If you give the same rewards every year, then you will get the same results.
Companies need to keep this mantra in mind as they think about the benefits they offer to employees, and how they encourage company growth.
A long term incentive plan (LTIP) is a great idea to reward and motivate your employees in a way that helps your company succeed as well. But LTIPs come in all sorts of shapes and sizes – here’s a simple guide to help you find the one that best suits your company.
There are essentially four different LTIP designs.
Appreciation-based means that the value of the employee’s award depends on how much the company’s value increases over time. These are common options or stock appreciation rights.
Stock-based means that after a certain amount of time, the employee receives shares in the company.
A performance-based award also means that the employee receives shares in the company, but it depends on their meeting certain goals, rather than time.
Cash-based means that the employees receive a cash bonus.
Which one is right?
Naturally, different companies are going to have different needs. Depending on your industry and your jurisdiction, your company might be better suited to one of these. So, it’s important to understand the positives and negatives of each one.
For example, appreciation-based awards can have massive upsides for employees, particularly in startups and growing companies. It shows that both you and your employee have faith in the potential of the company. And it ensures that your employees are committed to the same goal that you are, while the vesting period makes it more likely that they’ll stay and remain focused. However, there is a risk with these awards. The upside might not show up after all, if the company struggles.
Stock-based awards have similar positives, but the awards are guaranteed to have value when they vest. They also have a vesting period, which means that employees will stay with the company for longer. And their value is tied to the company’s value – once they own shares, then any growth is a profit. However, there is less room for the potentially massive gains that come from options. Because of that, and because they simply vest after a certain amount of time regardless of the employee’s performance, they don’t provide as much incentive for hard work.
Performance-based awards, on the other hand, ensure that employees are not just waiting for their vesting. In order to receive their bonus, the employees need to hit certain targets. It’s easy to see why this is an enticing plan for companies. However, you need to keep in mind that if the targets are not set correctly and are too hard to achieve, the employees could lose morale as they don’t receive anything.
Cash-based awards are generally given in jurisdictions or companies where share valuation is complicated. However, if possible, it’s best to avoid these. Cash flow is important to your company’s growth, and tying up a lot of it in a long term plan is not a great idea. Besides, it does not help your employees commit to the long term success of the company.
The most important feature of all these plans is the vesting – the timeline and/or requirements an employee needs to meet in order to receive their awards. You need to determine how long an employee needs to be with the company, or how many targets they need to meet.
There are two ways of vesting – cliff vesting and ratable vesting. Cliff vesting is what it sounds like. After a certain period of time, the employee receives the entire award. Ratable vesting is when the award vests a portion at a time. So, an employee might receive one-third of their shares each year for three years.
Again, which one you choose depends on the needs of your company, as both have positives and negatives. Cliff vesting means that if an employee leaves before their vesting, then they leave with no shares. This means that fewer shares leave the company. However, depending on the length of time, it can mean that employees work for a long time with nothing to show for it. Whereas in ratable vesting, they’re receiving a portion for each year.
These are a lot of choices and a lot of factors that need to be taken into consideration. We’ve presented a few designs, and a few of their positives and negatives – but there are many, many more. It’s hard to get all the right answers from reading a blog post. What you really need is an equity compensation expert, with 15 years of experience in the field, including LTIPs.
Global Shares can take you through the launch of your LTIP, from the right design to the right vesting – and a whole lot more. Get in contact with us today.
Read more here about Long term incentive plans and how we can help you.