To hold on to great people – and keep them motivated to perform – companies need to design policies that incentivise them to do their best work. For many businesses, the long-term goal is to transition to being a publicly listed company, with shares trading on a stock exchange. At that point, companies often seek to expand beyond their established employee share plans to consider a long-term incentive plan (LTIP) for certain executives.
LTIPs are a type of compensation plan designed to be more performance-oriented than a typical share option scheme. There are also some key differences in how the plans are operated, including the tax implications for participating employees. Let's explore the value an LTIP adds to a business, and how these plans are operated.
What is a long-term incentive plan (LTIP)?
An LTIP is a way to reward key employees for reaching performance targets, usually over multiple years. The aim is to align the compensation of participating employees to the share price performance of the company. LTIPs often involve awards of company stock, but can also include other forms of payout including cash bonuses.
LTIPs usually involve setting targets which go above and beyond 'business as usual' and imply significant success for the business.
Which businesses use LTIPs?
Most commonly, LTIPs are put into place in public companies. Partly, this is due to the fact that the conditions of an LTIP often focus on basing targets on the company's share price, which is more difficult for private companies to measure. However, private companies can also set up LTIPs. (In the UK, many companies structure their LTIPs as part of an employee benefit trust.)
Remember that the structure and incentives you set out in an LTIP really matter: if incentives are seen as being overly beneficial to the executives enrolled in the plan, and therefore detrimental to the company, the consequences could be severe.
Which executives participate in LTIPs?
LTIPs are primarily designed for senior executives, such as the CEO and/or C-suite executives who sit on the company's management team. LTIPs help companies and their boards carefully manage retention and performance expectations for the most senior executives.
What are some common long term incentive plan structures?
There are a number of ways to structure long-term incentive plans, and LTIPs can use different kinds of payment, including share awards and cash bonuses. No matter how the LTIP is designed, the plan will need board approval before it's put into action.
An LTIP can stipulate that if certain performance targets are met, executives qualify for a cash bonus (you might see this called a long-term cash incentive). Because LTIPs usually involve equity, any cash payment is likely to be awarded alongside shares or share options.
Restricted stock awards
It's common for an LTIP to award executives restricted stock as part of the payout. Restricted stock awards convert into shares after a set amount of time at no cost to the employee. People resigning during the vesting period will lose their rights to any unvested shares.
A performance share plan is a variation of an LTIP that makes share awards contingent only on performance targets. For instance, performance shares may vest for a CEO if the company share price hits a certain level at any point in the future and remain there for a given length of time. In this instance, this part of the LTIP focuses on performance criteria and contains no time-based component.
How do shares in LTIPs vest?
Setting up vesting schedules for long term incentive plans can be a more complex exercise than with an employee share option plan, which is normally solely time-based. This is because an LTIP often uses performance-based vesting triggers as well as time-based triggers.
For instance, shares might be awarded to employees as part of an LTIP on the understanding that they will take between three and five years to vest. However, during that long term vesting schedule there may be other covenants that accelerate vesting – for instance, if the share price reaches a certain pre-determined mark and stays there for a certain amount of time.
LTIPs may also accelerate if a liquidity event – such as an IPO or an acquisition – takes place, with share awards or bonuses being brought forward.
In cases such as these, companies should be clear with participating employees when vesting can and will accelerate, and what the financial and tax implications of accelerated awards will be.
How are LTIPs taxed?
The taxation of LTIPs depends on the components of each individual's plan, and on the country in which the plan is set up. Awarding stock or stock options through an LTIP is treated similarly to a regular employee stock option plan. When shares are awarded directly, for instance through restricted stock awards, gains for the employee are taxed as income. Bonus payments, meanwhile, are usually taxed as income. In the UK, this would mean paying ordinary income tax, National Insurance contributions and so on. The taxes would ordinarily be deducted straight from the employee's salary, meaning minimal tax overhead for participating employees.
Benefits of long-term incentive plans for your company
The purpose of an LTIP is to increase shareholder value by motivating key employees to deliver great long-term results for the business. Here are a couple of key benefits of long term incentive plans for employees and employers alike:
Lower (or no) cost to exercise shares
A common benefit of a long-term incentive plan is that for participating executives, shares are often granted with no exercise cost. This is contrast to many employee share option plans, where in order to convert their share options to shares, employees must make an upfront payment (at a discount to fair market value). Offering upside with minimal downside risk for participating employees is a notable advantage of the LTIP structure.
Setting up an LTIP aligns the motivation of key executives with that of the business as a whole. That can contribute to better retention, which in turn minimises the overhead for people and talent teams and helps the company grow steadily without excessive turnover. And the right LTIP can help to attract great talent too.
LTIPs: are they right for you?
Not every company is at the right size or stage to set up an LTIP. They're normally best suited for larger public enterprises, rather than younger private companies.
But LTIPs encourage employees to reach for ambitious targets that help deliver on the company goals. Tethering compensation to performance criteria is also a way to ensure people are focused on the outcomes of the work they do, and how their work connects to the overall health and success of the business.
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