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The Employee Ownership Path: An Alternative Route for Technology Startups
By Martin Staubus, Beyster Institute Staff
The standard path for a technology startup is well-known: find a venture capital firm, accept its money, give up most of the stock (and all control), and, maybe (though the odds are against it), wind up with riches when your company is sold in a few short years. If it works, of course, an entrepreneur can get a big pay day.
Attaining wealth is naturally a goal that many of us share. Still, for many technology entrepreneurs, there are other goals that matter, too. Most of us sense that it takes more than money to create a truly meaningful and satisfying life. For some, it may involve a continuing role in building and running an organization that generates a significant record of technological achievement. And that’s where the standard venture capital-backed path can be found especially wanting. Is there another path to startup success that can provide these broader returns?
The Employee Ownership Alternative
There is an alternative path – one most notably taken by Bob Beyster at SAIC and since emulated by many others. It has come to be known as the “employee ownership alternative.” It is grounded on the notion that those who contribute the resources that are essential to the firm’s growth should be the owners of the venture, in proportion to the value of their contributions. Certainly an organization needs financial capital, and those who supply it justly have a claim to ownership. But to grow and thrive, a technology startup also requires ideas, insights, expertise, customers, and products; and individuals who contribute those resources have likewise earned an ownership interest. With the employee ownership approach, overall ownership of the company is commensurate with the value-adding contributions that people have made to the venture.
The employee ownership alternative, then, begins with the notion of “fairness” to those who are making essential contributions to the venture. But make no mistake: the benefits of this approach include much more than simply a sense of moral propriety. As it turns out, distributing ownership in this manner produces major competitive advantages.
Employee Ownership and Business Success
For any business, the basic formula for success is the same: hire smart people, encourage them to perform in a way that delights customers, and reward them for it. The enduring challenge of business, however, lies in how difficult that formula can be to apply. It’s a bit like advising a baseball manager that what he needs to do is hire the best players and see to it that they score lots of runs. Thanks a lot, guru!
So let’s get specific. What’s different about the employee ownership alternative in operation is that, rather than seeing people as “resources” that are needed to supply the organization’s needs, it offers people a different role: that of a partner in enterprise. This in turn produces some powerful business advantages. We’ll discuss just a few.
Recruiting and Retaining Top Talent
One of the great benefits of the employee ownership approach is that it appeals most of all to entrepreneurial, high-achieving individuals. Those who just want a steady paycheck and don’t want too much asked of them will tend to steer clear of this arrangement. In contrast, people who know they have what it takes to deliver results will be drawn to it. It therefore tends to have a “self-screening” aspect – it attracts the kind of productive people that really make a venture go.
Employee ownership also encourages people to stick around. Once someone has become accustomed to the idea that he is a partner who will accumulate a growing ownership interest in the company if he performs and produces results, the idea of working for a conventional organization begins to lack a certain appeal. There is also a compelling appeal to working with colleagues who share a real commitment to building the organization by adding value and producing results. With everyone holding a stake in the success of the venture, focusing on value-adding performance becomes a way of life – a culture – within the organization.
Getting Through the Tough Stretches
The employee ownership approach can provide a critical advantage in coping with a fundamental challenge that confronts every startup: that of highly constrained financial resources. Like a couple entering marriage, business partners sign on for richer and for poorer, for better and for worse. One who sees himself as not merely an employee but as a partner, then, is more likely to endure the inevitable tough times and tough conditions, knowing that he will also be entitled to share in the lucrative times. Moreover, partners understand that a venture can’t pay out benefits (wages, etc.) that it hasn’t earned and doesn’t have, but that the partners will be assured of a share in the gains if the venture can produce those gains. Experience also confirms that owners simply have stronger and more enduring ties to their business than do mere employees. Partners are not only financially but emotionally tied to the fortunes of their firm. When the going gets tough, mere employees are likely to bail. Owners are likely to bear down and fight.
The “We” Company
Virtually every tech startup sooner or later adopts a stock option plan and starts granting options to various people in the organization. So what’s the big deal about the “employee ownership alternative?”
While most tech startups do indeed make use of stock options, the way they use them differs fundamentally from the way equity ownership is distributed at employee ownership companies. For one, the usual startup uses its stock options within the context of conventional “compensation.” That is, they continue to see employees primarily as resources that the company needs in order to achieve its goals. In order to “buy” such resources, they recognize that they must pay a price. While the traditional currency for the acquisition of employees is cash wages, tech startups may add stock options to the compensation mix in an effort to win the bidding for the services of talented individuals.
At the standard startup, the negotiation of these stock option deals is done on an individual basis. Stock options are often limited to “key” individuals, and those individuals negotiate deals that help them personally. This process, though quite civil, is at the same time adversarial – a kind of zero-sum, win-lose situation between the individual and the “company” (or primary shareholder).
By contrast, a characteristic of effective employee ownership companies is that the sense of adversarial relationship between an individual and his employer virtually disappears. Employee-owners share a common status as partners in the business, with shared obligations – to themselves and to each other – to perform at a high level. This generates a culture of personal responsibility, of candor and of trust that is known as the “we” company. It’s a label that comes from the language of employee-owners, who speak of their company in terms of how “we” are doing. Even more significant, pronoun-wise, is the absence of “they” in their speech – as in, “those senior management dummies; have you heard what they want us to do now?”
An Enduring Organization with a Lasting Purpose
When ownership is not limited to the financiers, then decisions are not controlled by the financiers – including the decision to sell the company. As a result, it becomes possible to sustain the independence of the venture for an extended period. This is in contrast to the fate of the startup that is controlled by a venture capital firm, which generally requires a sale of business (either to an acquiring firm or to investors via an IPO) in order to reap its return. If you are truly passionate about your work, do you really want to take a path that will lead almost surely to the closing out of your role in the firm? This is not to say that venture capital and employee ownership are mutually exclusive. In some circumstances, creating a “temporary company” may be the right way to go. Such companies can still operate as employee ownership ventures, with a shared understanding that all who have contributed resources to the venture (and thus become shareholders) will get a share of the proceeds at the end of the process.
How Do You Make It Happen?
Technology startups come in many forms and flavors. Certainly no single approach works for all. Just above, for example, we raised the idea of the “temporary company” – a notion that is certainly compatible with conventional venture funding. Entrepreneurs who may hope to build something more enduring, however, will need to find a way to limit their reliance on venture capital. For some industries, bootstrapping is a viable path. Another possibility may be to seek out angel investors who may be willing to offer more patient and flexible terms than the usual venture capital firm. Finally, not all venture capital firms are the same. Some may be willing to negotiate on ultimate goals and liquidity strategies and potentially provide funding without requiring a commitment to sell the firm. It’s not easy – but then no one promised it would be.
©2007 The Beyster Institute and its authors and their entities. All rights reserved.
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