Question: I have heard of long term incentive compensation plans. Should I consider one for my business?
A: A Long Term Incentive Compensation Plan (LTIC) is a compensation program for key executives that includes base salary, short and long term incentives, and benefits. These plans are created as a reward system to incentivize performance, as LTIC plans are tied to individual goals and objectives rather than a company’s revenue or share price. LTIC plans can be beneficial for participants. If your business is looking to attract, motivate or retain highly qualified senior executives, an LTIC plan may be right for you.
What constitutes an LTIC plan?
An LTIC plan is a complex reward system, made up of an employee’s base salary, short-term incentives, and long-term incentives.
Base salary. When determining a base salary, one must ensure its competitiveness and reasonableness. Once determined, the base salary is usually adjusted on an annual basis. Much of an LTIC plan depends on the base salary of key executives.
Short-term incentives. Short-term incentives, typically structured as annual bonuses, are intended to reward executives for achieving short-term business goals and are typically set by annual performance goals. Bonus measures can be financial or non-financial and often include an element of individual performance.
Long-term incentives. These awards are granted subject to the achievement of financial and operational objectives set over a period of several years. Providing long-term incentives to leaders is important because turnover at this level is more expensive since this team drives a long-term strategy.
What are the different types of LTIC plans?
There are many types of LTIC plans, and you will usually find that they are cash or equity based. Since granting ownership involves risk and most key employees prefer cash to stocks, most owners choose a cash incentive plan. This type of plan provides liquidity or entitles the company to an appreciation in the value of the business rather than the actual stock. Here are some examples :
- Ineligible deferred compensation plan: An unqualified deferred compensation plan (NQDC) is often the easiest, most effective and best method to motivate and retain your key employees. The NQDC plan promises to pay benefits in the future based on the current or past service of a key employee. The NQDC plan simply means that if specific requirements are met, the plan does not have to meet formal ERISA employee funding, reporting, discrimination, and coverage requirements.
- Phantom action plan: In a phantom stock plan, owners give employees something that looks like stocks, appreciates in value like stocks, and can be turned into cash like stocks, but isn’t stocks. As the employee strives to make the business more valuable, he or she makes his or her interest in the phantom plan more valuable.
- Stock appreciation rights regime: A stock appreciation rights plan (SAR) is like the phantom stock plan in that the value of the benefits of the SAR plan is tied to the value of the shares of the company. Unlike phantom shares, the employee under a SAR plan is only entitled to receive an appreciation of a certain percentage of the SAR unit value relative to the shares of the company. When the employee leaves the company, the units in his account are revalued to reflect the current market price of the stock, or the price of the formula.
How do I choose the right LTIC for my business?
When designing executive compensation plans, we recommend that you take the following steps:
1. Identify the main objectives: Setting clear goals allows your decision-makers to formulate a compensation agreement that aligns with company goals. For many employers, this could include attracting and hiring executives, rewarding and inducing executives, and retaining executives.
2. Identify key employees: key employees act and think like you. They want more challenges and opportunities to thrive and grow like the business does.
3. Determine the most attractive and practical compensation components: take into account the analysis of competitive compensation, industry practices, compensation philosophy and corporate culture.
There are many other factors to consider when choosing the best LTIC plan for your business. Here are some questions you might want to ask yourself before deciding on a plan:
- What does the leader consider to be a valuable incentive that would motivate him to achieve company goals (equity or cash plans)
- Will the current owners of the business be leaving the business in the future.
- What are the tax consequences for the employer and the manager?
- What group of leaders does the business need to motivate differently?
A well-designed LTIC plan should be simple, easy to read and summarize, and communicated to employees with advisors present to answer questions. In successful LTIC plans, determinable performance standards or key metrics must be linked to the value of the business so that when employees meet their goals, the business is successful. If you are interested in pursuing an LTIC plan, contact a trusted CPA or financial advisor to help you choose the plan that best suits your business needs.
Crystal Faulkner is a Cincinnati Market Leader with MCM CPAs & Advisors, a CPA and Consulting Firm providing expert advice and beyond thinking for today’s public and private businesses large and small. , non-profit organizations, government entities and individuals. Tom Cooney works at Wealth Dimensions, an investment advisory firm. For more information, call 513-768-6796 or visit online at mcmcpa.com. You can listen to Tom and Crystal daily on WMKV and WLHS on “BusinessWise,” a morning and afternoon radio show that features successful people, businesses, organizations and issues from across our region.