The Use of Equity Incentive Plans in a Family-Owned Business

Boscov’s Department Store: A Family Business Succession Story That So Far, Equals SuccessFamily businesses continue to struggle with attracting and retaining top talent. Compensation levels continue to rise at a faster pace than most companies can increase prices, thus creating a margin compression on profits. So what enticements can a family business offer beyond salary and bonus to attract and retain high quality employees without further eroding margins?

In addition to a real cultural advantage that a family business can offer to talented employees, it can also consider alternate methods of compensation in the form of equity incentive plans. As you can imagine, there are many different types and uses for these plans. At the end of the day, they all share one common goal: keep an employee engaged in the business and retain them for the long-term.

Long-term incentive plans generally fall into one of three broad buckets: stock/equity plans, phantom stock plans, or financial metric plans. Here is a summary that highlights the main features and uses of each of these types of plans.

Stock/Equity Plans

Stock plans (or, if your company doesn’t have stock, equity plans such as in a partnership or limited liability company) are more commonly used in large privately-held companies or with publicly-traded companies. One of the main reasons is that these types of plans require regular valuations of the business in order to properly account for them. Public companies have a readily determinable value, while private companies need to go through the exercise of completing a formal business valuation.

At a high level, in an equity/stock plan, the owners are offering plan participants the right to acquire tangible ownership of the family company in the form of restricted stock or stock options. Once these options are exercised, the participants become partial owners of the company.

Phantom Stock Plans

Phantom stock plans are popular amongst privately-held and family-owned businesses because they provide a compensation incentive without diluting the current ownership via actual shares of stock or units of equity. The employee’s benefit is tied to the company’s value, providing him or her the opportunity to participate in what everyone hopes will be an increase in the company’s growth. There is flexibility when setting up these plans, so they can be customized to a certain degree in a manner that meets the individual needs of the participants.

Financial Metric Plans

Lastly, financial metric plans involve creating profit pools or deferred compensation plans. Profit pools are one of the simplest forms of long-term incentives, whereby the company takes a percentage of profits to create a pool, and allocates those dollars to the participants of the plan. These allocations are paid out over a period of time and the benefits compound as profits are added each year.

Deferred compensation plans, on the other hand, are a promise the company makes to pay an employee an amount at a later point in time. These payments can be an annuity stream or a lump sum. Payouts for deferred compensation plans are tied to a triggering event such as retirement or a change in control event.

As you can see, there are many compensation options available to family-owned businesses beyond traditional salary and bonus. For more information on this topic, register for our seminar on June 14 where we will be covering equity incentive plans in more detail, with a focus on phantom stock plans.

Steven E. Staugaitis is a director at Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email or 215.441.4600.

 

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