18:29.039
Julia Sexton: Equity sharing plans can also apply to existing owners, or contractors, or even outside parties in acquisition scenarios.

114
00:18:29.220 –> 00:18:36.840
Julia Sexton: or as a recruiting tool. So there’s definitely uses and motivations outside of just internal succession planning or retention.

115
00:18:41.000 –> 00:18:53.320
Julia Sexton: And the best way to remain intentional and consistent, with your who is to communicate equity opportunities through clearly defined career paths.

116
00:18:54.680 –> 00:19:05.629
Julia Sexton: This is because career paths can help employees understand how they can grow, what expectations exist, and what compensation opportunities may exist over time.

117
00:19:07.230 –> 00:19:15.620
Julia Sexton: This is an example, of a high-level career path across producers, service, operations, and investment roles.

118
00:19:18.400 –> 00:19:32.739
Julia Sexton: There we go. And as you can see here, a lot of firms use phantom equity as a first stage or an early stage incentive, and then introduce real ownership opportunities later in someone’s career progression.

119
00:19:33.770 –> 00:19:49.920
Julia Sexton: This will help you communicate… creating a career track, or an intentional pathway, will help you communicate more directly and confidently with your employees about their long-term career progression and growth opportunities within your firm.

120
00:19:50.970 –> 00:20:04.350
Julia Sexton: Because I promise, even if they haven’t asked yet, they do want to know what success looks like with your firm. How do they advance? What opportunities exist for them long-term? So if career pathing’s done well.

121
00:20:04.370 –> 00:20:14.689
Julia Sexton: Equity conversations and overall equity sharing, from, you know, you being the primary owner or leader of that equity creation.

122
00:20:15.050 –> 00:20:21.630
Julia Sexton: Those conversations will feel more natural and intentional, and part of a much bigger career development conversation.

123
00:20:25.680 –> 00:20:35.079
Julia Sexton: So, now that we’ve covered the foundation, let’s talk about strategy, and what those are, and the actual plan options that you can consider.

124
00:20:37.600 –> 00:20:45.770
Julia Sexton: At a high level, there are two main categories. Phantom Equity Plans and ownership equity plans.

125
00:20:46.700 –> 00:20:59.429
Julia Sexton: Ownership equity means true ownership, and phantom equity at its core is a deferred compensation arrangement that mimics ownership economically without actually transferring ownership rights.

126
00:21:00.140 –> 00:21:05.860
Julia Sexton: So, there are, of course, several important differences to highlight, which we have on screen here.

127
00:21:06.080 –> 00:21:10.430
Julia Sexton: We’ll start with Phantom Equity, and that is…

128
00:21:10.580 –> 00:21:24.600
Julia Sexton: Structured around the fact that participants don’t receive any decision-making power, they don’t have rights to see financials of the company like an owner would, because they aren’t becoming a real legal owner.

129
00:21:25.610 –> 00:21:36.339
Julia Sexton: Ownership equity participants, on the contrary, may receive some or all of the rights, like decision-making power, or the economic benefits, depending on

130
00:21:36.480 –> 00:21:42.990
Julia Sexton: The operational structure you have, and the available ownership classes, maybe, that you have at the operational level.

131
00:21:44.070 –> 00:21:51.570
Julia Sexton: Another important distinction is the participation eligibility, because phantom equity plans

132
00:21:51.670 –> 00:21:58.579
Julia Sexton: We’re often structured as top hat plans, meaning they’re reserved for highly compensated employees only.

133
00:21:58.840 –> 00:22:03.029
Julia Sexton: And this is very intentional to help firms avoid

134
00:22:03.130 –> 00:22:10.589
Julia Sexton: ERISA and certain Department of Labor requirements, including some pretty serious annual compliance costs.

135
00:22:12.710 –> 00:22:20.049
Julia Sexton: Ownership equity plans, provide a much broader flexibility regarding who can participate.

136
00:22:20.820 –> 00:22:36.709
Julia Sexton: We’ll talk a little bit about that as well. Payout structure is different as well. Phantom Equity Awards often require payout within a relatively short time frame after vesting and exercise, whereas ownership equity can be held long-term.

137
00:22:36.930 –> 00:22:38.650
Julia Sexton: establishes basis.

138
00:22:38.820 –> 00:22:45.439
Julia Sexton: And then redeemed with… As most people would, argue, more favorable taxation.

139
00:22:46.070 –> 00:22:50.970
Julia Sexton: I’m just scratching the surface here, though, and we’ll get into more of these considerations shortly.

140
00:22:54.740 –> 00:23:07.350
Julia Sexton: I also thought it might be helpful to show you what firms are actually implementing in practice. And over the last several years, about 64% of the plans we’ve worked on have involved phantom equity.

141
00:23:07.540 –> 00:23:12.330
Julia Sexton: And among those, appreciation rates plans have been the most popular.

142
00:23:12.680 –> 00:23:31.960
Julia Sexton: In case you’re not familiar, we’ll get into what that means, what an appreciation rights plan is. But a big reason for this is due to the flexibility. Phantom equity plans are easy to implement, they’re easy to modify, and require less commitment, at least organizationally or operationally.

143
00:23:32.930 –> 00:23:51.600
Julia Sexton: As I mentioned earlier and illustrated through the career track example, phantom equity plans are also used commonly as a stepping stone or prerequisite to real, we’ll call it, ownership or ownership equity. It allows firms to test that alignment with this individual and create

144
00:23:51.650 –> 00:23:59.579
Julia Sexton: Additional incentives before introducing actual ownership, and bringing in a new, you know, true partner of the firm.

145
00:24:03.680 –> 00:24:10.239
Julia Sexton: So, let’s dive a little deeper into the phantom Equity Plans to start.

146
00:24:11.430 –> 00:24:25.119
Julia Sexton: At a high level, phantom Equity Plans offer, as I just mentioned, a high level of flexibility or discretion, especially when structured properly as a, or as we would argue properly, as a top hat plan.

147
00:24:25.600 –> 00:24:31.259
Julia Sexton: Phantom Equity Plans are restricted, meaning they are subject to vesting.

148
00:24:31.290 –> 00:24:49.410
Julia Sexton: And one of the reasons they’re so popular is because, again, they’re flexible and relatively easy to undo or unwind, either all together or some specific decisions that were once made if circumstances change, and that flexibility can be very valuable.

149
00:24:50.760 –> 00:25:01.819
Julia Sexton: A key decision in deploying a Phantom Equity Plan is whether the award will track with total company value or only the appreciation in company value.

150
00:25:02.030 –> 00:25:07.969
Julia Sexton: And that distinction creates the two primary types of phantom Equity Plans.

151
00:25:10.960 –> 00:25:19.839
Julia Sexton: The first, which I mentioned, a couple slides ago as the most commonly used phantom Equity Plan, is the appreciation rates plan.

152
00:25:20.320 –> 00:25:21.919
Julia Sexton: These are…

153
00:25:22.050 –> 00:25:33.389
Julia Sexton: referred to as either, equity appreciation rates, or EARs, unit appreciation or stock appreciation, if you’re familiar, or if any of those ring a bell. But…

154
00:25:33.540 –> 00:25:40.060
Julia Sexton: How this plan works is it’s only rewarding participants for future growth in company value.

155
00:25:40.760 –> 00:25:53.250
Julia Sexton: The second option, that’s on screen here is the liquidation rights plan. And this plan tracks with the total value of the company, meaning participants are effectively

156
00:25:53.740 –> 00:25:59.819
Julia Sexton: Sharing, or receiving a portion of current value plus the future growth, not just the growth.

157
00:26:00.810 –> 00:26:09.159
Julia Sexton: The practical question here then becomes, are you rewarding someone for what they helped build historically?

158
00:26:09.290 –> 00:26:17.799
Julia Sexton: Or are you rewarding them for helping build future value? And that usually helps guide the recommendation of which plan makes most sense.

159
00:26:20.300 –> 00:26:33.320
Julia Sexton: So let’s walk through a quick example, again, some more numbers here. Under the appreciation rights plan on the left, the participant only benefits, again, from the growth above the initial grant date value.

160
00:26:33.660 –> 00:26:45.979
Julia Sexton: So, if the company grows from $10 per share to $15 per share, the participant will receive that $5 increase times the number of appreciation rates that they were granted.

161
00:26:47.100 –> 00:26:50.089
Julia Sexton: Under the liquidation Rights Plan on the right.

162
00:26:50.500 –> 00:27:06.660
Julia Sexton: the participant participates, again, in the full value. So instead of receiving only the appreciation amount, or that $5 of appreciation per share, they’re receiving the full share value at exercise times the number of liquidation rights that they’ve been granted.

163
00:27:07.720 –> 00:27:19.530
Julia Sexton: The liquidation rights plan, then, can be a powerful tool for rewarding someone who has already significantly contributed to company value, because you’re sharing value on day one.

164
00:27:20.060 –> 00:27:22.610
Julia Sexton: Whereas the Appreciation Rights Plan.

165
00:27:22.940 –> 00:27:34.350
Julia Sexton: are more commonly used, and often better used for incentivizing that future growth. So inviting someone, essentially, into this appreciation rights plan because they’ve

166
00:27:34.350 –> 00:27:43.129
Julia Sexton: Shown what it takes to earn participation, but they’re only receiving that award as value based on future growth.

167
00:27:44.010 –> 00:27:50.060
Julia Sexton: This is why context matters, because the same plan isn’t necessarily appropriate for every employee.

168
00:27:50.230 –> 00:27:59.730
Julia Sexton: But there can be room for both. There are circumstances where it may make sense to have both plans, depending on the targeted participants on your team.

169
00:28:04.140 –> 00:28:18.040
Julia Sexton: When structuring phantom equity plans, we also have to determine how grants are earned, then, and when they vest. So how does someone actually, I’ll say, earn the award, which is cash compensation from them?

170
00:28:18.850 –> 00:28:27.109
Julia Sexton: I strongly recommend tying grants of Anthem Equity to measurable performance criteria whenever possible.

171
00:28:27.360 –> 00:28:40.540
Julia Sexton: So that might include revenue growth goals, net new asset targets, profitability targets, maybe leadership goals, or other operational achievements, if it’s not a producer role.

172
00:28:41.420 –> 00:28:53.910
Julia Sexton: Tenure can absolutely be part of the equation or consideration, but generally shouldn’t be the only factor, so maybe we’re layering tenure on to one of these other performance metrics or targets.

173
00:28:54.920 –> 00:29:04.689
Julia Sexton: Then we move into vesting. The two most common approaches, in terms of the structure of vesting, would either be gradual or cliff vesting.

174
00:29:05.060 –> 00:29:09.770
Julia Sexton: Gradual, meaning it vests, or payments are made over time.

175
00:29:09.890 –> 00:29:17.110
Julia Sexton: Whereas CLIF is payment made at one time, and usually tied to a specific event, such as

176
00:29:17.110 –> 00:29:31.780
Julia Sexton: The participant’s retirement, so they’ve stayed with you and worked for you through their entire career. Maybe sale of the practice, so if you fully liquidate, or some other, maybe, defined service milestone, so number of years.

177
00:29:32.990 –> 00:29:44.150
Julia Sexton: And this is where firms can really start to customize plans around, again, your objectives, because we don’t have a one-size-fits-all here, and depending on

178
00:29:44.150 –> 00:29:58.230
Julia Sexton: what you are putting this plan in place for, or as a benefit to achieve. It may make sense to use these longer-term event-based vesting criteria, or maybe a shorter service milestone.

179
00:30:02.450 –> 00:30:11.819
Julia Sexton: So, now, let’s talk about some of the other equity sharing options, and that being true ownership equity strategies.

180
00:30:13.000 –> 00:30:21.349
Julia Sexton: Once we start talking about actual ownership or partnership, we’re also talking about corporate governance.

181
00:30:21.540 –> 00:30:34.090
Julia Sexton: What decision-making powers you may be sharing, fiduciary responsibilities that these employees will take on or have, and long-term partnership dynamic considerations.

182
00:30:34.830 –> 00:30:41.930
Julia Sexton: This is why candidate selection becomes incredibly important, because you are not just…

183
00:30:42.040 –> 00:30:59.619
Julia Sexton: simply rewarding a high performer. You’re potentially adding a future business partner, which means you are needing to evaluate leadership, culture fit, communication style, decision-making ability, and again, considering that long-term alignment with your business goals.

184
00:31:00.210 –> 00:31:07.560
Julia Sexton: So, something that I… Would want you to consider is a statement that

185
00:31:08.100 –> 00:31:27.080
Julia Sexton: Not every great employee necessarily wants to be an owner, and not every great employee should be an owner. These are very independent or different things, and ownership should absolutely be earned and very intentionally shared, so not just considering this as a form of an award.

186
00:31:30.850 –> 00:31:38.269
Julia Sexton: When we talk about real ownership equity, there are 3 primary ways that you can share ownership equity.

187
00:31:38.380 –> 00:31:45.680
Julia Sexton: Either by granting it, By selling it, or purchasing it, or by swapping it, or through an equity swap.

188
00:31:46.630 –> 00:32:00.329
Julia Sexton: Each of these pathways, or lanes, works very differently depending on, again, what your objectives are, so your why, and potentially even based on the dynamics of what you’ve promised, a

189
00:32:00.470 –> 00:32:03.240
Julia Sexton: Participant, or a buyer.

190
00:32:03.700 –> 00:32:20.519
Julia Sexton: Or could depend on what you’ve awarded in the past, based on what your overall business strategy was, and how that’s evolved. So, it really matters in determining how you are sharing equity, based on potentially what you’ve already committed.

191
00:32:26.080 –> 00:32:38.190
Julia Sexton: We’ll start with the first one on that last slide there, equity grants. Equity grants involve giving ownership, rather than, of course, requiring someone to purchase it as the alternative.

192
00:32:39.490 –> 00:32:47.410
Julia Sexton: Grants may have restrictions, or vesting, but they also may be immediately earned, so unrestricted.

193
00:32:48.340 –> 00:32:52.149
Julia Sexton: Sometimes the equity is retained long-term.

194
00:32:52.710 –> 00:33:03.870
Julia Sexton: And sometimes the company redeems it or requires it to be redeemed upon vesting, and therefore participants really are just receiving a monetary award instead of the…

195
00:33:04.120 –> 00:33:08.170
Julia Sexton: Use, or action of having equity ownership.

196
00:33:09.220 –> 00:33:16.449
Julia Sexton: From a tax perspective, grants are generally treated as compensation, therefore subject to ordinary income and FICA taxes.

197
00:33:16.820 –> 00:33:35.869
Julia Sexton: And in some cases, an 83B election may be available, if you’re familiar, which essentially allows a grantee to accelerate taxation earlier when the value is lower, hypothetically. But this option is very dependent on both your operating entity

198
00:33:36.010 –> 00:33:38.090
Julia Sexton: And,

199
00:33:38.220 –> 00:33:48.600
Julia Sexton: tax election, and the nature of what features I just mentioned above. If you have a non-restricted grant, then they’re not going to be deferring taxes because it’s immediately received.

200
00:33:49.540 –> 00:34:01.570
Julia Sexton: So, in general, a grant plan, is used given these different structures and ways that you can design a grant quote-unquote plan. It’s used for individuals, though, who have

201
00:34:01.830 –> 00:34:08.050
Julia Sexton: Already contributed significantly to building company value, so maybe a little bit closer aligned to that liquidation.

202
00:34:08.230 –> 00:34:10.800
Julia Sexton: Rights Plan on the phantom Equity side.

203
00:34:10.909 –> 00:34:19.950
Julia Sexton: So maybe you’ll hear people, you know, reference equity granting in terms of why someone would be granted equity based on their sweat equity.

204
00:34:23.739 –> 00:34:37.600
Julia Sexton: The granting criteria here is pretty similar to that of the Phantom Equity Plan, or that last slide that we looked at. Again, with the idea that you’re rewarding someone for something, or multiple things.

205
00:34:37.600 –> 00:34:44.880
Julia Sexton: That they’ve done or accomplished to earn the rights of something more valuable than, say, an alternative being a

206
00:34:44.940 –> 00:34:52.450
Julia Sexton: cash bonus. So again, I strongly recommend tying awards to measurable goals

207
00:34:52.659 –> 00:34:59.469
Julia Sexton: And the activities, that would… Demonstrate leadership qualities.

208
00:35:00.690 –> 00:35:19.250
Julia Sexton: One important difference, though, is that you can grant equity that is immediately vested, as I mentioned, meaning it’s awarded, so you are adding a partner now. So if that is not the goal, then a restricted grant with either gradual or cliff vesting would be more appropriate.

209
00:35:24.840 –> 00:35:35.169
Julia Sexton: If they haven’t earned it through sweat equity or some other rationale or reasoning, then you’re selling equity, which is a purchase plan.

210
00:35:36.040 –> 00:35:38.939
Julia Sexton: In these plans, the…

211
00:35:39.060 –> 00:35:50.680
Julia Sexton: Buyer purchases ownership, and the plan can either be built to support a flexible timeline or schedule, or a more structured, predetermined schedule of equity.

212
00:35:51.140 –> 00:36:04.709
Julia Sexton: So think about the amount that’s purchased, the frequency that it is purchased, or future purchases, as well as the terms, all being predetermined, or just determined as you go, or later.

213
00:36:05.590 –> 00:36:09.859
Julia Sexton: One of the reasons that firms that use these plans

214
00:36:10.330 –> 00:36:25.470
Julia Sexton: have chosen to implement them, or have gone this route where it’s being purchased, is because it creates real commitment. The buyer has financial investment, and therefore has made the financial investment, therefore has skin in the game.

215
00:36:25.950 –> 00:36:38.100
Julia Sexton: And from the company’s perspective, this can help founders take some chips off the table over time, so it often aligns nicely with long-term succession planning, naturally.

216
00:36:42.570 –> 00:36:57.489
Julia Sexton: The last lane here, being an equity swap, is slightly different and more narrowly used. This usually occurs when someone contributes a book of business or a list of clients that you’ve given them equity in.

217
00:36:57.490 –> 00:37:04.460
Julia Sexton: In exchange for ownership in the company. So, this would be relevant… relevant,

218
00:37:04.550 –> 00:37:24.389
Julia Sexton: If, like in my previous example, when you’ve maybe shared equity in client groups, and you want to, say, unravel this arrangement or plan, have the employee contribute their equity value from this client group to the company, and they receive equity ownership in the whole company in exchange.

219
00:37:24.690 –> 00:37:30.989
Julia Sexton: The resulting ownership percentage is generally based on the relative value that they’ve contributed.

220
00:37:31.380 –> 00:37:41.720
Julia Sexton: So, for example, if someone contributes a million dollar practice, or group of clients in terms of value, into a $3 million business.

221
00:37:41.950 –> 00:37:46.729
Julia Sexton: They would have a resulting ownership of 25%, hypothetically.

222
00:37:47.570 –> 00:38:04.580
Julia Sexton: these types of transactions can become more technically complex depending on the entity structure, and tax treatment. So it is definitely an area where we would suggest involving industry experts like ourselves and technical professionals like CPAs.

223
00:38:04.580 –> 00:38:17.949
Julia Sexton: As early as possible, because it can be important to consider where you have flexibility, or what the overall strategy should consider, depending on, again, what your current structure allows.

224
00:38:20.960 –> 00:38:38.590
Julia Sexton: So at this point, we’ve covered the different equity strategies themselves, so Nicole, if you would, walk us through what I would say one of the most important and often overlooked components of equity sharing is, which again, is organizational and entity structure.

225
00:38:38.690 –> 00:38:49.360
Julia Sexton: Because, as we both know, even the best designed plans can create some major problems if the entity structure beneath it isn’t built to support it.

226
00:38:50.180 –> 00:39:01.190
Nicole Frey: Absolutely, thank you, Julia. So now that we’ve discussed the different types of equity sharing plans, the next question is, what does equity actually mean at the business level?

227
00:39:01.190 –> 00:39:11.320
Nicole Frey: And I think we can all agree that equity is intended to represent value, but before value can be shared, we need to understand where it actually resides.

228
00:39:11.320 –> 00:39:20.470
Nicole Frey: And in many advisory firms, that means clarifying whether the goodwill, which is your business value, belongs to the individual advisor.

229
00:39:20.540 –> 00:39:27.629
Nicole Frey: Or if that goodwill is something that we can document and record in the operating entity.

230
00:39:27.710 –> 00:39:39.299
Nicole Frey: So, my focus is now on, how to structure the organization so equity sharing is tied to the right value, it is in the right place, and will be shared under the right terms.

231
00:39:41.460 –> 00:39:43.940
Nicole Frey: So when we look at the…

232
00:39:44.460 –> 00:39:53.690
Nicole Frey: Organizational structure, we have to understand that all this can be implemented better if there is a formal entity in place.

233
00:39:53.900 –> 00:40:13.810
Nicole Frey: Everyone here in the audience who operates as a sole proprietor, yes, you can share equity, but you expose yourself to more risk. You might not have a formalized structure in place that allow you to, govern that relationship with a new partner. So the entity will help, consolidate all of that.

234
00:40:13.810 –> 00:40:27.970
Nicole Frey: First of all, we want to make sure the entity is the place where the value resides, where the revenue ends up, and also where you hold your operations, because we have to make decisions with our partners with respect to our operations.

235
00:40:28.190 –> 00:40:37.839
Nicole Frey: It is also the place where we can create formal rules with respect to how we want to manage our business going forward with a business partner.

236
00:40:37.920 –> 00:40:55.169
Nicole Frey: The entity will also give you personal liability protection, so if you don’t have that entity in place, and you add a partner, you basically operate as a general partnership, and now you could potentially be liable for the acts committed by a partner.

237
00:40:55.570 –> 00:40:57.570
Nicole Frey: And then, last but not least.

238
00:40:57.620 –> 00:41:12.760
Nicole Frey: Entities are set up into perpetuity. You usually use them to be a contracting part… party on your lease agreement, for your employees, any utilities you might use, technology vendors.

239
00:41:12.760 –> 00:41:25.939
Nicole Frey: So that entity stays in place regardless of who the owners are. So as you transition ownership, maybe as part of your succession plan, you can easily transfer that over to your successors.

240
00:41:25.940 –> 00:41:39.010
Nicole Frey: And usually entities also have the documentation in place that then provide for that transfer. So you will have, provisions that document how value is determined.

241
00:41:39.010 –> 00:41:48.469
Nicole Frey: How we pay for it, what happens if somebody leaves prematurely due to death, disability, so all that is regulated in a formal entity.

242
00:41:49.610 –> 00:42:05.339
Nicole Frey: So, because we talk about equity sharing here, I want to make sure we cover 3 main points. If we could go to the next slide, thank you. These main points, are the enterprise value.

243
00:42:05.400 –> 00:42:12.329
Nicole Frey: We need to make sure that the value actually resides on the level where you share the equity.

244
00:42:12.700 –> 00:42:27.989
Nicole Frey: We also need to talk about governance, so I saw earlier that some of you are concerned about giving up too much control, so I will share some elements with you that help you regulate how much control you are actually giving up, or not.

245
00:42:28.130 –> 00:42:36.210
Nicole Frey: And then, last but not least, we will cover how an entity’s tax status will influence certain equity sharing options.

246
00:42:38.450 –> 00:42:49.120
Nicole Frey: So, first up, let’s talk about the value, because it is not always a given that the entity you might have for your operations has your business value.

247
00:42:49.210 –> 00:43:08.959
Nicole Frey: For those of you here in the audience who operate your own RRA, and you have an RA entity established, we can presume you’re set up in a way that makes equity sharing easy. Usually, that entity holds the contracts with your clients, and therefore is presumed to have the ownership of the goodwill.

248
00:43:08.960 –> 00:43:14.709
Nicole Frey: And revenue flows directly to your entity. So that’s exactly where we want to end up.

249
00:43:14.710 –> 00:43:28.320
Nicole Frey: But for any folks here in the audience who have an affiliation, either with a broker-dealer or an RA, there are some extra steps that we have to take to make sure you actually are ready for equity sharing.

250
00:43:28.670 –> 00:43:48.359
Nicole Frey: And the reason for that is the entity you have doesn’t have relationships with your clients. There are no contracts, they don’t have any interaction with your entity. That resides with you personally. So, you start off as the personal owner of your goodwill or book of business.

251
00:43:48.470 –> 00:43:57.220
Nicole Frey: And in addition, the revenue usually also flows to you directly, so we need to make sure that all of this ends up in the entity.

252
00:43:58.010 –> 00:44:08.719
Nicole Frey: With the goodwill, we can do that easily through legal paperwork, so that is something that we help teams with, to establish that the entity actually owns the goodwill.

253
00:44:09.030 –> 00:44:16.290
Nicole Frey: When it comes to the revenue flow, we would need to make sure there are certain elements in place.

254
00:44:17.690 –> 00:44:35.349
Nicole Frey: So, for revenue flow, if we go to the next slide, you can see that most of you might be set up just the way you see it here on the slide, where you receive your revenue personally as 1099 income, it is reported to your social security number.

255
00:44:36.230 –> 00:44:50.070
Nicole Frey: So what has to happen to get that revenue into an entity, on the practical side, you just take that out of your personal business account, how I call it sometimes, and you put that into your entity’s business account.

256
00:44:50.150 –> 00:45:06.289
Nicole Frey: On the tax side, this might raise some questions. An auditor might say, well, if you’re the owner of that income, you should also be the taxpayer. So what is the reason for you to put this income into the entity and then report it there?

257
00:45:06.670 –> 00:45:23.490
Nicole Frey: And the answer here is that you operate a team, you added another partner, you and your partner generate this income together, and therefore need to have access to that income together in your entity, because that’s where you cover your expenses.

258
00:45:23.490 –> 00:45:31.489
Nicole Frey: You make certain investments… investment decisions, and then the remaining income is distributed as profits to the owners.

259
00:45:32.150 –> 00:45:45.409
Nicole Frey: So we’ll have to put a few elements here in place, so we can help you reduce your audit risk, one of which is that we need to set up a contractual basis for that assignment of the income.

260
00:45:45.510 –> 00:45:54.940
Nicole Frey: We also need to work on the control over that income, so even though you might be concerned about giving up too much control over your business.

261
00:45:54.940 –> 00:46:15.529
Nicole Frey: What I’m talking about is a very narrow control item here, and that is just simply how revenue flows from you personally into the entity. So the assignment itself should be subject to the consent of more than one owner. That way, you can establish that you are not in sole control.

262
00:46:15.850 –> 00:46:30.870
Nicole Frey: And then, last but not least, an element that we also need to consider is a salary. If you do operate an S corporation, you’re actively involved, any auditor would want to see a reasonable W-2 salary paid to the owners.

263
00:46:31.820 –> 00:46:39.290
Nicole Frey: So that is the flow of revenue. We also hear sometimes concerns about, compliance.

264
00:46:39.290 –> 00:46:58.760
Nicole Frey: considerations here by paying, for example, brokerage-type revenue into an entity. There was a recent no-action letter from the SEC last year that did, confirm that advisors can put that type of revenue into an operating entity so you can cover your expenses.

265
00:46:58.760 –> 00:47:13.809
Nicole Frey: There are some few more nuances that we typically help teams with to make sure that this is still utilized properly once that revenue ends up in the entity, but the short answer here is you can get that revenue into the entity as well.

266
00:47:15.950 –> 00:47:23.570
Nicole Frey: The next element, and I saw that earlier in our poll, that we would help you

267
00:47:24.410 –> 00:47:36.819
Nicole Frey: streamline a little bit more for equity-sharing purposes is control. That often is raised as a concern, as you bring on a partner, how much control do you actually give up?

268
00:47:36.820 –> 00:47:45.740
Nicole Frey: And the answer is here that you don’t have to give up any control if you don’t want to. We can do that through different ownership classes.

269
00:47:45.850 –> 00:48:04.409
Nicole Frey: We can also make sure that the entity’s management structure is set up in a way that allows you to manage a lot of that control until you’re ready to give some of that control up. And then, last but not least, by also customizing your voting requirements.

270
00:48:05.000 –> 00:48:09.209
Nicole Frey: So, if we take a closer look at these ownership classes…

271
00:48:10.620 –> 00:48:27.779
Nicole Frey: Here, we often implement 3 different types of ownership classes, from voting to non-voting and to liquidation units. Those are ownership classes that you commonly see implemented in LLCs, Texas partnerships.

272
00:48:27.780 –> 00:48:41.969
Nicole Frey: With S-Corporations, we’re a little bit more restricted, so those liquidation units, unfortunately, are not an option if you do have an S-Corp, but the other two ownership classes are, something that you can implement.

273
00:48:42.880 –> 00:48:50.219
Nicole Frey: The main rights associated with an ownership, is voting rights, profit rights, and liquidation rights.

274
00:48:50.230 –> 00:49:02.030
Nicole Frey: And you, as the founder, can have all three of those rights, and if you’re not ready yet to give up any voting power, you can consider issuing either the non-voting shares.

275
00:49:02.030 –> 00:49:11.939
Nicole Frey: So here, the owner would receive profits and liquidation rights, meaning at the time when they are ready to sell their interest, they get the fair market value for those shares.

276
00:49:12.140 –> 00:49:22.280
Nicole Frey: Or even just the liquidation shares. So here, you don’t give up any profit or voting rights, you are just sharing a parada interest in the value of the company.

277
00:49:23.360 –> 00:49:40.769
Nicole Frey: So that’s one way to regulate control. The other one is through the management structure. So if we go to the next slide, you will see a common management structure, or two common management structures for LLCs.

278
00:49:40.770 –> 00:49:44.959
Nicole Frey: The most common one is the member-managed LLC.

279
00:49:44.960 –> 00:49:59.169
Nicole Frey: So here, we only have one group of decision makers. It is the members with voting rights. So only the members with voting rights get a seat at the table, and then vote based on their voting percentages.

280
00:49:59.510 –> 00:50:13.819
Nicole Frey: And I say voting percentages here, because if you start using non-voting or liquidation units or shares that I mentioned earlier, those holders are still owners, but they do not participate in voting.

281
00:50:13.860 –> 00:50:22.339
Nicole Frey: So, your voting percentage might be higher than your actual ownership percentage, but key here is, this is how you can regulate control.

282
00:50:22.340 –> 00:50:35.209
Nicole Frey: You might start someone off with non-voting units, and then later, when you feel like they’re ready to take on more decision-making power or authorities, you convert them over to voting.

283
00:50:36.550 –> 00:50:46.209
Nicole Frey: If you’re too concerned about that, or you don’t want to have that conversation about voting and non-voting, you could also consider a manager-managed LLC.

284
00:50:46.210 –> 00:50:57.149
Nicole Frey: This is a structure that mimics corporations, where you have members, just like shareholders, elect managers. In corporations, they’re called directors.

285
00:50:57.340 –> 00:51:08.969
Nicole Frey: You could be the only manager making most of the decisions, and there might be some decisions, just a few, that are left for the members to decide, including yourself.

286
00:51:09.070 –> 00:51:16.329
Nicole Frey: That pertain to either the life of your entity or the rights and responsibilities of the members.

287
00:51:16.520 –> 00:51:30.650
Nicole Frey: So that’s one of those structures that might work well for certain founders if they’re worried about control, but typically we see this type of management structure more for larger companies with a lot of partners where you have to worry about efficiencies.

288
00:51:32.010 –> 00:51:33.460
Nicole Frey: So, and then the last…

289
00:51:33.850 –> 00:51:35.330
Julia Sexton: Level.

290
00:51:35.330 –> 00:51:36.000
Nicole Frey: No, of course it’s.

291
00:51:36.000 –> 00:51:42.230
Julia Sexton: If you don’t mind, on the non-voting shares specifically, under S-Corps.

292
00:51:42.430 –> 00:51:49.079
Julia Sexton: Is there any ability, the question is, to restrict profits on non-voting shares?

293
00:51:49.610 –> 00:52:04.219
Nicole Frey: The answer, short answer is no. For S-corporations, the liquidation and distribution rights of the owners have to be based on ownership, so you cannot create a different share class for distribution and liquidation.

294
00:52:04.490 –> 00:52:18.699
Nicole Frey: If you would like to utilize different ownership classes, give us a call. There might be an option to change your entity structure, so we can talk about some sort of reorganization, if that’s one of your priorities.

295
00:52:21.890 –> 00:52:37.310
Nicole Frey: Alright, so, just quickly, one more feature on, the control concern. If you have a regular entity set up just with voting rights, you want to keep it simple, it’s member-managed.

296
00:52:37.450 –> 00:52:45.979
Nicole Frey: You can also still structure your voting requirements, especially in limited liability companies and LLCs.

297
00:52:46.110 –> 00:52:57.759
Nicole Frey: Corporations are more of a creature of statute, so here you have to adhere to statutory requirements, and some of them do have voting requirements, so you have to follow those.

298
00:52:57.940 –> 00:53:14.869
Nicole Frey: With LLCs, typically, you can customize them. So the statutory requirements are only applicable in certain instances if there is no other agreement, like an operating agreement in place, where you can customize those voting requirements.

299
00:53:15.340 –> 00:53:26.840
Nicole Frey: So for anyone here who’s concerned about control, you can make sure that most of your decisions are subject to a simple majority vote, meaning anything greater than 50%.

300
00:53:26.840 –> 00:53:35.899
Nicole Frey: Because, most likely, you want to hang on to that majority interest for some time until you’re ready to truly transition that business over to a successor.

301
00:53:36.050 –> 00:53:54.920
Nicole Frey: But there might be instances at which point you want to bring on some of your next-generation owners, you want to get their consent, otherwise they might be discouraged to be an owner, because you can outvote them and significantly influence their rights and responsibilities.

302
00:53:54.920 –> 00:54:08.190
Nicole Frey: So here you might want to consider utilizing a supermajority consent, something like 75% or greater. That percentage can be customized. Some teams use two-thirds or 80%.

303
00:54:08.370 –> 00:54:19.270
Nicole Frey: So that might be an option. Unanimous consent is also up here on this slide. I don’t recommend that a whole lot, because you give a 1% owner a whole lot of control.

304
00:54:20.310 –> 00:54:35.090
Nicole Frey: So how that looks like on a practical level, on the next slide, you can see an excerpt from our voting worksheet. So we spend quite a bit of time with clients to really customize those voting requirements.

305
00:54:35.190 –> 00:54:40.139
Nicole Frey: They get to see a list of potential business decisions they might be making.

306
00:54:40.240 –> 00:54:55.640
Nicole Frey: And then they can decide who’s my decision maker. Does that go to the members, or if I’m manager-managed, is that a manager decision? And then you can choose, who… what voting requirement you want to tie to that.

307
00:54:55.640 –> 00:55:02.600
Nicole Frey: Whether that’s a simple majority, supermajority, or sometimes for the managers, it might be unanimous consent.

308
00:55:05.320 –> 00:55:17.280
Nicole Frey: The last item we need to look at here, and we just had this great question from the audience, is how the tax status influences your equity sharing plans.

309
00:55:17.560 –> 00:55:23.499
Nicole Frey: And I just want to cover a couple basics before we dive into the partnership and the S-Corp here.

310
00:55:23.790 –> 00:55:37.670
Nicole Frey: When you set up an entity, you have to first decide what your basic legal form is. So that’s how the entity is registered on the state level, and it dictates which state laws apply to that entity.

311
00:55:37.880 –> 00:55:54.309
Nicole Frey: The corporation is a creature of statute. I don’t recommend it a whole lot. It’s really just something people implement if their CPA says there are some benefits to that, but it doesn’t let you customize a whole lot, so usually advisors start off with an LLC,

312
00:55:55.220 –> 00:56:11.309
Nicole Frey: These entity types come with their default tax status. On the corporation side, it’s the C-Corp status, so double taxation would apply here. And on the LLC, it would be the partnership tax status.

313
00:56:11.510 –> 00:56:26.200
Nicole Frey: you can deviate from that default tax status by making a special election. So this is where that S-Corp election comes in. The S-Corp is not its own entity type, it simply refers to an entity’s tax status.

314
00:56:27.220 –> 00:56:46.910
Nicole Frey: The reason why a lot of people are interested in that S-election is because it gives you a tax benefit on any profits an owner receives. Those profits are not subject to FICA taxes, so you only pay FICA taxes on a W-2 salary that, as an active owner, you should receive.

315
00:56:46.990 –> 00:56:51.629
Nicole Frey: And that any profits you take out are not subject to FICA taxes.

316
00:56:52.470 –> 00:57:02.290
Nicole Frey: Usually those savings, though, are limited to Medicare taxes, because your W-2 salary might be high enough to cap out the Social Security taxes.

317
00:57:03.240 –> 00:57:14.149
Nicole Frey: So that’s the foundation. There are those tax savings that you can have with the S-Corp, but the flip side is that you also sign up for a whole lot of restrictions.

318
00:57:14.150 –> 00:57:27.129
Nicole Frey: One of which is that question I just answered. You can only have voting or non-voting units or shares, but you cannot create any other share class that restricts someone’s liquidation or distribution rights.

319
00:57:27.970 –> 00:57:44.229
Nicole Frey: The S-Corp owners typically get a W-2 salary, bonuses are paid as W-2 income, profits are K1 income. Those profits have to align with ownership percentages, so again, no flexibility here.

320
00:57:44.800 –> 00:57:55.770
Nicole Frey: with the partnership, all income paid is K1 income, but you can structure it so it somewhat mimics the S-Corp compensation structure.

321
00:57:55.770 –> 00:58:10.900
Nicole Frey: Guaranteed payments, for example, are fixed compensation, so this is similar to a salary. Special profit allocations can be similar to bonuses, and then you have your regular profit distributions.

322
00:58:11.050 –> 00:58:21.189
Nicole Frey: And those distributions do not have to align with ownership percentages. So more flexibility here, but no tax savings on the FICA side.

323
00:58:21.510 –> 00:58:29.269
Nicole Frey: When it comes to equity sharing, here is where these tax statuses are important.

324
00:58:29.400 –> 00:58:46.179
Nicole Frey: Julie already mentioned, if there is an equity grant, it is treated as ordinary income. Your entity’s tax status does not really impact that. But where it becomes important is if we are dealing with an equity purchase.

325
00:58:46.380 –> 00:58:55.889
Nicole Frey: So, if you’re thinking about successors buying an equity stake in your business, the S-Corporation would provide basis

326
00:58:56.350 –> 00:59:03.590
Nicole Frey: In the equity that they purchased, and the only write-off your buyer will receive is the interest that they’re paying.

327
00:59:04.430 –> 00:59:18.570
Nicole Frey: In the partnership, you can structure the deal so that it is basically treated just like an asset sale. You might be familiar with buying a book of business, and you can amortize that purchase over 15 years.

328
00:59:18.820 –> 00:59:33.809
Nicole Frey: So with a partnership purchase, you have that same option if a special election is made. That’s called a 754 election. So here, your buyer can amortize the purchase price and also write off that interest that they are paying.

329
00:59:35.310 –> 00:59:54.380
Nicole Frey: For equity swaps, the S-Corp is also not ideal, because the IRS typically considers this a sale of a book of business. So if you have an advisor who joins you and contributes a book to your S-Corp in exchange for ownership.

330
00:59:54.770 –> 01:00:01.519
Nicole Frey: That advisor most likely will have to pay taxes on the value they received in the form of stock.

331
01:00:01.620 –> 01:00:08.129
Nicole Frey: So they don’t have the cash available to meet that tax liability, which is typically an issue.

332
01:00:08.130 –> 01:00:21.749
Nicole Frey: So here now we have to look into tax-free statutory mergers as one option, and as you can tell, this gets a little bit more complex and probably also costly and time-consuming.

333
01:00:21.750 –> 01:00:29.890
Nicole Frey: So the partnership is the easier vehicle here. Individuals can simply contribute that book in exchange for ownership.

334
01:00:29.890 –> 01:00:45.860
Nicole Frey: It is called a 721 contribution. It is not taxable at that time, as long as your stock is received. If there is a cash portion, we have to be a little bit more careful, but typically, this can be done tax-free at that time.

335
01:00:46.610 –> 01:00:59.890
Nicole Frey: So, tax statuses are definitely important, probably a dense topic, and we can talk a lot more about this, and there might be some more questions, so feel free to just send a message to us if that pertains to you.

336
01:00:59.890 –> 01:01:06.930
Nicole Frey: But I’m going to hand it back to Julia at this point, who will walk you through the implementation of these equity sharing plans.

337
01:01:10.610 –> 01:01:15.670
Julia Sexton: Perfect. Thanks, Nicole, and I know that we are just at about time, so I will…

338
01:01:15.860 –> 01:01:24.109
Julia Sexton: try to make this quick, but again, you’ll have the slides here to refer back to some of these, but I will wrap up with some of the

339
01:01:24.400 –> 01:01:31.520
Julia Sexton: Key implementation and best practices that we’d encourage you to think about and take away from today’s conversation with.

340
01:01:31.930 –> 01:01:35.389
Julia Sexton: And my first piece of advice is

341
01:01:35.390 –> 01:01:58.349
Julia Sexton: to start before you need to. I know this seems like a common statement, and you’ve probably heard it before, but I’m sure you’ve also heard some of your peers say, because we’ve definitely heard clients say, I wish I had done this sooner. Start writing things down even a couple years before you think you might be needing them.

342
01:01:58.490 –> 01:02:11.349
Julia Sexton: So start by writing down your goals now, so you can kind of map out a timeline or a plan of when you might need some of these tools as it relates to equity sharing, or if you’re gonna start sharing equity, that you might need to start.

343
01:02:11.500 –> 01:02:20.329
Julia Sexton: Dusting off your operating agreement, and really considering how you’re structurally organized, and if that supports, those goals.

344
01:02:21.650 –> 01:02:31.320
Julia Sexton: So, having your long-term goals mapped out will help you create a more intentional equity-sharing strategy, and again, a plan that actually helps grow with your business.

345
01:02:31.350 –> 01:02:43.629
Julia Sexton: This also means then reviewing the foundational tools, like I just mentioned. Operating agreement, bylaws, any other corporate governance documents to help ensure that your foundation is built

346
01:02:43.630 –> 01:02:51.680
Julia Sexton: to support those goals, and if your priorities have changed. You know, when you filed your entity 10 or 15 years ago.

347
01:02:51.680 –> 01:03:04.049
Julia Sexton: Now, if you’re trying to expand into a multi-owner team, your documents may have been fined at that time based on those goals, but as you are growing and your business has grown.

348
01:03:04.050 –> 01:03:18.619
Julia Sexton: You know, for the success of your long-term equity sharing strategy, and overall equity value, we have to make sure that, you know, you’re reviewing your documents, that’ll ultimately end up govern

349
01:03:18.870 –> 01:03:22.549
Julia Sexton: End up governing these decisions that you’re making and implementing.

350
01:03:23.470 –> 01:03:28.499
Julia Sexton: That’s also why it’s critical to seek objective and professional advice.

351
01:03:28.520 –> 01:03:46.310
Julia Sexton: find someone like us, who can help cut through all of the noise and all of the options out there. We’re experts in the space who have helped teams by listening to their goals and objectives, definitely help them even prioritize their goals and objectives, and then, you know, help

352
01:03:46.490 –> 01:04:01.460
Julia Sexton: You understand your options and these different pathways and how to get to and achieve these goals, and then the actual implementation of the strategies, and the execution of these initiatives, so that you know that you have

353
01:04:01.470 –> 01:04:20.479
Julia Sexton: the formality behind these rather monumental business decisions. You know, we play an important role in making sure that you are thinking through all of the practical decisions and solutions to these potential long-term hurdles that might otherwise

354
01:04:20.480 –> 01:04:24.550
Julia Sexton: Not be addressed in standard attorney-led contracts.

355
01:04:25.630 –> 01:04:38.680
Julia Sexton: When it comes to valuation, it’s certainly important to understand your value as a starting point for any equity sharing plan. It may even be a requirement to have a formal valuation done to support your equity sharing strategy.

356
01:04:38.680 –> 01:04:51.599
Julia Sexton: But it’s certainly recommended to keep this up to date at least every couple of years, so that you can communicate these changes in value with your current stakeholders, or with your phantom Equity participants.

357
01:04:51.800 –> 01:04:56.340
Julia Sexton: This will help you really strengthen the outcome of these equity sharing plans.

358
01:04:56.860 –> 01:05:08.699
Julia Sexton: So while we, again, generally provide the recommendation to have a formal evaluation analysis done, at least when you’re granting or executing, or exercising.

359
01:05:08.720 –> 01:05:25.460
Julia Sexton: Some of these awards, doesn’t need to mean that you need to delay the strategization of creating an equity sharing plan. It may be an important step that we fold in, but starting to think through these things early.

360
01:05:26.400 –> 01:05:38.909
Julia Sexton: And lastly, we’ve talked about the importance of having documented entity and governance documents, and it’s just as important to have your equity sharing strategy written down in formal plan documents.

361
01:05:39.060 –> 01:05:49.320
Julia Sexton: Complexity can become the enemy of execution, and again, we help business leaders filter through all of these options that we talked about today and more.

362
01:05:50.310 –> 01:05:53.950
Julia Sexton: We highly suggest…

363
01:05:54.390 –> 01:06:09.399
Julia Sexton: Developing a plan to then support, you know, find experts, find trusted people in this space to help with the execution of the plans, because there’s protections that are important to address

364
01:06:09.570 –> 01:06:16.890
Julia Sexton: Before they happen, and there are certainly, you know, changes that will happen over time that…

365
01:06:17.230 –> 01:06:23.820
Julia Sexton: We want to make sure that you are thinking about, so that we can have plans built in such a way that they can evolve.

366
01:06:25.130 –> 01:06:39.870
Julia Sexton: We have just launched a poll here, just looking for some feedback, and then again, if you have any questions that you didn’t get to popping into the chat box today, please feel free to do so.

367
01:06:40.350 –> 01:06:45.759
Julia Sexton: Our team will be… In touch, with…

368
01:06:46.210 –> 01:07:02.880
Julia Sexton: the slides from today’s presentation, so if there’s anything that, you know, you wanted to refer back to, or again, have any questions, feel free to reach out to any one of our team members up on screen here. But we thank you for your time today, and we hope to hear from you.