Many business owners and entrepreneurs grapple with whether they should have a long-term incentive (LTI) plan. Inevitably, that simple question leads to numerous others: Will it make a difference in attracting and retaining the best employees? Which employees should be eligible? What are the metrics for vesting or payout? How will it impact my bottom line? What type of plan is right for my business? When is the right time to put an LTI into place?
Each of these questions on its own can be difficult for a business owner to answer. Taken together, they can feel overwhelming and prevent or delay entrepreneurs from putting an LTI into place, despite the benefits to employees as well as to the long-term growth and value of the business.
In my work as head of Fortis Law Partners corporate and securities practice, I counsel and educate entrepreneurs on a variety of topics, including LTIs. I usually advise them that putting an LTI into place is an excellent idea for the following reasons:
Leaders need their team members to care as much as they do about the long-term growth and profitability of the company. LTIs are an essential way to motivate, reward and retain key employees. Many entrepreneurs rely heavily on them, especially in the early stages of the business when they may not be able to provide employees with as much monetary compensation as is desired or deserved.
Properly structured LTIs can offer significant tax and accounting advantages. The key words here are “properly structured.” Entrepreneurs don’t always grasp just how important it is to design and implement the right kind of long-term incentive plan for their type of company.
Venture capital investors often expect companies to have an LTI plan in place or, at a minimum, to have already set aside 10% to 15% of their stock for employee incentives. Ideally, the best time to develop an LTI plan is as the company approaches or reaches $1 million in revenue and the owner begins to think about raising their first round of venture capital.
There are many different LTI vehicles and many different considerations—from business goals to company culture to eventual exit strategy—to take into account when deciding which LTI will create the most value for both employer and employee. I have met with entrepreneurs who’ve spent days, weeks or even months building out their own LTI plan. They bring it to me for review only to find that it is not properly structured, violates securities laws, creates unintended tax consequences, puts a monkey wrench into their future exit plans or otherwise is just not the right structure for their business.
To avoid these unintended consequences and the costly fees associated with remedying errors, business owners will be better off retaining competent legal counsel prior to establishing an LTI. In part two of this series, we’ll explore the different types of long-term incentive plans and their respective pros and cons.