Sharing “Ownership” With Your Executive Team & Others: What are you talking about, Bob?
In our experience, one of the most asked about and misunderstood subjects in the broad area of executive pay is the use of equity or equity-like pay vehicles to share “ownership.” In fact, the quickest way to get a rise from a group of private-business owners is to suggest they give some ownership in their company to executives or employees. That is generally a good time to duck.
With this in mind, we plan to discuss equity and equity-type compensation vehicles over the coming few months to define what it means, provide examples of when it works and also when it does not. We will begin this month.
For a generation Boards of Directors and business owners have used equity-based and equity–like compensation vehicles to help retain and reward key executives and employees.
Typically, equity-based or equity-like vehicles have been used to meet two strategic end objectives—
- Joining the interests of the executives team and company owners in the common cause of value creation; and
- Retaining key and valuable executives in company employment for long periods of time into the future. We used to like to use 10-year plans for private company arrangements prior to recent deferred-compensation legislation by the IRS somewhat limiting plan flexibility and perceived value to both parties.
What tools are currently available to Boards of Directors and business owners?
There are generally two common types of equity or equity-like vehicles that are used today—in either a public- or private-company setting.
- Stock grants—a company grants an executive (or perhaps a Board member) actual shares of stock in the company. Hence, they have the right to the underlying value of the stock (at issue) and any future appreciation of these shares. This may or may not be in lieu of cash compensation. Often such grants are restricted to only allow the grantee to actually own the share after a set amount of time has passed. Clearly, there are tax consequences for an executive being awarded shares of valuable stock.
- Participation rights—a company grants an executive (or perhaps a Board member) the right to the future appreciation on a specified number of shares of stock. In the case of a public company, these are stock options and the employee can purchase the (underlying) stock for its value at the time of grant (called exercise). Any appreciation on the stock options is income to the executive. In a private company, the employee can earn future appreciation on the synthetic “option” in cash. These private-company vehicles are often called phantom stock or stock-appreciation rights. However, stock appreciation rights can also be granted in a public-company setting. Formerly, participation-rights plans had significant short-term tax and accounting advantages to both grantor and grantee. But in the past couple of years, these advantages have diminished as the result of new SEC and IRS regulation.
Recent economic and market events have brought the effectiveness and value of this type of compensation into question. We strongly believe that ignoring or rejecting these type of compensation tools can be both a short-sighted and risky perspective. In short, this stuff can really work—if done correctly.
So if I am on a Board of Directors, when and where should I consider equity or equity-like compensation?
During the next few months, we will give you some real-world examples of the application and uses of these types of compensation tools generally applied in a private-company setting. And, we might even throw in a few of tricks and traps in the process.