Author: Zach Witonsky

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Why I Chose to Implement ESOP at Integral: Beyond the Balance Sheet

Why I Chose to Implement ESOP at Integral: Beyond the Balance Sheet

We are pleased to present a unique feature on our blog today. The following post comes courtesy of a guest contributor, Collective 54 member Ashok Sivanand, CEO @ Integral. We are honored to share his knowledge and viewpoints with our readers. Enjoy this unique piece that broadens the horizons of our usual content.

During my time at Shoplogix and Pivotal Labs, I experienced the transformative power of Employee Stock Ownership Plans (ESOP). While the outcomes for me were moderate at-best, (think downpayment on a house), I was fortunate to have experienced this first-hand on my journey to founding Integral.

Witnessing how ESOP reshaped the workplace was enlightening – it felt more than business strategy. It was a catalyst for a more engaged and vibrant company culture. Compared to my time at larger enterprises, I clearly felt and experienced increased employee commitment, a surge in tenacity, and a strong sense of belonging among employees. This wasn’t just about numbers; it was about nurturing a workplace where everyone feels invested and accountable to our collective success.

My close interactions with the founders offered me a unique perspective on the intrinsic value of ESOPs and how they help bridge the typical divide between shareholder and employee. ESOPs create a shared sense of purpose and success, transforming every team member into a stakeholder in our collective journey.

The Viability of ESOP in Professional Services

Implementing ESOP in a professional services setup isn’t always a straightforward path. Similar to how Collective 54 has a pro-serve specific model to EOS (Entrepreneurial Operating System), ESOP demands tailoring the popular models catered to product companies to fit our industry dimensions

Considerations at the Forefront

Here are some of the top considerations we had to confirm in order to confidently implement our program.

    • Intent of Business: Decide early whether you’re running a lifestyle business or growing a scaled business. It’s my opinion that an ESOP makes a lot more sense for the latter.
    • Structural Choices: While it’s more straightforward to implement the program for a C-Corp, there are various approaches like phantom stock that can help achieve the same goals for an LLC.
    • Vesting Strategies: Consider whether vesting happens based on time (eg. 4 years), performance, or some combination. Time-based vests are a lot simpler to implement and will likely work for most cases.
    • Ownership Percentages: Decide early what percentage of the business you want to allocate to the stock option pool. Since you can always allocate more shares in the future, i’d recommend starting small. We started with 15% with the intent of adding another 15% as we grow.
    • Compensation Balance: Generally, stock options allocations follow similar proportions as salary allocations. The % of upside an employee might receive from the equity versus their salary increases as the employee is more senior.
    • Stage of the Firm: In the earlier days, when cash was tight and we couldn’t afford to pay market salaries, we allocated higher values of stock options. As we grew, we adjusted to market compensation and reduced the stock option allocation per employee.
    • Managing Exits: Plan for scenarios like key employees leaving and be transparent about it. I have witnessed peers end up in wasteful legal battles with senior executives leaving and trying to take them off the cap table.
    • Dividends for Alumni: If you choose to pay out dividends, you’ll have to decide early whether alumni shareholders get paid those dividends. Like the point above, this can seem difficult, especially if the alumni left on bad terms. My advice is to remind you that you set out to build something great. Channel that emotional energy toward solving meaningful problems and serving more people and chalk these payments up to “dumb taxes” as the Collective 54 members call it.

Implementing ESOP: Legal and Practical Learnings

    • Choosing the Right Law Firm: It’s crucial to work with a firm that has experience with this. My initial struggle with a non-specialized firm led to high costs and no results, whereas a specialized firm in Palo Alto was more efficient and cost-effective.The initial cost was $3,500 with the right firm.
    • Options Galore: There’s a variety to choose from, like ISO/NSO. At the bottom of this post, I have attached a table prepared by my legal firm in 2017. I would advice legal and tax consult to confirm this information is still relevant before taking action. Deciding between options is more about aligning with your company’s values and principles than just logic or math.

Operationalizing the ESOP Program

    • Educating Employees: We observed a trend where many colleagues either undervalued or overvalued their stock options. Addressing this through regular education sessions and transparent communication about valuations has been key.
    • Encouraging Voluntary Participation: We’ve been cautious not to sway employees towards participating or create a divide between those who exercise their options and those who don’t. It’s tempting to use future valuations as a significant part of compensation, but this should be approached carefully based on the factors mentioned above.
    • Attracting Talent: Interestingly, some colleagues were drawn to our firm because of the stock option program, resonating with their own values and aspirations to be part of the firm’s growth trajectory. They chose us over competing offers and marginally higher compensation for the value alignment.
    • Maintaining Transparency and Fairness: We emphasize transparency in our operations but also respect privacy by keeping shareholder identities confidential and ensuring equitable treatment.
    • Tools for Efficient Management: I highly recommend software tools like Capshare or Carta for managing ESOP programs and your annual valuations (409A). These tools offer efficiency and clarity in administration.

Implementing an Employee Stock Ownership Plan in a professional services firm is more than just a strategic decision; it’s a transformative journey towards collective growth and success. ESOPs offer a unique opportunity to align the interests of your employees with those of the company, creating a powerful sense of ownership and shared destiny. This alignment not only enhances engagement and commitment but also drives innovation and performance, as every team member becomes an integral part of the firm’s success story. As you grow and evolve your firm, consider the profound impact that an ESOP can have. It’s not just about sharing financial success; it’s about fostering a culture of unity, motivation, and collective achievement. Embrace this opportunity to not only grow your business but to also enrich the lives of those who contribute to its growth. Let the journey of ESOP be your firm’s stepping stone to new heights of success and fulfillment.

 CorporationCorporationLLCLLCCorporation/LLC
Incentive AwardIncentive Stock Option (ISO) (early exercisable) (employees only)Non-qualified Stock Option (NSO) (early exercisable)Option to purchase common LLC Unit (early exercisable)Profits InterestCash Incentive Program
MechanismEmployee is granted an option to purchase shares of the Company’s common stock in the future, exercisable immediately but subject to vesting based on continued service to the Company.Person is granted an option to purchase shares of the Company’s common stock in the future, exercisable immediately but subject to vesting based on continued service to the CompanyPerson is granted an option to purchase units of the Company’s common equity in the future, exercisable immediately but subject to vesting based on continued service to the Company.Employee is granted an interest in the Company’s future profits and losses, which may or may not be distributed to employee depending upon operating income and tax distributions. May be subject to vesting.Program allows for grant of specified number of units, and each participant is granted a number of units, which may or may not be subject to vesting.  Payment on units made on change in control only.
DocumentationStock Option Plan, Notice of Grant, Option Agreement and Exercise Agreement.Stock Option Plan, Notice of Grant, Option Agreement and Exercise Agreement.Equity Option Plan, Notice of Grant, Option Agreement, Exercise Agreement, Operating AgreementEquity Incentive Plan, Profits Interest Agreement, Operating AgreementCash Incentive Program and Award Agreement
Exercise Price> FMV at grant> FMV at grant> FMV at grantN/AN/A
Individual’s Tax Treatment

Taxed only on sale of shares acquired upon exercise of option. If holding period is met, difference between sale price and exercise price is taxed at long-term capital gain rates.

Holding period = 1 year from exercise & 2 years from date of grant

*Spread at exercise may be included in taxable income for purposes of determining AMT.

Taxed at exercise at ordinary income rates on difference between exercise price and FMV on exercise date assuming 83(b) election is made. Additional tax upon sale at capital gain rates on difference between FMV on exercise date and sale price.Taxed at ordinary income rates when units are issued upon exercise on difference between exercise price and FMV on exercise date. Taxed on date of sale at capital gain rates on difference between FMV on exercise date and sale price.Taxed annually when profits/income is allocated to profits interest holders.  Allocation of profits to profits interest holders may occur only if certain thresholds are met.Taxed only upon payment in connection with a Change in Control.  Taxed at ordinary income tax rates when cash is received.
Treatment upon Change in ControlUnexercised awards (or exercised but unvested awards) will accelerate immediately prior to CIC unless otherwise assumed or substituted by acquirer. Holders of vested shares will receive same consideration if, when and as other stockholders are paid.Unexercised awards (or exercised but unvested awards) will accelerate immediately prior to CIC unless otherwise assumed or substituted by acquirer. Holders of vested shares will receive same consideration if, when and as other stockholders are paidUnexercised awards (or exercised but unvested awards) will accelerate immediately prior to CIC unless otherwise assumed or substituted by acquirer. Holders of vested units will receive same consideration if, when and as other stockholders are paidPaid out in accordance with terms of Operating Agreement (generally will convert into right to receive a cash payment at closing, subject to the threshold and any senior equity rights.Each unit represents the right to receive a cash amount equal to X% of the consideration paid to the Company’s owners in connection with a Change in Control, if, when and as paid to the stockholders. Program is treated as a liability that is paid out before the stockholders receive consideration for their equity.
Treatment upon IPOFull stockholder rights upon exercise of option. (Vested shares are freely tradeable.)Full stockholder rights upon exercise of option. (Vested shares are freely tradeable.)N/A (unlikely that entity would go public as LLC)N/A (unlikely that entity would go public as LLC)No payment is made without a change in control.
Treatment as Stockholder/ MemberFull stockholder rights upon exercise of option; provided that unvested equity can’t be transferred.Full stockholder rights upon exercise of option; provided that unvested equity can’t be transferred.Full member rights upon exercise of option; provided that unvested equity can’t be transferred. Eligible for tax distributions.Full member upon grant of profits interest, regardless of vesting (provided that unvested equity can’t be transferred). Eligible for tax distributions.No
Treatment as EmployeeYesYesPrior to exercise, yes. Following exercise, treated as partner, and the employee-partner will be responsible for paying the employer portion of his/her own employment taxes (FICA, Medicaid, etc.). Any benefits paid for by the company (e.g., medical benefits) cannot be provided on a tax-free basis.Immediately after grant, treated as partner and the employee-partner will be responsible for paying the employer portion of his/her own employment taxes (FICA, Medicaid, etc.). Any benefits paid for by the company (e.g., medical benefits) cannot be provided on a tax-free basis.Yes
Tax ReportingForm 3921 regarding exercise of option must be distributed by company to employee in the year following year of exercise. If option is exercised for unvested shares, Section 83(b) election must be filed by employee with IRS within 30 days of exercise.If option is exercised for unvested shares, Section 83(b) election must be filed by employee with IRS within 30 days of exercise.  Income at exercise reported by company on W-2/1099.After exercise of option, Form K-1 must be distributed annually to partner detailing partner’s shares of profits and losses for each fiscal year. If option is exercised for unvested Units, protective Section 83(b) election should be filed by employee with IRS within 30 days of exercise.Form K-1 must be distributed annually to partner detailing partner’s shares of profits and losses for each fiscal yearForm W-2 will report income earned in transaction as compensation.
Effect on Entity Tax TreatmentNo effect on entity tax treatment.No effect on entity tax treatment.Prior to exercise of first option or sale of equity to another third party, entity is treated as sole proprietorship.  Once first option is exercised or equity is sold to a third party, entity is treated as partnership. A new tax ID may be required. Partnership tax returns are then required.Prior to first grant, entity is treated as sole proprietorship.  Following first grant of a profits interest, entity is treated as partnership. A new tax ID may be required. Partnership tax returns are then required.No effect on entity tax treatment.
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Craig Dickens: CEO, JD Merit

HOW A MANAGEMENT TEAM VALIDATED THEIR STRATEGY AND ACHIEVED ALIGNMENT ON SCALING THEIR PROFESSIONAL SERVICES BUSINESS

NAVIGATING THROUGH A SEA CHANGE

JD Merit is a boutique investment bank that provides its clients strategic merger and acquisition guidance, corporate finance solutions, and value enhancement services. Whether arranging a business sale, negotiating a merger or acquisition, raising capital, or pursuing strategic ventures, JD Merit focuses on helping its clients win. Still, the bank’s CEO, Craig Dickens, believed he needed a particular kind of assistance.

“I’ve got plenty of business and finance experience, but I don’t have much experience in scaling a professional services firm,” said Craig.

It was a sea change for Craig when he realized he needed to understand the dynamics of operating a professional service business. Being the CEO, he knew it was essential to have the complete picture.

“The management team and I wanted to ensure that we understood the key to unlocking knowledge relating to scaling the business,” said Craig. “We’re strong believers in not reinventing the wheel. We wanted to learn from a peer community that would embrace us.”

FINDING THE RIGHT TRIBE

Craig’s very intentional search for such a peer community led him to Greg Alexander’s book titled The Boutique: How to Start, Scale, and Sell a Professional Services Firm. After reading the book and listening to a few of Collective 54’s podcasts, he knew he had found his tribe. Craig, along with the bank’s Chief Operating Officer and its Chief Strategy Officer, joined the mastermind community.

“It was important to me that the entire management team was a part of Collective 54,” said Craig. “That way, we all get into the depth and breadth of the ecosystem, so each person works to learn every aspect of the business and agree on our direction for the future.”

the professional services mastermind community

Collective 54 is the first mastermind community for boutique professional services firms. The community aims to help members make more money, work fewer hours, and get to a bigger sale faster. This is done through peer-to-peer mentoring, expertise sharing, and specialized programming built to help founders and owners grow, scale, and sell their firms.

One crucial element of Collective 54 is that all members operate professional services firms, regardless of their industry. Those members talk among themselves and help each other learn.

“There are ideas that come out of those conversations that I would’ve never thought of. I wouldn’t come at an issue from a marketer’s or an IT consultant’s perspective,” said Craig. “Having real conversations with different peers makes a leader a more well-rounded executive. That leader must hear from the voices of others who have solved the same problems. And in Collective 54, those voices are located throughout the world.”

For Craig, having access to a proven playbook and learning a common language with his peers helped him and his management team execute thoughtful plans contributing to the business’s overall growth and success.

collective 54 business impact

validation

“We undertook a change in how we structure our business,” said Craig. “It was helpful to get feedback from the Leadership Board as well as a one-on-one with founder Greg Alexander as to how we should manage that change.”

tangible value

Craig is active and receiving great value from his Leadership Board, a private sub-group of ten members. He’s also advised other Collective 54 members on how to improve their businesses. “There’s a commonality in language and viewpoint relative to how
professional services should be run and managed, and we are benefitting from that language,” he said.

clarity & alignment

“Collective 54 has given the management team clarity and alignment,” said Craig. “We’ve taken the group’s Boutique Framework and turned it into a scorecard that will help us continually improve performance. Now, we are more effective managers as we grow.”

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Craig Dreiling: Founder and CEO, Solutions-101

Solutions-101 experiences a seven-figure breakout win after joining collective 54

processes but no capacity

Solutions-101 uses proprietary software to assist dental practices with
repositioning their insurance reimbursements to increase profits and retain patients. Although helping clients grow their revenue is one of his specialties, the firm’s founder, Craig Dreiling, struggled to do the same himself.

Craig’s growth strategy was to first focus on sales, then delivering services followed by client management. When he completed the cycle, he started at the beginning with sales again. He realized this cycle wouldn’t get his business where he wanted it to go.

“Sure, we were growing, but we hit a ceiling, and the problems we faced
were self-inflicted,” said Craig. “Not only did I not have the right processes in place, but I also didn’t invest in the right people to break through that ceiling. Consequently, we just didn’t have the capacity for significant growth. I could only do so much.”

THE SEARCH FOR KNOW-HOW

To solve his capacity issues, Craig intended to either increase prices or grow the number of clients the firm serves at one time. However, Craig noted that “it’s a real struggle doing either or both if you don’t understand how to
manage toward those objectives.”

Craig continued, “There are a lot of groups on LinkedIn and Facebook that say they can help members better manage their business, but it’s nearly impossible to know the expertise of the group’s leadership—they may just be out to make money. You have to take them at their word that what they and the group’s members share will work.”

His situation left Craig open to solutions. When one of his neighbors shared Collective 54 founder Greg Alexander’s book titled The Boutique: How to Start, Scale, and Sell a Professional Services Firm, Craig immediately purchased and read it. That led him to become a member of Collective 54, a community specifically geared toward professional services firms.

A MASTERMIND GROUP FOR PROFESSIONAL SERVICES FIRMS

Collective 54 is a curated mastermind community for professional services
firms. With members who talk among themselves and help each other learn,
the community aims to help them make more money, work fewer hours, and get to a bigger exit faster. This is accomplished through peer-to-peer mentoring, expertise sharing, and specialized programming built to help founders and owners grow, scale, and sell their firms.

“After joining Collective 54, I immediately got a reality check,” said Craig. “I found it difficult to explain to the people in my group what my company does. When I tried, I received lots of questions. That was a pivotal moment for me. I realized then my team had to get hyper-focused on our company’s messaging so that we can improve as a team and raise the caliber of our clients.”

Struggling with creating a clear value proposition and targeting the ideal client profile are common themes among Collective 54 members.
Fortunately, members struggling with these issues have the opportunity to learn from other members who have solved the same problems.

Even though Craig is the first to admit that he hasn’t taken full advantage of what Collective 54 offers, he said the community is more of an asset than expected.

“I’m still a member after two years because the organization is constantly evolving,” said Craig. “Every interaction either challenges or validates my thinking on a topic. I benefit greatly from the knowledge and experience of the organization’s members.”

collective 54 business impact

leveled up project size

“After joining Collective 54 and realizing how to do what we do, things shifted quickly,” said Craig. “We signed a seven-digit contract worth more than we’ve ever earned in a year.”

increased revenue

“We didn’t change the fundamentals of what we do—we just streamlined operations and changed how we presented ourselves to our clients,” said Craig. “By doing that and staffing appropriately, we drastically increased revenue by changing our pricing model.”

improved quality of life

“Owning your own business isn’t always glamorous—it’s a lot of work that creates lots of stress,” said Craig. “Collective 54 gives me a cheat sheet to operating my business successfully so that I can improve my quality of life.”

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Adriaan Bouten: Founder and CEO, Digital Prism Advisors

How Adriaan Bouten found his tribe in Collecitve 54 and grew his professional services firm

You don't know what you don't know

Adriaan Bouten is the founder and CEO of Digital Prism Advisors (dPrism), a boutique consulting firm that helps executives unlock hidden potential in today’s digital ecosystem. dPrism works with enterprise organizations to identify and execute digital growth opportunities through sound cohesive strategy, effective technology selection, and digital process improvement.

Founded in 2014, dPrism has grown into a successful firm with clients that generate a few hundred million in revenue to a few billion in revenue. “We know how to serve our clients very well,” said Adriaan. “However, our biggest challenge is getting more clients.”

In addition to the continual need to attract new clients, Adriaan had contracting and invoicing issues he needed to be resolved. He also wanted to expand dPrism’s sales and marketing capabilities. But with so many tasks on his plate, he wasn’t sure where to start.

“I didn’t know what I didn’t know,” said Adriaan.

what makes collective 54 unique

When Collective 54 reached out to Adriaan, he took a long look at the organization. “The first thing I noticed was that I already knew a few of its members,” said Adriaan. “That made me even more comfortable becoming a member myself.”

Collective 54 is the first mastermind community for boutique
professional services firms. The community is focused on helping members make more, work less, and get to a bigger exit faster. This is done through peer-to-peer mentoring, expertise sharing, and specialized programming built to help founders and owners grow, scale, and sell their firms.

“Over the years, I’ve been a member of various CEO ‘peer group’
organizations,” said Adriaan. “The problem with those groups was that my issues weren’t the same as the issues the other CEOs were dealing with.

“In Collective 54, even though we’re all working in different specialties, we’re all boutique consulting firms. From public relations firms to human resources consulting firms, our core issues are the same.”

As a member of Collective 54, Adriaan quickly learned that the group offers far-reaching benefits that flow from unmatched peer-to-peer knowledge sharing. Based on his experience, Adriaan decided to have both dPrism’s president and COO join Collective 54.

“The reason I wanted my president and COO to join was that I don’t have the bandwidth, or the responsibility, to deploy everything I’m learning in Collective 54,” said Adriaan. “Now, they learn alongside me and we have group debriefs after each session to make our learnings more actionable.”

Adriaan has made many valuable connections with other Collective 54 members, which have led to one-on-one conversations that helped him address specific business issues. He’s also become a client of a couple of members who are helping him better manage his firm.

“My firm is in a better place than it would’ve been if I hadn’t joined Collective 54,” said Adriaan. “I continue to be a member not just because I’m always learning new things, but also because I’ve built relationships with other members whom I respect and who respect me.”

membership has its benefits

expanded sales and marketing capabilities

An important business impact has been Adriaan’s ability to expand dPrism’s sales and marketing capabilities. “Through Collective 54, I’ve gotten excellent checklists and tools to help us create new business opportunities,” said Adriaan.

actionable learnings

“One of Collective 54’s strong benefits is that what
we learn during sessions is immediately actionable,” said
Adriaan. “That helps us make better business decisions.”

better cash flow position

“I learned about best practices regarding our invoicing and
contracting issues,” said Adriaan. “Now I know what really works with this deceptively straightforward issue. Today, we are in a much better cash position after changing the way we do things.”

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Julian Lumpkin: Founder and CEO, SuccessKit

how a relevant peer group makes a bigger impact

searching for best practices

Julian Lumpkin had ambitious plans for growing SuccessKit, a
professional services firm that produces case studies, video testimonials, and custom content for B2B-focused companies. As the founder and CEO, Julian wanted help and support in running his business.

“Because we create content in a complex and competitive sector, it’s critical that I operate the business according to relevant best practices,” said Julian. “Over the years, I’ve learned that creating content demands a specific set of skills, and running a content creation business requires quite a different set of skills—skills that must be learned.”

Prior to launching SuccessKit, Julian worked primarily for technology companies. As such, he knew how to run a software as a service (SaaS) company, but not a professional services firm, and so he wasn’t confident that he could properly grow SuccessKit.

“Even after several years operating SuccessKit, I still struggled to find useful best practices that pointed me in the right direction,” said Julian. “The information I was digesting from the Internet and LinkedIn was mostly related to running technology companies or other types of businesses.”

A passively managed LinkedIn group would not have met Julian’s needs, and other professional networks would only have given him information irrelevant to his type of business. Julian’s goal was to find a community of professional services leaders to discuss the issues he faced daily.

collective 54: THe Pro Serv mastermind group

Collective 54 is the first mastermind group designed for boutique professional services firms. The community’s objective is to empower its members to earn more while working less. This is accomplished through peer-to-peer mentoring, expertise sharing, and specialized programming developed to help founders and owners grow, scale, and sell their firms.

“As far as I know, Collective 54 is the only fully managed network for professional services firms,” said Julian. “Sure, there are some groups out there for professional services firms, but no one is actively running them for the benefit of its members. Meanwhile, Collective 54’s founder has been in my shoes, and he has a full-time team dedicated to making one-on-one connections and helping me get the information I need.”

Once Julian understood what Collective 54 offered, he realized he found the perfect network to meet his needs.

“Interacting with knowledgeable peers has been one of the best
outcomes from being a member of Collective 54,” said Julian. “When I have a question, I can send a direct message to another member and get a response. It’s like I have instant, actionable information at my fingertips.”

collective 54 business impact

saved money

“Thanks to Collective 54 members, I avoided hiring the wrong automation vendor and found a much better option that saved me money,” said Julian.

increased productivity

Julian noted that “because the other members of Collective 54 provide the kind of support I was looking for, I’m much more productive by spending my time and attention on the right actions
targeted at growing my business.”

saved time

“Based on what I’ve learned from Collective 54, I’ve directly saved my own time and energy by focusing on the things that help me achieve my goals,” said Julian.

The first mastermind community for

boutique professional services firms.

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