Long-Term Incentive Plans for Private Companies: A Quick Introduction
Long-Term Incentive Plans (LTIPs) are a popular choice for private companies looking to attract, reward, and retain employees.
As the name suggests, LTIPs aren’t designed to deliver an immediate reward; instead, such plans are typically structured to last three to five years. This is done with a view towards encouraging employees to excel over an extended period of time, as the better the business fares over the life of the plan, the greater the rewards will ultimately be for participants.
Typically, time and performance conditions apply with long-term incentive plans for private companies. So, participants are effectively promised shares after a specified number of years and as long as certain performance goals are achieved. If the value of company shares increases during the life of the plan, participants will benefit even more.
The type of LTIP that a business opts for will depend upon their own individual needs and objectives. There are several possibilities, but among long-term incentive plan examples are:
- Stock options: This umbrella term can cover a lot of ground, but for our purposes here, think of it in terms of participants being granted options linked to time and performance. Typically, the structure might be that the options become exercisable after three years, assuming performance targets have been achieved and that an individual has remained with the company. The participant is under no obligation to exercise the options at that point, and can instead choose to retain them, and no tax falls due until they are exercised.
- Restricted stock units: Participants receive a promise that they will receive free shares after a set period of time, usually three years, assuming they are still with the company and performance targets have been met. Tax is applied on receipt of the shares.
- Stock appreciation rights (SARs): While stock options give employees the right to purchase shares at a set price, SARs enable those individuals to receive the benefit from an increase in company share price value over time. Participants are not given shares or options in the first instance; instead, they are granted SARs for a specified number of shares, with the value of the grant linked to the market value of company shares on the grant date. So, if the share price increases over time, when the employee chooses to exercise their SARs, they receive the value of the difference between the share price at the outset and at the point of exercise. No tax liability will apply until SARs are exercised.
So, how might all this play out in practice? Let’s look at a hypothetical real-world scenario…
How Fred made a long-term incentive plan work for his company
Fred runs a large company, Tangerine. They specialise in exporting citrus fruit, and over the past two decades, they have been extremely successful. Last year, they nearly broke nine figures in profit.
There was one problem, though. Fred started his company in 1998. He was 30 years old. He’s now 50 and while he’s not slowing down – his morning fitness routine sounds more strenuous than mine – he has started to make plans for transitioning the business after he retires.
Fred has always cared a lot about his employees. Right from the start, he was a firm believer in profit-sharing. Some employees recall that they were able to send their children through school on these extra bonuses.
So, Fred didn’t know what to do. He wanted to retire comfortably, he wanted to make sure his business continued to grow, and he wanted to make sure that his employees were well taken care of.
Tangerine is a private company, and they certainly had plenty of callers – interested in taking them public or acquiring them. But Fred couldn’t do either of those. Neither one would guarantee all three things on his list.
Fred came up with an idea: A long-term incentive plan (LTIP)
And not just any old long term incentive plan – one that would work for him. He decided on a Restricted Stock Units (RSU) plan. This did two things. It gave a great incentive for employees to remain with the company – the longer they work at Tangerine, the bigger their payout. But not only that – how hard they work, and how well the company performs also affects how large their payout will be. With just one plan, Fred came up with a great way to merge two great benefits into one solution for his dilemma – ensuring his company would continue to grow.
If that was all the LTIP did, that would be fantastic. But Fred didn’t just implement any LTIP. Fred’s LTIP didn’t merely ensure that his company would have the best employees, it also ensured his other two needs – to retire comfortably, while ensuring his employees were looked after. Because now, the employees own the company. With his LTIP, he has converted the private company that he owned into a private company that his employees own. He can be sure that they’ll be taken care of – after all, they’ll be taking care of themselves.
That’s the power of an LTIP that works for you
It can transform your business in more ways than you can imagine. And because private companies don’t have a public market or the easily accessible company valuation it supplies, it’s more important than ever for private companies to ensure their LTIPs are designed in a way that benefits their company in more than one way.
There are many different long term incentive plans for private companies to choose from, above and beyond the three referred to briefly earlier here. To attempt to list them all and go into the potential positives and negatives associated with each would be beyond the scope of this blog piece. Also, what LTIP makes most sense for you will depend upon, for example, your location, your industry, and the structure of your company, so it won’t be a one size fits all solution, and the type of plan that best suits your needs may not be as suitable for another business. All that said, one of the general pluses associated with LTIPs is that they are incredibly flexible – each plan can be customised ad infinitum.
Your best bet is to go through all of the different designs and plans with somebody who specialises in equity compensation management. Otherwise, you could potentially end up with the wrong LTIP, or at least one that is not the best fit for you and your employees.
What if Fred didn’t know about RSUs – what if he found an LTIP that was pretty good, and he figured that was as good as he would get? He might’ve managed to retire, or keep his company successful, but he couldn’t have achieved both, as well as looking after his employees if he had chosen the incorrect LTIP.
How Global Shares can help you set up and manage your LTIP
At Global Shares, we have helped companies of all sizes to set up and manage award-winning employee share plans. We can take you through setting up an LTIP that will bring out the best in your company. Contact us for a commitment-free demo today.
If you want to learn more about how LTIPs can benefit you and your business, check our long term incentive plan design guide.