Equity Participation

From CEOpedia | Management online

The Equity Participation tell of the ownership of shares in a property or company. Equity participation can involve the acquisition of shares through options or by enabling partial ownership in exchange for financing. The greater the equity participation rate, the higher the percentage of shares owned by stakeholders. A very important fact is that companies may use different types of equity to create an equity participation program, for example, common stock, preferred stock, reserve, options or phantoms stock. A more profitable company will provide stakeholders with bigger gains (J. M. Schell 2019, p. 8-61).

The main points of Equity participation (J. L. Batman 2007, s, 681):

  • equity participation effectively ties the stakeholder's success to that of the company's success
  • equity participation constitutes the ownership in an asset, such as property or company
  • equity participation is essentially used as a form of employee compensation or by companies doing business in emerging economies

How Equity Participation works

Equity participation is used in many companies and investments because of two main reasons. First, equity participation is used by companies operating in emerging economies in which local governments want to benefit the rewards brought on by development. The second reason for equity participation is it may be used to tie the financial rewards of executives to the fate of the company, climbing the likelihood that executives will make decisions that will pick up company profitability (E. Talmor, F Vasvari 2011, p. 17-41).

Stakeholder Capitalism

Rogene Buchholz in his literary work entitled "Rethinking Capitalism: Community and Responsibility in Business" is writing: "The typical stakeholders are considered to be consumers, suppliers, government, competitors, communities, employees, and of course stockholders. These are considered to be the primary stakeholders, but the stakeholder map of a corporation with respect to a specific issue can become quite complicated (R. Buchholz 2013, p. 98).

Stakeholder capitalism is a system in which corporations and companies are oriented to serve the interests of all their stakeholders. Under stakeholder capitalism, the main purpose of the company is to create long-term value and not to maximize profits and enhance shareholder value at the cost of other stakeholder groups. Stakeholder capitalism bases out understanding and expectations of business, not on the worst that company can do, but on the best. It sets a high moral standard, recognizes the common sense practical world of common business today, and asks managers to get on with the task of creating value for all stakeholders. It simply allows the possibility that business becomes a fully human institution (A. Bettley, D. Mayle, T. Tantoush 2005, p. 37).

Examples of Equity Participation

  • Employee Stock Ownership Plan (ESOP): An ESOP is a qualified retirement plan that allows employees to own shares in the company they work for. Employees can purchase stock directly, through payroll deductions, or through an employer matching program. ESOPs can be used to reward employees for their loyalty, increase employee engagement and productivity, and even help companies attract and retain top talent.
  • Preferred Shares: Preferred shares are a type of equity that gives investors the right to a certain portion of the company’s profits before any common shareholders are paid. Preferred shares also typically have a fixed dividend rate that is paid out on a regular basis.
  • Options: Options are a type of equity that give investors the right to purchase a certain number of shares at a predetermined price at a future date. Options can be used to incentivize employees, raise capital, and even help companies attract and retain top talent.
  • Phantom Stock: Phantom stock is a type of equity that gives investors the right to receive a predetermined number of shares at a future date. This type of equity is often used to reward employees for their loyalty and performance.

Advantages of Equity Participation

One of the main advantages of equity participation is that it allows for the potential for profitable returns for stakeholders. Here are some other benefits:

  • Equity participation can provide a company with additional resources, since the shareholders can provide more capital to the company.
  • Equity participation can increase the value of the company in the long run and provide the shareholders with higher returns than other forms of investments.
  • Equity participation can create a more stable financial situation because the shareholders are more invested in the company's success.
  • Equity participation can incentivize employees to work harder, since they will be more invested in the company's success.
  • Equity participation can create loyalty among shareholders and can create a stronger bond between the company and its shareholders.

Limitations of Equity Participation

The limitations of equity participation include:

  • Lack of liquidity: Equity investments are generally not liquid since there is no established market for them. This can make it difficult for investors to sell their shares and realize their profits.
  • Lack of control: Equity participation usually does not grant the investor any control over the company's operations and decisions.
  • Volatility: Equity investments can be highly volatile due to the stock market and its fluctuations. This means that the value of the investment can go up and down frequently.
  • Dividend risk: Equity investors may not receive dividends as the company may not have enough profits or may choose not to pay out any dividends.
  • Tax implications: Equity investments can be subject to different types of taxes such as capital gains tax. This can reduce the overall return on the investment.

Other approaches related to Equity Participation

One of the most common approaches to equity participation is granting of stock options and phantom shares. These two methods allow companies to attract and motivate employees without having to provide actual equity ownership. Other approaches include the use of convertible debt and venture capital investments.

  • Stock Options - In this approach, a company grants its employees the right to purchase a certain amount of stock at a pre-determined price. This allows employees to benefit from the increase in stock prices and gives them a stake in the company.
  • Phantom Shares - This approach allows a company to provide its employees with the equivalent of equity ownership without actually having to issue shares. Phantom shares are valued based on the company's performance and are usually granted to key employees as a form of incentive.
  • Convertible Debt - This approach allows a company to issue debt instruments with an option to convert them into equity. This allows investors to benefit from the company's success while minimizing their risk, as the debt can be converted into equity if the company is successful.
  • Venture Capital Investments - This approach allows companies to raise capital from venture capitalists in exchange for equity. This allows venture capitalists to benefit from the company's success while still taking on a certain amount of risk.

In summary, equity participation can take many forms, and companies have a variety of approaches to choose from when creating an equity participation program. Stock options and phantom shares are two popular approaches, while convertible debt and venture capital investments are other options available to companies.


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References

Author: Patryk Kozioł

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