Long-Term Incentive Compensation for Private Company

March 15, 20193:40 pm3611 views

According to Investopedia, “Long-term incentive (LTI) is a reward system designed to improve employees’ long-term performance by providing rewards that might not be tied to the company’s share price.” This reward plan is designed to reward employee, especially executives, for achievements in terms of company’s strategic objectives that will maximise shareholder value. Additionally, long-term incentive plan is important for company because according to the Garner Group, it can:

  • help attract and retain high-performing executives,
  • successfully compete with public companies in attracting high calibre executives,
  • align executive employee’s financial interests with that of the shareholders/investors, and
  • help executives focus on behaviour and decision making on long-term company goals

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According to Thomas B. Wilson, president of Wilson Group, public and private company need to have LTI plan. While public companies have to expense options and restricted stock, the gain that is realised is paid for by outside investors. This is not true in a private company unless the objective is to sell the company to outside investors. Therefore, LTI plan from private company needs to be thoughtfully created than that in public companies.

How does private company create their LTI plan?

LTI is used because organisation needs a leadership team who cares about their growth, sustainable profitability, and long-term value of company. This is concern of most business owners, commented Wilson. So, right question to ask is whether you want your executives to be hired-gun or adopted into family business. This is how you will create a LTI plan you needed.  

Executive should be included in your LTI plan

Most private business start with CEO to be their man in charge of LTI plan. However, if your CEO comes from outside, equity is needed especially if you want him to think more like an owner than a hired gun. After CEO, these plans are expanded to senior management or leadership team. “LTI plans usually stop there, but there are a number of firms that use stock options or restricted stock as performance based recognition awards to all or many employees,” added Wilson.

Long-term incentive

According to World at Work report on “Incentive Pay Practice: Privately Held Companies”, 54 percent private company offers LTI plan because of the complexity of setting up these plans. In 2017, the number of companies offering more than one LTI plan increase only slightly with primary objectives are to retain employees (62 percent), align employees with long-term goal (62 percent), and be competitive with other firms (41 percent). Moreover, there are strategies can be used to create LTI such as:

01  Stock option – a contractual right granted by company to purchase a specified number of shares of company’s stock at specified price and period of time.

02  Restricted stock – grants of shares of company’s stock subject to restrictions on sale and risk of forfeiture until vested by continued employment.

03  Restricted stock unit (RSU) – grant valued in terms of company stock. Company distributed shares or cash equivalent of shared numbers.

04  Phantom stock – type of incentive grant in which recipient is not issued actual shares of stock on grant date but receives an account credited with certain number of shares.

05  Stock appreciation right (SAR) – contractual right that allows an individual to receive cash or stock of value.

06  Long-term cash plan – cash awards in which payment is contingent on performance as measured against predetermined financial or strategic objectives.

07  Performance shares – grant of actual shares of stock with payment that is contingent on performance as measured against predetermined objectives.

08  Performance units – grants of dollar-dominated unites with value that is contingent on performance against predetermined objectives. Actual payouts might be in cash or stock.

09 Nonqualified deferred compensation – an elective of nonelective plan between employer and employee to pay employee compensation in future.

Among those strategies, World at Work report shows that long-term cash plan is the most prevalent LTI vehicle at private company because this plan typically spans three years and are tied to company financial performance measures. And yet – these strategies must be used wisely according to private company’s revenue. LTI plan should follow evolutionary growth and development of private company. Thus, methodology for making LTI decision is important.

These plans bond individual and company for long-term, and are based on creating value for both. So long-term incentive planning is fundamentally a win-win opportunity but needs to be carefully planned and executed to realize desired LTI benefits”, said Wilson.

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