Building Unified Financial Visions

Tom Miller
June 28th, 2010 by Tom Miller

So What Makes a ‘Good’ Phantom Stock Plan?

In my last blog I described the 5 biggest mistakes made by companies that adopt phantom stock plans. Today—the 5 best innovations that can make your plan a driver of performance and value.

  • Determine how much value you want to share with employees before you begin to design the plan. To do this, you need to model company growth under reasonable scenarios and see how much new value would be created for shareholders. Then, and only then, can you begin to consider how much of that new added value should go to your key employees. For most companies this would range between 5% and 20%.
  • Now that you have a “budget” for the plan you can back into annual awards. But first you’ll have to set a phantom value. Do this by creating a Formula Value (FV) for the company. The FV might be a reasonable multiple of earnings (or EBITDA, whatever you prefer). You’ll probably want to subtract long-term debt. Then pick a hypothetical number of phantom shares, e.g., 1,000,000. Divide your shares into your FV and, voila, you’ve got a share price.
  • Now pick your participants (and allow for some future ones). Begin to place some number of phantom shares into their account annually (we’re still doing this in a model spreadsheet—not for real yet). There are a number of good techniques for doing this—but not enough space to discuss here). Work the numbers until the values seem right—and you’re within your budget.
  • As you see how the shares grow in value you’ll realize that you need to determine when they’ll be redeemed (paid in cash to the participants). We typically recommend payouts starting 5-7 years from the year of grant. Don’t wait until “retirement” as employees will learn the only way they can get cash is to quit.
  • When you complete and document your plan you’re ready for a roll-out. Make that meeting meaningful. Help the employees see that you’re trusting them with the creation of your future company and that you plan to reward them well for making it happen.

Don’t be stingy. If your key management team creates millions for you, the least you can do is make them feel like shareholders—at least financially. Every company that expects to be bigger in the future than they are today needs some type of long-term incentive plan. A phantom stock plan just might be the key to tying your leadership team to the creation of that future company.

Of course there are a number of other things to do to make a phantom stock plan work. But these five will get you off to a good start.

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Posted in Business Growth & Compensation, Business Growth and Rewards, Current Pay Trends and Topics, Incentive Planning | No Comments »

Tom Miller
June 11th, 2010 by Tom Miller

What Think Ye of Phantom Stock? Does it Work?

Twenty years ago very few people were familiar with the concept of ‘phantom stock.’ Today, most business owners are familiar with the term—and many have strong opinions about whether they work or not. Do they?

 For a plan to  ‘work’ it should: (a) provide a meaningful reward for employees if the value of the company goes up over time, and (b) serve as an effective retention tool for key employees.

 I’ve designed a lot of phantom stock plans over the years. And I’ve seen many more that were put into place by others. I’ll offer up, first, some of the biggest mistakes I’ve seen in phantom stock plans. And in my next blog I’ll offer up the most innovative and effective practices that can make a plan, possibly, the most effective compensation plan you’ve ever utilized.

 Here are the top 5 mistakes to make when designing a phantom stock plan (if you really want to do it wrong):

  • Require that the plan valuation be determined by a formal appraisal. Result: significant, unnecessary, periodic expenses for the company.
  • Be sure to use the actual number of company shares for the number of shares in the phantom stock plan. Result: the plan will be very confusing and complicated whenever you try to conduct routine corporate shareholder transactions (redeem shares, issue new shares, etc.).
  • Issue “shares” in a block grant up front. Results: certain regrets later on when you realize you gave too much to some people and you have too few new shares to award to others; also, people will probably vest in all their shares before you really want them to.
  • Pay annual dividends to the “phantom shareholders.” Results: a completely unnecessary drain on company cash.; plus, no alignment or retention purposes whatsoever.
  • Have an attorney help you design the plan. Result: (with apologies to my attorney friends) this results in an overly technical plan without ‘real world’ practical and compelling provisions. (Tip–let the attorney document after the creative discussions have been conducted.)

These 5 steps will insure you years of headaches, regrets and costs. Any you’ll be sure to lower productivity, worsen retention and diminish shareholder value. In my book, that doesn’t ‘work.

 Next blog—best practices tips for plans that really work.

Posted in Business Growth & Compensation, Business Growth and Rewards, Current Pay Trends and Topics, Incentive Planning, Phantom Stock, Uncategorized | No Comments »

Ken Gibson
June 10th, 2010 by Ken Gibson

Is Your Compensation Plan Driving or Hindering Growth?

Ask any CEO or owner that question and chances are you will get a response something like this: “Hmmm. Not sure.”  Ask the same CEO what the largest budget item is on the company’s financial statement and the response will likely be: “Compensation.”  Does anyone see the disconnect here?  How can a company leader not know whether the highest financial investment the company is making is driving or hindering growth?

This happens, of course,  because most companies don’t have mechansims for assessing the impact rewards are having on critical performance indicators and outcomes.  And so they continue to pour millions of dollars into something that isn’t being measured (for results) in the same way other large capital investments are evaluated.  (Sounds like a government entitlement program to me….but that’s for another blog.)

For a business to get its arms around this concept, it must be able to determine both the soft and the hard criteria it will use to measure the relative success of a given compensation strategy.

Soft Results

These outcomes don’t show up on the income statement or balance sheet, but they have a real impact on the financial results of the company.  And they can be measured.  Essentially, these fall into the following categories:

Partnership–Do employees feel like participating partners in the company’s business successes?  If compensation isn’t creating this link in the minds of employees, they aren’t mentally participating in the company in the same way as ownership.

Clarity–Through compensation, does the company effectively communicate and reinforce its organizational standards and the value of the total rewards opportunity?  In other words, do employees make a connection between the financial results of the company and the fulfillment of their own financial objectives–in a non-manipulative fashion?

Engagement–Has the company achieved a crucial level of employee commitment, passion and execution?  Is compensation creating a sense of stewardship that reinforces the intrinsic motivation all employees need to perform at the highest levels?

These areas can be effectively measured through carefully engineered surveys.  VisionLink’s Alignment Appraisal is one such tool for performing an assessment of this type but you may be able to come up with your own.  Regardless of the tool used, if these issues aren’t being measured, you don’t yet really know whether your compensation strategies are driving or hindering growth.

Hard Results

When it comes to  outcomes that have a real dollar impact, the issue becomes one of measuring productivity.  How does the business determine the amount of value that is created through financial capital at work in the company as opposed to the productive output of its people?  To make this contrast, the company should consider performing an analysis such as VisionLink’s ROTRI calulation.  Here are the figures measured and contrasted in such a process:

  1. Determine the total investment currently being made by the company in all rewards programs–salaries, commissions, bonuses, benefits, long-term incentives, etc.
  2.  Identify a capital account for the company–all cash, equipment, inventory, etc.
  3. Assign a cost to that capital account–an amount such as your borrowing rate or a  return you feel shareholders should expect to receive on that working capital (10 to 12% are typical).  We’ll call this your “capital charge.”
  4. Determine the company’s most recent 12-month net operating profit, after tax (NOPAT).
  5. Subtract the capital charge from the NOPAT.  We will call this your “productivity profit”–the amount you will consider attributable to people capital at work as opposed to financial capital at work in your business.
  6. Divide your total rewards investment into the productivity profit.  This becomes your ROTRI percentage.

Once you arrive at your ROTRI figure, you will likely instinctively ask, “is this good or bad?”  Actually, it’s neither.  For now, its just a benchmark–and your ROTRI will be different from another company’s percentage depending on margins and a number of other factors.  The key issue is whether or not your ROTRI improves year to year.  If it does, then you can conclude that productivity is improving.  If productivity is improving, it is easier to conclude that your rewards strategies are having a positive impact on results–therefore they are driving rather than hindering growth.

Don’t Be Caught without an Answer

In summary, if you are leading an organization, you don’t want to be left wondering whether your company’s largest financial investment is draining or fueling  growth.  You need to know.  Hopefully, some of the measures indicated above will help you get a jump start on figuring out what your answer will be going forward.

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