October 17th, 2011 by Tom Miller
Can Sally (our national sales leader) buy phantom stock from the company? Is such a thing possible?
In fact, we can sell Sally phantom shares. Let’s see how it would work.
This is referred to as a Deferred Stock Unit plan—a form of deferred compensation. Sally would be given the opportunity to defer some of her cash compensation (e.g., salary or bonus) into units of phantom stock. Said differently, Sally would “convert” some of her future pay to phantom stock.
An example: Assume Sally makes $200,000 in annual salary. She might defer up to 25% (or more, or less) of her salary into the plan. Assuming she does so she would acquire a deferred compensation interest that would have $50,000 worth of starting value. In other words, she would have 5,000 units of phantom stock (at $10/share) credited to her deferred comp account.
In reality, you’re not selling shares to her. That is, she’s not acquiring an ownership right in exchange for writing you a check. She’s deferring some of her income into an unsecured bookkeeping account that is measured by the growth of the phantom share price. But it has the same essential effect as selling Sally phantom shares. She is voluntarily foregoing wages in order to ‘invest’ in the company! That’s a pretty serious commitment. We’re definitely building an ownership mentality.
Plus, it’s much better for Sally tax-wise than buying actual stock. Why? Because she gets to do it with pre-tax dollars.
Tax-wise for you it’s not perfect, but it’s not so bad. You (or the company) will forego the current tax deduction on the income Sally chooses to defer. However, it’s a delayed deduction, not a lost deduction. Instead, of getting the deduction today of $50,000 (wages) you’ll get the future deduction on $90,000 (assuming our EBITDA growth example given in my previous blog).
This is a pretty flexible and promising arrangement when you have employees who believe in the future of the company and an owner who’s willing to share that growth—for a price.
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | 2 Comments »
October 6th, 2011 by Tom Miller
So we’ve agreed (haven’t we?) that some form of phantom stock is likely to be better for private businesses. I mentioned that there are
three types of plans that may fit. Here’s the first.
Full value grant. We could give Sally (our senior sales executive) some shares that are valued, in full, at $10 per unit. We’re going to specify some conditions and restrictions (to be discussed later). Nonetheless, we’re committing the full $10 in value times the number of shares we decide to give her. If we give her 5,000 shares she’ll start with a true value of $50,000 (subject to vesting and other restrictions). At some future date she’ll redeem those awards for real cash. Assuming EBITDA grows to $18mm (from $10mm) on her
redemption date, Sally will receive a check for $90,000.
What about Sally’s taxes? Well, remember that with actual stock awards Sally would pay taxes when she received the grant or when the vesting lapsed. With phantom awards, Sally pays no taxes until she actually receives her award value (e.g., the $90k). In this way, she
never has to pay income taxes until she’s in receipt of the actual cash. It’s true that had she received actual stock (and paid the taxes up front) she might have saved some taxes in the long run. However, with phantom stock your tax deduction (i.e., the company’s) is higher than it would have been with actual stock. In the first case (actual stock), your deduction was for $50,000, thus a tax benefit of $20,000 (assuming 40% bracket). With the phantom stock example, you get to deduct the full $90,000, resulting in a tax benefit of $36,000. If
you’re feeling guilty about Sally’s taxes go ahead and give her more shares, enough to result in your “after-tax cost” being the same.
A full-value award of phantom stock may be just right for Sally. But generally, we suggest it only for those special employees who have been involved with the company for some time (i.e., they’ve earned some of the value that exists now). There are better ways for most employees.
Next time: Can we sell phantom shares to employees?
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | 1 Comment »
September 28th, 2011 by Tom Miller
In my last blog I began the discussion of phantom stock—and why it’s often better for the employer and the employees. Here’s how to go about establishing a plan.
- First, you must establish a way to value the phantom shares. In essence, you’re trying to identify the value of the company. You can obtain a formal appraisal or you can establish the value by a formula. The latter will work best in most
situations. Perhaps the formula will reflect a multiple of EBITDA or Net Income. Any reasonable formula can work. To be safe, use a formula that is going to be less than the actual fair market value you might sell the company for some day. You don’t want the employees’ phantom shares to be valued higher than your own.
- The next step is to create some phantom shares. Pick a number—1 million, 10 million—the number doesn’t matter as long as you have enough to make the plan work with the number of eligible participants you anticipate. This part can sometimes seem confusing or cause concern. “Wait,” you might be thinking, “shouldn’t I use the same number of shares we have outstanding in the company? Aren’t I trying to ‘shadow’ the movement of actual stock?” Actually, no. We don’t like the term ‘shadow stock’ because we’re not trying to replicate actual shares. We’re simply trying to provide an attractive award for employees at a future date. As you’ll see, it doesn’t matter whether there are more or fewer shares
in the plan than in your company. Let’s do an example using EBITDA (earnings before interest, taxes, depreciation and amortization) as our value indictor:
EBITDA $10,000,000
Multiple selected 5
Formula Value $50,000,000
Shares selected 5,000,000
Starting share price $10
3. Now let’s design our plan. Remember that with actual stock plans we had three choices: (a) give shares, (b) sell shares, or (c) give options (to buy in the future at today’s price). Guess what? We have the same three options. We can simply award Sally (our national sales leader) some phantom shares. Or we can “sell” her some. Or we can create a phantom option.
Coming up—we’ll look at all three of these options using phantom shares.
Posted in Business Growth & Compensation, Business Growth and Rewards, Incentive Planning, Key Talent Compensation, Phantom Stock | 1 Comment »
September 15th, 2011 by Ken Gibson
I have recently become somewhat a student of innovation; particularly looking at how great companies and individuals manage to get ideas and products implemented while others stop and stall. Among the things I’ve assimilated in that learning process are the following:
- Great innovators associate. Those that are prone to effective innovation are constantly associating one idea or experience with others. They also systemitize the association process so that it occurs regular and naturally.
- Great innovators question everything. Their curiosity is insatiable and they want to get to the bottom of things. Why are things the way they are? Do they need to be like that?
- Great innovators network. They want to associate with people that have a broad range of backgrounds and experiences so their life view is expansive and their feedback loop is broad.
- Great innovators seek feedback. They want to know what others think before they introduce a product to market. They want it tested. It doesn’t have to be perfect, but it has to meet the right need in the right way.
- Great innovators have a bias towards action. Innovating is not dreaming or wishing or even just being creative. It is about getting ideas implemented and working in a way that transforms the end user’s experience.
There’s more I’ve learned, but let’s work with that list for now. As we examine it in the context of compensation there are some important issues to consider. A company’s approach to building effective rewards needs to follow a similar process:
- Those that develop compensation programs need to be able to view compensation as a dynamic tool and ”associate” each component both with other elements of pay and with the business model of the company. As the company’s innovation cycle continues and expands, the approach to rewards needs to be able to reflect that new reality.
- If individuals are going to create an “innovative” rewards structure, they have to be willing to question everything. What is the outcome we’re trying to drive? Why is that important? How should that outcome be rewarded? When should it be rewarded?
- Innovative companies look beyond the “network” of their own industry in seeking creative ways to properly reward people for value creation. They don’t think in terms of what the peer companies in their “space” are doing. They look at what great, innovative companies are doing and then take lessons from their approaches to everything, including pay.
- Businesses that are effective at every level have a continuous feedback system in place. They measure and assess. They look at data and make decisions based on what that data reveals. Similarly, they seek feedback from their workforce about whether they are succeeeding at creating a sense of partnership, painting a compelling vision and building a sense of unity about the outcomes being pursued. If they aren’t, they use pay as one of their strategic tools to target a better result.
- Companies that get compensation right usually get a lot of other things right because they are prone to act. They don’t let the pursuit of the perfect paralyze them from taking action. They get close enough, they stay focused, they get it done, roll it out and then make adjustments as they need to.
As you approach bettering the compensation strategies you wish to adopt, hopefully you will likewise become a student of innovation. If you do, the horizon of possibilities will expand and your ability to drive results will be magnified.
Tags: breakthrough success, Culture of Confidence, Pay for performance, Sustained Results
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Key Talent Compensation | No Comments »
September 9th, 2011 by Tom Miller
In my last three blogs I discussed why stock ownership for employees may not be such a good idea. So what’s better?
Phantom Stock—A Better Approach
Each of the ideas for Sally (our Sales VP) had merit. Granting stock is simple and clear-cut. It provides instant recognition and value. It’s great, particularly, for someone who’s been with you for awhile and has made a contribution to your past success. But, the concept carries the baggage we described.
Having Sally buy stock also is intriguing. It deepens her commitment and aligns her with both short-term and long-term goals of the company. But again, baggage.
Stock options are attractive because they’re win-win. Sally only wins if shareholders see their stock value go up. Sally is tied to future growth of the company. But…complexity, cash flow problems (i.e., baggage)
What if we could replicate any or all of these approaches without making Sally an actual owner? Is it possible to generate the ownership value and mentality without the baggage? In a word, yes. We can do it with phantom stock.
Phantom Stock Defined
A phantom stock plan is a contractual agreement wherein a company promises to make cash payments to employees upon the achievement of certain conditions. What’s the purpose? Just as with stock awards, the purpose of a phantom stock plan is to generate an ownership mentality and reward key employees for helping to grow the business value.
However, phantom stock has one big advantage—no sharing of actual equity with the employees. No requirement to open the books. No ownership rights. No need to pay dividends (although some plans do). The existing owners stay in control of 100% of the stock or interest in the company.
At the same time, phantom stock can create comparable or even identical value as actual stock. Next time I’ll outline some of the positive things that happen when you create a plan on behalf of employees–and the ways to do it right.
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | No Comments »
August 31st, 2011 by Tom Miller
We’ve looked at restricted stock and stock purchase plans. There’s an even more common way to get stock in the hands of employees.
Of course: stock options. Public companies use them commonly. Why shouldn’t you? This would enable Sally (your national sales director) to get some stock at a fair price and help her get capital gain taxation if you sell the company some day.
Maybe. Maybe not.
First of all we still have a cash-flow concern. Sally will need to come up with enough cash to exercise her option after the vesting period has passed. Let’s say the stock is worth $10 today and you give her 5,000 options to buy the stock at that price. Her three year vesting period passes and Sally scrapes together the $50,000 to exercise her options. Let’s assume the company share price has grown to $18 in the meantime. She now has $40,000 of new equity value (($18-$10) X 5,000). How do the taxes work?
There are two different types of options—nonqualified and qualified (or incentive). This isn’t the place to cover the differences in taxes—except to say that incentive options, generally, produce a better tax result for Sally and a worse tax result for you. Meanwhile, Sally may now be in a position to benefit from a future transaction (i.e., sale of the company or IPO) assuming the event occurs at least a year from the date of the exercise of the options.
However, what if neither event ever occurs? You’re back to our original problems of redemptions, dividends, etc. In my “30 plus” years experience coaching companies on these plans I’ve seen many more situations where the “future transaction” doesn’t happen, than it does happen. As a result the majority owner and the owner-employee face the grind of negotiating a “fair” price for the stock at the time of a future separation of service. How well do you think you’ll enjoy that future conversation with Sally’s attorney?
The bottom line: the financial results of stock or stock option awards can appear to justify the effort—under the perfect circumstances. But reality is never as simple as you expect it to be. The majority of private company owners will regret the move to stock awards for employees. The perceived value of employee ownership is, nine times out of ten, not nearly worth the price.[1]
So what should we do instead. Stay tuned.
[1] The author acknowledges the primary exception to the rule: if your company is on a clearly lit IPO track, stock options offer an excellent and efficient way to reward employees.
Tags: Company stock options, employee stock, employee stock ownership, private company stock, restricted stock, restricted stock units
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation | No Comments »
August 29th, 2011 by Tom Miller
Last time we looked at the possibility of granting restricted shares to Sally, the head of your national sales team. We pointed out some of the pitfalls. What other approaches do business owners take to get stock in the hands of their leadership teams. After all, creating an ownership connection with employees sounds like a great idea.
Second approach: Sally could buy stock. Now she’s putting her own money into the deal. Investing her own capital will tie Sally more closely to the success of the company. Hopefully so. It’s not the worst of ideas. But, you still have many of the same problems discussed last time. The open books. The discussion about your compensation. The little chat about the size of dividends. Redemption issues. Buy-and-sell agreements. Termination-of-employment loose ends. And does Sally even have the cash to buy in? If she was going to be concerned about the taxes on a grant, how is she going to come up with the full amount needed to purchase the shares?
Maybe you’ll think it’s a good idea to lend her the money. Think about that one. You’ll loan her the money that she can give back to you (to buy the stock) so that you can have all the headaches described above? Some employers envision allowing her to use her share of company dividends to repay the loan. How is this any different than giving her stock in the first place—you’re paying yourself back for helping her buy some of your stock by reducing the dividends you would otherwise have been entitled to? That’s quite a partnership!
There’s gotta be a better way! Next time: Approach #3.
Tags: phantom stock, sharing stock, stock options
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation | No Comments »
August 24th, 2011 by Tom Miller
Let’s take a look at three different ways to get stock in the hands of Sally, the leader of your national sales team. Here’s how you could do it—and the potential consequences. Today–approach #1.
You can simply give Sally some stock. More formally, this is a Restricted Stock Grant (or one of its variations). Congratulations, you have a new partner-shareholder. She’ll be entitled to take a look at the books. She may want to discuss the new compensation program—hers and yours! She’ll be entitled to her share of profit distributions. And so on. You get the idea. Of course, you’ll control the majority of the shares and the final decisions. But the nuisance factor may become intense. If you’re lucky, Sally won’t be interested in those details. She’ll trust you and be truly grateful for the award—so she won’t want to cause problems. That’s good.
But we have to consider the tax consequences. Your award of stock to Sally results in an immediate tax cost for her. Let’s say your accountant tells you your stock is worth $10 per share. If you give her 5,000 shares that’s $50,000 of value. Sally will need to pay taxes on that value. As far as the IRS is concerned, it’s as if you gave her $50,000 of cash. Now, assuming you placed restrictions (like a vesting schedule) on the shares (which you should do), she could defer the income taxes until she vests. However, if your share price goes up (which you’re both hoping for) she’ll wind up paying taxes on the higher amount.
Sally will love the idea of getting stock, but she may not love the idea of coming up with the money to pay the taxes. There are more potential problems ahead. What if things don’t work out with Sally? If you let her go (or if she chooses to move on) what will become of her shares? Will you buy them back? Or will she just retain them? You’ll really like the latter solution when you discover that Sally went to work for a competitor. By the way, if you do buy them back how will the value be determined? And don’t expect a tax deduction for the redemption. You’ll buy them back with after-tax dollars. I could go on, but you get the idea. Making employees shareholders opens up a Pandora’s Box of potential headaches.
Next time: Approach #2
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation | No Comments »
August 17th, 2011 by Ken Gibson
Engagement is one of the Holy Grails in business. Every organization seeks it in its workforce. Most company leaders can’t define it, but they know it when they see it…and they know it’s what’s missing when the business fails to reach its potential. Engaged employees are like fuel to company growth and those who aren’t make everything move in slow motion.
For an employee to become “engaged,” a company must address what I refer to as “The Three ‘Cs’.” They go like this.
Engagement emerges when an employee feels:
- Compelled–the business has a compelling future and the employee sees how his unique ability can contribute to its fulfillment. This is about shared vision and values.
- Clarity–leadership gives the employee a clear understanding of the business model and strategy what will fulfill the vision, what role he has in that plan and what’s expected of him in that role, and how he will be rewarded if he fulfills those expectations.
- Connection–the employee feels a sense of partnership with company owners. Whether or not equity is shared, he understands there is a philosophy about value creation and value sharing that is fair. As a result, all stake holders feel connected.
Well, if that’s what it takes to secure an engaged employee, what will the result look and “taste” like once it’s achieved? In my experience, companies that nurture engagement end up with employees that manifest that quality in each of three ways:
- Focus–more time is spent on the “best” results that can be achieved, not just good or better. There is an outcome rather than a task orientation that is evident. The employee “gets” what result the company is looking for and displays a sense of stewardship about it.
- Commitment–company leaders see that the employee has taken ownership of the future in a similar way that shareholders have. It is apparent that it is meaningful to him for the company to achieve its vision because he knows what it will mean to him personally.
- Shared Purpose–an engaged employees demonstrate a contribution ethic that extends beyond his specific role in the company. It is a manifestation of the shared purpose he has with co-workers, other teams or departments and with ownership. This means he behaves in a way that demonstrates his understanding of the interdependent nature of the independent roles throughout the organization. He understands that today he may depend on someone else, but tomorrow that same associate may depend on him to achieve a desired result in which all have a stake.
In my experience, companies that use compensation as the strategic tool it is intended to be see rewards as one means of smoothing if not reinforcing the path to engagement. For example, they offer employees a long-term incentive plan that fosters the shared purpose indicated above. It’s payout metrics are tied to a combination of company-wide performance, team or department performance and individual performance. Such an approach nourishes a culture of contribution–because all have a financial stake that evokes a kind of “moral” bond with their associates. If I fail in my stewardship, it doesn’t just impact me and if you slow down, I am also affected.
Leadership, then, should examine its current practices through a kind of reverse engineering process. It starts by asking whether the workforce is currently, as a whole, manifesting outward signs of engagement (focus, commitment, shared purpose). If not, it should then ask what can be done to promote a compelling vision, create greater clarity and enable the sense of connection and partnership that are foundational to engagement. In the process, it should be sure to ask itself whether current compensation practices are more likely or less to promote the outcomes just discussed.
It is realistic to anticipate a fully engaged workforce? It is. I’ve seen it first hand. For one example, see my blog entitled: “What a Competitive Advantage Sounds Like.” The concept is further developed in another blog posting entitled: “Compensation and Trust.” Finally, to learn how to get from an entitlement mentality to engagement, view our recent webinar entitled: “What to do When your Employees Act Entitled.”
Tags: Applied Medical, breakthrough success, compensation, compensation philosophy and strategy, Culture of Confidence, Employee Trust, Growth, key people, Pay for performance, Sustained Results
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Incentive Planning, Managing Talent | No Comments »
August 10th, 2011 by Ken Gibson
Pay can either be an asset or a liability to a company. Stated another way, it can either drive growth or hinder it– fuel performance or diminish it. Is that placing too big a burden on compensation to produce results? I don’t think so. In fact, my experience and observation has been that most businesses don’t set high enough expectations for their rewards programs. The evidence is they don’t invole compensation in other strategic discussions. The result is there is little to no link established between pay and the key success measures the company needs to reach.
To change this outcome a company must alter how it makes compensation decisions. Here I would like to suggest five of the key issues a business must include and successfully address in its decision making process if it wants to drive better results in the execution, productivity and performance of its people. Here are the five presented in the form of questions to be answered:
- How can we reinforce our business model through the way we pay our people? Implied in this decision is a company’s ability to clearly articulate its business model and distinguish it from it’s business strategy. (For more information on this distinction, view our recent webinar entitled: Compensation Strategy and Business Strategy, An Interdependent Relationship.) Walmart and Four Seasons Hotels have very different business models, so their approach to pay would need to reflect that difference. Presumably, your business will be equally distinct. So in this category two essential issues need to be addressed: A)What outcomes reinforce the core virtuous cycles of your business model? B)What kind of pay strategies will best reinforce those outcomes?
- What kind of value-sharing approach best reflects the kind of partnership we want to have with our employees? I prefer the term value sharing to incentives because the latter implies that someone needs a carrot to become motivated. Value sharing, on the other hand, implies all stakeholders deserve to participate in the value they help create. Company leaders must think in these terms as they approach the building of short and long-term rewards programs. Such programs must be self-financing (no dollars paid unless results are produced at a sufficiently high level) on the one hand and yet meaningful to participants (employees want to see them achieved because the payout helps them fulfill their personal financial needs and goals) on the other.
- What pay components will best foster a unified financial vision for growing the business? This issue has to do with how employees will be paid as opposed to how much. Addressing this issue forces a company to develop a basic rewards philosophy. Where do you want to be vis a vis market pay for salaries? How about for total compensation? It asks a company to think about the elements of pay that will best foster an ownership mentality throughout the organization, so employees are empowered in their decision making and more instinctively act in the long-term interests of shareholders and all other stake holders.
- What structure do we need to maintain to ensure our compensation strategies produce the desired results? Structure has to do with organization and process. A company needs to have a systemitized means of assessing performance and productivity and then “pivoting” in a different direction if necessary. The structure continues to keep strategy front and center with a constant eye on cost and productivity. For most companies, this means there should be a compensation committee established with a regular meeting schedule (no less than twice a year) to review and make decisions about these issues.
- How can we communicate our rewards strategies in a way that best impacts the mindset of our employees? If effective, a strategic approach to building rewards programs should result in more engaged employees. This does not come by simply rolling out a great compensation plan. Engagement is built over time through a reinforcement process that integrates the discussion about pay into an overall strategy and business plan review to which all stake holders are exposed. As employees come to work each day, there should be a clear connection in their minds between the following: A) The vision of the company–where it’s headed; B) The business model and strategy of the company–how it’s vision will be fulfilled; C) The role and expectations of the employee within that model and strategy–defining the stewardship, and; D) How the employee will be rewarded if he or she meets the expectations–including the range of pay potential.
Certainly, more could be added to that list. However, if a company attempts to address even one of the five decisions summarized here they will naturally be lead to the other four. You will see that they are really interdependent in nature. Likewise, other core decisions will emerge such has what balance should there be between short and long-term value sharing plans, and what type of long-term rewards ”incentive” should a company adopt (equity sharing, profit pool, phantom stock, stock appreciation rights, etc.)? Most will need help answering all of the questions that will emerge, but it must start with a foundational commitment to becoming more strategic in your approach to rewards development.
The promise is that, if incorporated, this list of five core decisions will help ensure that compensation will become an asset rather than a liability in your organization.
Tags: compensation philosophy and strategy, Employee Trust, Growth, incentives, long-term shareholder value, Pay for performance, Sustained Results
Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation | No Comments »
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