Benefits of Synthetic Equity for Next-Generation Owners

The term “synthetic equity” refers to a set of compensation tools that is commonly used to provide key employees some of the economic benefits of ownership without actual stock changing hands. While existing owners may benefit from synthetic equity by capitalizing on employee performance without relinquishing ownership, there are key benefits to next-generation advisors, too.

Reduced Financial Risk

One of the most beneficial aspects of synthetic equity for a next-generation advisor is that it does not require a financial investment in the firm. As a younger professional, you may already be juggling the financial obligations of a new family, a recent home purchase, or student loans, and you may not be interested in taking on the added burden of ownership buy-in–yet.

Granted, true equity ownership is often financed through profit distributions from the growing firm, but there is risk in that. If the business does not perform as expected and the profit distributions are less than you’d hoped, you are still on the hook for the equity shares you’ve purchased. On the other hand, synthetic equity provides upside monetary incentive based on individual and business performance. Your payout may be lower if the business does not perform as well over the period of your agreement, but you have not “purchased” anything you are obligated to pay for.

The investments you do make when it comes to synthetic equity are in time and effort. The better you perform and the more you contribute to the business’s success, the higher your reward at the end of the term. However, if you don’t put in the work, you won’t be able to maximize your incentive. Additionally, you may forfeit your payout if you leave the firm before your agreement period has concluded. Synthetic equity may not require a financial buy-in, but you’ve tied yourself and your benefits to the success of the business, to which you are a large contributor.

More Control Over Your Path

As a next-generation advisor in a synthetic equity arrangement, your commitment to the business is shorter-term than that of an actual owner. Rather than devoting the duration of your career to the business, you are instead promising “ownership-level” commitment for the agreed upon period. This way, you are able to benefit from the business’s growth while retaining the freedom to change firms or locations, start your own practice, or even change your career’s focus at the end of your agreement period (and with fewer complications).

Being a successful professional does not mean you have to sacrifice your desire for variety and change. Not all advisors aspire to be business owners and not everyone wants to work at a single firm for decades. This doesn’t mean you shouldn’t be rewarded for your efforts and contributions. Variety is the spice of life and being a talented and in-demand advisor allows you to carve your own journey that includes as many people and experiences as you choose.

Trial Period

Synthetic equity agreements are sometimes used by existing owners to test out a next-generation ownership candidate. Responsibility and reward can be leveraged without an ownership transfer through synthetic equity to provide a lower-risk but “live” testing environment to see how an advisor might perform in an ownership role.

As a next-generation professional, this testing period is to your benefit as well. You are afforded the opportunity to get involved with the business at a higher level and receive appropriate compensation for your commitment while determining if the business and ownership team are a good fit for you in the long term.

Once you and the existing owners have a chance to test this new arrangement, you’ll all have a better idea of what to expect, including how to structure a transition should you all decide to move forward with an internal succession plan and begin the transfer of real equity.

Expanded Eligibility

The flexibility of a synthetic equity arrangement means it can be customized in many ways and allow the business to reward a larger pool of professionals. Existing owners can extend benefits to junior advisors who are talented, but who are not in the running for equity ownership for one reason or another. It also opens up incentive opportunities for non-licensed staff (who might not be eligible for ownership) and a chance to recognize those who have greatly impacted the growth of the firm.

Synthetic equity can be tailored to match the scope of individual team members and their contributions, making it an effective tool for a variety of roles–and accessible to you as a next-generation professional, advisor or not.

It’s Your Decision, Too

Business owners are the ones to decide how and when equity opportunities are offered to their top professionals, and so synthetic equity is often framed in terms of what’s in it for them. As a next-generation talent in a growing firm, however, it’s just as important to understand how synthetic equity benefits you as you shape your career path.

Utilizing synthetic equity over an actual equity transfer depends on the unique situation at hand. Ownership and compensation options should be discussed between existing owners and next-generation professionals, as both parties need to agree on the incentive strategy employed. Whichever strategy you choose, it must benefit all parties, and most of all, the business itself.