Insights

Long-term retention: Tip the scales in your favour!

Overview
Published on: June 11, 2021
Subjects:  Total compensation, Executive compensation

For many companies, the combination of key talents scarcity and increased demand for certain expertise is a persistent problem that creates overhead costs and could impact their long-term growth. With unemployment rates at record lows and nearly 50% of employees considering leaving their current position[i] in Quebec alone, companies in many sectors are in constant competition to attract and retain talent.

In a market in which open positions exceed interested applicants, more and more executives and key employees are seeking competitive compensation packages and even a share of the profits of the company they helped grow. To meet these expectations, the first reflex of business owners and shareholders of private companies is often to consider the implementation of a shareholding plan to draw in key executives, either by selling shares or freezing the value of their shares.

However, setting up a shareholder plan results in immediate shareholder dilution, which isn’t necessarily desirable for either the shareholder or the employee. Several shareholders do not wish to open the capital, plus, buying or receiving shares in a private company may have (negative) repercussions for the employee:

  • Stress caused by the perceived risks of becoming a shareholder
  • Feeling that they have limited decisional impact on the share price
  • Lack of flexibility for the resale of shares (non-liquid market)

Luckily, there’s another way to motivate and retain key employees and share a company’s medium- and long-term success: a long-term incentive plan (LTIP).

What is an LTIP?

Long-term incentive plans are promises to pay a sum of money or shareholder rights if certain results are achieved, the intent being to align senior executives with the company’s strategy and performance.[ii]

LTIPs aim to:

  • Reward the organization’s long-term success
  • Retain key employees (usually executives) by establishing conditions for incentives and offering the potential of long-term gains
  • Encourage employees to strike a balance between short-term and long-term thinking, which aligns their interests with those of shareholders
  • Assess the achievement of goals over a three- to five-year horizon, depending on the plan

There’s no one-size-fits all LTIP. The right plan for a business will need to address:

  • The risk of stock dilution
  • Cash flow projections
  • Accounting expenses and taxation for plan participants and the business
  • The duration of the performance period
  • Your desired effect on retention
  • Employee demographics

LTIPs may be based on the value of the company’s shares, but they are most often “phantom” plans, i.e., payable in cash and without the issuance or ownership of shares.

Of the many available LTIPs, one type has been increasingly popular in recent years with private companies of all sizes: stock appreciation rights plans (SARP), also known as a phantom stock plan.

Under an SARP, employees receive a percentage of the company’s growth as determined by a set formula for assessing its market value. Payments are made in cash, for example, every five years or at the end of any other period determined by the employer.

Example

Ms. Roy is a key employee of ABC company

ABC introduces an SARP that says that in five years, Ms. Roy will be paid the equivalent of 0.5% of the growth in the value of ABC company over the next five years

If ABC’s value increases from $5 M (year 0) to $15 M (year 5), Ms. Roy will receive a taxable payment of $50,000 at the end of year 5

 

The advantage of the LTIP is that companies only have to pay out if the company’s value increases and employees are required to remain in their positions to receive their payment.

In conclusion

Long-term incentive plans are a powerful tool for retaining and motivating key employees. Plus, they are relatively simple to set up. Most of the time, incentives are tied to company performance and, in a way, pay for themselves. Employees who are offered the privilege of participating in an LTIP will be highly motivated to contribute to the future growth of their organization. They will often act as a full shareholder of the company, without the need to buy shares, which will also avoid the problem of stock dilution. That makes LTIPs a smart addition to a solid compensation program.

Want to discuss your options for retaining your best employees? Talk to our experts!

Author

Bilal Khoder, Senior Consultant

Sources

[i] 2021 Salary Guide, Hays Canada

[ii] Régimes d’intéressement à long terme (RILT), Ordre des CRHA

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