Family-owned businesses often cherish the hard equity they have created over multiple generations and parting with it is often very difficult. Many businesses realize that hiring talented outsiders who can bring a fresh perspective is a key to continued growth and prosperity, but they do not want to give away their ownership in the process. Incorporating long-term compensation incentives, along with a competitive salary and benefits, is a solution.
Long-term compensation plans can align company goals with employees, encourage constant improvements and efficiencies in running the business, and attract and retain outside talent. So what are these long-term compensation incentives and how do they work? Below is a summary of the three most common categories of long-term incentive plans.
Phantom Stock Plans
Phantom stock plans are a form of deferred compensation plan. They are often created as a stock appreciation or a full value plan. In a stock appreciation plan, the participant receives the increase in value of the company as their compensation. In a full value plan, the participant receives not only the increase in the company’s value, but also the starting value that was initially granted. There is also a performance plan, which only grants the participant shares of phantom stock after obtaining certain pre-determined financial metrics.
As the phantom stock name implies, there is no allocation of actual equity. The valuation of the company is simply a means to track the change in the performance of the business, which allows for a means to calculate and allocate that increase in value.
Financial Metric Plans
There are three common forms of financial metric plans: performance plans, profit pools, and strategic deferred compensation plans. In a performance plan, the company determines financial metrics that will need to be obtained in order for future cash payments to be made. Often, a table will be created to demonstrate the effects of reaching certain targets.
In a profit pool plan, the company establishes a percentage of the profits it will allocate to the pool for employees. Baseline profits can be incorporated into the plan to ensure payments only occur at certain levels. Often, only a percentage of a profit pool is distributed at the end of the year, with the remaining portion rolling into the subsequent year.
In a strategic deferred compensation plan, specific amounts are allocated to an account that tracks the benefit. The funding of this type of plan can be made in cash, but in either case must be tracked appropriately.
The end result of equity plans is the distribution of actual ownership, so they are often not found in family businesses. However, they are worth noting. Equity plans are a type of long-term incentive that gives away actual ownership in the business. They include stock option plans and performance share plans. A stock option plan allows an employee to purchase equity in the company at a future date, but at a more attractive price. In a performance share plan, the company establishes specific financial metrics that, when achieved, will trigger the issuance of equity to participating employees.
There are many options when it comes to long-term incentive compensation plans. These plans allow you to achieve the balance of attracting and retaining talent, while still being able to keep the family business in the family.