Incentivising Your Team Without Losing the Farm: Practical Equity Models Explained
How to Motivate and Reward Employees Without Giving Away Too Much
For small and medium-sized enterprises (SMEs), attracting and retaining top talent is critical to growth. Larger companies often lure employees with high salaries, generous bonuses, and long-term career stability. SMEs, on the other hand, may not have the same financial flexibility, leading many business owners to believe that offering equity is the only way to remain competitive.
While equity can be a powerful tool for alignment and motivation, giving it away too freely can create long-term challenges. Many founders regret handing over large stakes too early, only to realise that dilution has left them with little control over their own company. Others struggle with disengaged or departing employees who still hold shares, complicating decision-making and investment opportunities.
The good news is that there are smarter ways to incentivise employees—ones that reward performance, drive retention, and align team goals with business success, without the pitfalls of unnecessary equity dilution.
Why SMEs Should Be Careful When Offering Equity
Equity is a long-term commitment. Once shares are granted, they cannot be easily taken back. For this reason, business owners should carefully evaluate whether offering ownership is the right incentive—or if other models would be more effective.
Common problems with poorly structured equity incentives include:
- Employees receiving significant equity upfront but leaving before contributing meaningful value.
- A complicated cap table, making future fundraising difficult.
- A misalignment of expectations, where employees do not fully understand the risks and responsibilities of being shareholders.
Before issuing equity, consider: Are there alternative ways to reward and retain employees that do not require giving up ownership?
Three Highly Effective SME Incentive Models
For SMEs looking to build an engaged and high-performing team, here are three proven alternatives to outright equity grants.
Profit-Sharing Plans
A profit-sharing plan distributes a percentage of the company’s profits to employees, ensuring that when the business does well, everyone benefits. Unlike equity, profit-sharing does not involve ownership transfer, making it a flexible and risk-free way to align employees with company success.
Profit-sharing works particularly well for:
- Companies with variable revenue—since payouts fluctuate based on performance.
- Employees who prefer immediate rewards rather than long-term equity stakes.
- Businesses that want to maintain full ownership while still incentivising employees.
How it works:
- A fixed percentage of net profits is allocated to employees annually or quarterly.
- Distribution may be equal or performance-based, ensuring top contributors are rewarded accordingly.
- Unlike dividends, profit-sharing does not make employees shareholders, meaning they do not gain voting rights or ownership influence.
For many SMEs, profit-sharing provides a strong incentive for performance without creating long-term dilution concerns.
Phantom Equity
Phantom equity gives employees a financial stake in the company’s growth without issuing actual shares. This model allows employees to receive payouts linked to the business’s valuation, ensuring they benefit from the company’s success while the founder retains control.
Phantom equity is ideal for:
- Businesses that expect significant growth but do not want to dilute ownership.
- Founders who want to align incentives while avoiding a complex cap table.
- Employees who value financial rewards but do not necessarily want the responsibilities of being a shareholder.
How it works:
- Employees are awarded phantom shares that mimic real equity but do not represent actual ownership.
- Upon a liquidity event—such as a sale, acquisition, or set timeframe—employees receive a cash payout based on the value of their phantom shares.
- Employees do not hold voting rights, meaning founders retain full strategic control.
Many SMEs find phantom equity to be the perfect middle ground—it incentivises employees for the long term while ensuring that founders maintain decision-making power.
Employee Share Schemes (ESS)
Employee share schemes (ESS) allow employees to acquire real shares in the company, often at a discounted price. Unlike profit-sharing or phantom equity, ESS involves actual ownership transfer, but when structured correctly, it can be a tax-efficient and strategic way to offer equity without excessive dilution.
ESS works best for:
- Businesses that want to retain top talent with long-term equity incentives.
- Companies planning for future liquidity events, such as an IPO or acquisition.
- Employees who are deeply invested in the company’s long-term vision and growth.
How it works:
- Employees are given the option to purchase shares at a discounted price or are granted shares that vest over time.
- A well-designed ESS includes vesting conditions to ensure that employees earn their equity gradually, reducing the risk of people leaving too soon.
- The structure is often tax-efficient, with benefits for both the employer and employees, particularly under Australian tax laws.
ESS can be a powerful retention tool, but it requires careful planning to avoid unnecessary dilution.
How to Structure an Effective Incentive Plan
For SMEs looking to build a strong, motivated team without unnecessary equity dilution, the key is to choose the right incentive structure and implement it effectively.
Use Cash-Based Incentives Before Resorting to Equity
Equity should be reserved for key employees and long-term contributors. In many cases, performance-based bonuses or profit-sharing plans are sufficient to motivate employees without the complexities of ownership transfer.
Before offering equity, consider:
- Would a higher salary or performance-based bonus achieve the same goal?
- Does the employee truly need an ownership stake, or would phantom equity be more effective?
- Is there a way to tie incentives directly to business performance without permanent dilution?
If Offering Shares, Use Structured Vesting and Performance Conditions
If equity is the best option, it must be structured correctly. A vesting schedule ensures that shares are earned over time, preventing employees from walking away with a stake in the business before they have made a meaningful contribution.
Best practices for structured vesting:
- Implement a four-year vesting schedule with a one-year cliff, ensuring that employees must stay for at least a year before any shares vest.
- Tie vesting to performance milestones where appropriate, ensuring that equity is awarded for results, not just tenure.
- Include buyback clauses, allowing the company to repurchase shares if an employee leaves.
Keep the Cap Table Lean to Avoid Unnecessary Dilution
A clean and manageable cap table is critical for attracting future investors and maintaining long-term control. Too many small shareholders can create legal and operational complications.
Before granting equity:
- Consider using phantom equity or share schemes instead of issuing direct shares.
- Ensure that only key contributors receive ownership stakes, rather than distributing shares widely.
- Regularly review cap table management and dilution strategies to keep ownership aligned with business goals.
Case Study: How One SME Increased Retention Without Giving Up Equity
A Melbourne-based technology firm wanted to retain top talent but was hesitant to give away shares. Instead of offering direct equity, they introduced a phantom equity program tied to company growth.
The result:
- Employee retention increased by 35 percent within two years.
- The company maintained full founder control while keeping employees financially invested in long-term success.
- The structured incentive model attracted higher-calibre talent, as employees saw clear financial benefits without needing to become shareholders.
This approach allowed the business to align employee incentives without complicating ownership structures—a win-win scenario for both founders and team members.
Final Thoughts: Smarter Incentives for Sustainable Growth
Attracting and retaining top talent does not mean giving away the business. With the right incentive structures, SMEs can motivate employees, drive performance, and ensure long-term commitment—all while maintaining control over equity and decision-making.
By carefully considering profit-sharing, phantom equity, and employee share schemes, business owners can design tailored incentive models that reward employees while keeping the company’s long-term ownership strategy intact.
For SMEs looking to implement effective incentive plans, strategic planning and expert guidance can ensure that incentives work for both employees and business owners—paving the way for sustainable, long-term success.