Most growth-oriented business leaders have come to accept that they need to provide a way for employees to participate in the company value they help create. In particular, they know key performers expect to benefit from the revenue and profit growth they generate—and that to attract and retain such talent, the company needs to provide a long-term incentive plan. As a result, the question for most organizations is not whether or not they should have a plan, but rather who should participate and to what degree. So, let’s explore some guidelines that can help you make that determination.
Define Your Purpose
Before deciding who should be in your long-term incentive plan, you have to first decide why you are providing an LTIP. And the reason should not (solely) be because you think you need one to compete for the best talent. While that is important, if it is the only reason you have a plan, you run the risk of serving the needs of the people you are trying to recruit or retain but at the expense of shareholders. The reality is both interests are critical and so each should be included in your rationale for having a plan.
Here are some legitimate purposes for having an LTIP:
- Create a focus on long-term value-creation.
- Align employees with shareholder interests.
- Reward key contributors for fueling business growth.
- Accelerate an increase in company/owner value.
- Provide a mechanism for transitioning ownership of the business to someone else.
- Tie employee earnings to long-term performance—for example, revenue or profit increase.
- Build a unified financial vision for growing the business.
Once you define your purpose, it becomes easier to identify participant criteria. At least in part, your standards will be based on who can best help you accomplish those purposes as well as who you want to be influenced by those aims.
Determine Which Plan is Best
After deciding why you want a plan, the natural next question to consider is what type of plan you should have. There are nine different types of LTIPs and each carries its own implications for who should participate.
Restricted Stock, Stock Options, Performance Shares. These plans actually make participants owners in the business. As a result, they are typically offered to a limited few and then only under rare circumstances—at least in a private company setting.
Phantom Stock, Phantom Stock Options, SAR. Phantom equity arrangements do not dilute owner value nor do they involve the exchange of actual shares of stock. As a result, they are usually offered to a broader group of employees than stock plans, but are still limited in their participation scope. Phantom stock plans are essentially a deferred compensation arrangement tied to the value of the business. As a result, there are ERISA and 409(A) guidelines on who can participate. They can only be offered to management or highly compensated employees.
Profit Pool. Sharing value from a pool that is generated by the profits of the company has less restrictive participation requirements than either a stock or phantom stock plan. Here, the company can determine who will participate; there are no statutory limitations. However, these plans are most commonly offered to those whose role can actually “move the needle” on long-term profit growth. Broader groups of employees usually participate in short-term incentive plans tied to profit targets instead of the long-term profit pool.
Performance Unit Plan (PUP). This type of plan is used to reward performance over a two to five-year period. Performance units are assigned a “par” value when they are distributed. The value goes up or down depending on certain metrics the company designates. Units can be given out based on the achievement of certain performance criteria or on an ad hoc basis. Units distributed this year are cashed in three years from now (or at whatever maturity date the company designates). Next year’s units are cashed in three years hence, and so forth. These plans can be set up for as many employees as the company wants, although most organizations make them available to managers and above.
Strategic Deferred Compensation. Deferred compensation has been around for a long time. Strategic deferral plans are typically set up as a long-term incentive where the company makes a contribution based on the achievement of certain performance goals by the employee. Often, participants are also able to make contributions of their own as well. Some organizations set up their plans with primarily employee contributions and then make a matching contribution based on meeting certain performance thresholds. In any of those constructs, deferred compensation plans have the same statutory requirements as Phantom Stock. They are subject to ERISA and 409(A) and can only be provided for a select group of management or highly compensated employees.
Your plan choice should align with your purpose in having a plan. Those two factors alone carry inherent criteria for who should participate.
Use Talent-Based Criteria
After deciding the reason you are offering a plan, and deciding which plan is best, you should then make a list of participation criteria that is consistent with your overall pay philosophy. Here are a few questions that can help you determine what might be included in those standards:
- Do you have employees that have made contributions to company growth over an extended period of time but have not yet participated in the value they helped create?
- Do you have strategic leaders in the business who have been given charge to achieve certain outcomes for the company that are key to its growth?
- Is there a certain type or class of talent you most need to recruit and retain?
- Are there certain employees for whom you want to provide an incentive to sustain performance over an extended period of time?
- Are some employees more in a position to impact company growth than others?
- Do you have employees that you want to make owners in the business?
- Do you have multiple “tiers” within your workforce that makes it easier to identify the employee level to which business growth can best be attributed?
- Are there certain types of employees for whom you need to provide a long-term plan in order to attract or keep them?
There are certainly other questions that could be posed, but hopefully these give you some sense for what should be considered in determining eligibility for your LTIP.
Getting clear on these issues is important in the highly competitive talent market that currently exists. Organizations will need a strong value-sharing philosophy and a compelling pay strategy if they expect to attract the people that will help them accelerate their growth and establish them as a superior employer brand.