THE BLOG
11/06/2012 07:29 pm ET Updated Jan 06, 2013

Can Embracing the Equity Upside Transform the Old Continent?

George Osborne recently announced plans for a new kind of UK employee contract called 'employee-owner'. Media coverage of the initiative has been mixed, as the upside of equity was being positioned as being traded for basic employee benefits. But the real point was missed -- most of the world's wealth creation is done through equity and to transform Europe we need as many equity owners as possible.

A quick look at the Forbes billionaire list shows that the richest people around the world made their fortunes largely by owning equity in their own or their family's business. A select few (like Eric Schmidt and Sheryl Sandberg), have made their fortunes by running other people's companies. But none of them got rich on a salary. There are a few professions -- like lawyers, bankers and consultants -- where one can earn enough to become rich through a paycheck, but even in those professions people are usually required to buy into equity partnerships.

In the U.S. people get it -- in 2005 when we finished Harvard Business School and European graduates moved back for finance jobs, some of my most talented classmates ended up in start-ups small and large from California to New York, working for a measly salary at first, hoping to make the big returns on their equity. Some of them have already done extremely well, like Jeremy Stoppelman -- the founder and CEO of Yelp, Alexandra Wilkis, the founder of Gilt -- but there are many more.

The question is not whether equity is a powerful wealth creation and motivation tool, but rather why aren't Europe's best flocking to the idea that owning more equity is the right way to align their talent with their interest? I know of European startup CEOs claiming that if they offered their employees the option of £10,000 or 1 percent share in the business, the vast majority of employees would take the cash money. It's "money in the bank" and "it is not scary". But what if the 1 percent is equity in one of Europe's success stories like Wonga, Zalando, or Spotify, companies that might end up being worth over $10B? That 1 percent could easily be worth tens of millions, dwarfing whatever cash payout one can achieve through salary in several lifetimes. And even in smaller exits, equity upside can be significant.

Then there is the alignment of incentives for all employees to create value in a business. Remember how short-term cash incentives without long-term equity ownership affected behaviour of investment bankers? There is benefit to every employee thinking and acting like an owner, and equity does that.

So what can we do to encourage people to own more equity in companies they work for?

1) Celebrate entrepreneurial role models and learn from them.

Just like British Olympic successes are inspiring a new generation of athletes, we should also look to the great entrepreneurs like Richard Branson to inspire a generation of entrepreneurs and risk-takers. I am proud of Holly Tucker and Sophie Cornish, the founders of one of our portfolio companies notonthehighstreet.com, who wrote a book on their experience of setting up and growing a business called: "Build a Business from Your Kitchen Table". It is regular people like Holly and Sophie, who with their hard work and passion for solving a problem create huge value, who we should celebrate and listen to more often.

2) Explain the mechanics of equity and encourage founders and employees to talk about it.

Equity should be exciting and not scary. Founders and companies should get into the habit of painting a picture of what equity means and what the upside can mean for an individual. At grant equity can often be worthless, so it is all about long-term vision and understanding how much given shares can be worth at different stages: what is the chance of success? What might success look like? Then there are questions like structure (options/equity), cost (how much might they cost an employee), vesting (time to maturity, what happens in case the person leaves), liquidity (how can the person actually get the money): founders, boards, and investors should all be a part of the education process to make employees less confused about the concept of owning equity.

3) Create incentives for people to own equity.

Even though equity upside can be significant, taxing equity proceeds at income tax level isn't optimal. There are many ways that people have tried to play the system and make ordinary income seem like capital gains. Genuine proceeds from equity value in businesses people have created should have advantageous benefits, and will enable companies to hire great people who might be attracted to entrepreneurship. Generous capital gains allowances will help talented people achieve their compensation expectations via the equity upside.

Entrepreneurs have a unique DNA. They are driven by passion, but at some point see the potential for major wealth creation. Entrepreneurs thrive on risk and are often successful because of -- rather than in spite of -- extremely difficult economic pressures. Their lives are often uncomfortable as they put all of their physical, mental and financial resources into building a successful business. But there is a bit of entrepreneur in all of us. We need Europe's best and the brightest to focus on building great companies and equity is the right way to motivate them to take more risk and enjoy potentially a great deal of upside from their work.