Securing Future Success and Commitment with Long-Term Incentive Plans‍

Securing Future Success and Commitment with Long-Term Incentive Plans‍

June 19, 2023

Securing Future Success and Commitment with Long-Term Incentive Plans‍

Remember when Tim Cook was given a million Apple shares as a part of his CEO compensation back in 2011? Those shares, subject to a ten-year vesting period, were not just a pat on the back. They were Apple’s way of ensuring Cook's long-term commitment and alignment with the company's vision. This strategic move wasn't merely about the immediate reward, but about shaping the future—Apple's future.

Now, imagine harnessing the same power for your startup. Not everyone has Apple’s stockpile, but the underlying principle can be universally applied. Long-Term Incentive Plans (LTIs) are the strategic anchors that can keep your team's sights set on long-term success, fostering commitment that transcends immediate gains. This article will guide you through understanding and implementing LTIs, ensuring that your startup doesn't just sprint but runs the marathon.

What is a Long-Term Incentive (LTI)?

A Long-Term Incentive (LTI) is a strategic promise of future value. In the world of ever-shifting priorities and short-term rewards, LTIs stand out as commitments to longevity and sustained growth.

Unlike immediate bonuses and raises that reward past or current performance, LTIs are forward-looking. They're a bet on both the company’s and the employee’s future. When you offer an LTI, you're saying, "We believe in where we're headed, and we want you to be a significant part of that journey."

LTIs bind the fortunes of employees with the organization. It's not just about the financial value but the symbolic gesture. When you offer someone a share of the future, it communicates trust, respect, and mutual ambition.

Business landscapes evolve, and to remain competitive, companies must adapt. LTIs allow organizations to keep top talents anchored, even amidst change. Whether it’s a market downturn, a company pivot, or a strategic overhaul, LTIs act as stabilizers, ensuring that the core team remains onboard.

So, when you think of LTIs, see them as more than financial instruments. They are trust builders, vision aligners, and evolutionary safeguards that ensure continuity in the ever-changing business cosmos.

Reasons Why Companies Offer You Long-Term Incentives

In a dynamic business landscape, companies continually seek tools that bring them a competitive edge. One such powerful tool is the Long-Term Incentive. But why are LTIs so appealing to businesses?

1. Sustainability in Vision

In a world obsessed with quarterly reports and immediate results, LTIs encourage a more holistic, long-range perspective. By offering LTIs, companies signal a commitment to sustainable growth and long-term vision, setting a tone that resonates with stakeholders, from employees to investors.

2. Employee Retention

The job market, especially for top-tier talent, is akin to a revolving door. As companies grapple with the cost and disruption of high employee turnover, LTIs emerge as an effective tool to reduce this churn. The promise of future rewards, especially ones that could potentially outvalue immediate gratifications, keeps employees engaged and loyal.

3. Performance Alignment

LTIs are not just static rewards waiting in the future. They can be contingent on various performance metrics, fostering an environment where employees are not just working for the 'now' but are continuously motivated to ensure the company's success in the 'future'. This aligns individual aspirations with company objectives.

4. Equity Conservation

Startups, especially, are wary of diluting their equity prematurely. Structured LTIs, like stock options, allow companies to promise future equity without immediate dilution. It’s a way to ensure that when equity is eventually shared, it's with those who've genuinely impacted the company's journey.

5. Tax Efficiency

Beyond the immediate financial allure of LTIs, there's a strategic aspect to consider. Offering LTIs can be a win-win for both the employer and employee from a tax perspective, depending on the structure and jurisdiction. It's not just about compensation; it's about smart compensation.

6. Creating a Culture of Ownership

Beyond the numbers, there's a psychological dimension to LTIs. They cultivate a culture where employees feel like true stakeholders. This sense of ownership translates into a higher degree of commitment, proactive problem-solving, and a deeper connection with the company’s mission and values.

7. Mitigating Risk

In uncertain markets or industries prone to fluctuations, LTIs act as a buffer. They help retain talent even during challenging times, ensuring continuity and stability.

In other words, the reasons for offering LTIs go beyond mere compensation strategy. They’re about building a resilient, aligned, and future-focused organization, capable of navigating both the calm and storms of the business world.

How Does LTI Work?

Long-Term Incentives might sound complex, but they are rooted in a simple principle: reward employees for their continued commitment and performance over an extended period. To appreciate the mechanics, here’s a step-by-step illustration:

1. Initial Grant

The journey starts when you, as an employer, offer an LTI to an employee. This 'grant' could be in the form of stock options, future cash bonuses, or any of the various LTI types we'll explore later. The key here is that this grant signifies a future potential value, not an immediate reward.

2. Vesting Period

Once granted, these incentives don't become accessible immediately. They are subject to a vesting period—a predefined duration during which the employee must remain with the company to become eligible to benefit from the LTI. This period, often spanning multiple years, ensures that employees have a sustained commitment to the organization.

3. Earning the Incentive

LTIs aren't just about waiting out the clock. Many LTIs come with performance conditions. This could mean that, for the incentive to fully vest, certain organizational or individual performance benchmarks need to be met. This ensures that the incentive remains a tool for motivation and alignment, not just a waiting game.

4. Exercising the Benefit

Post the vesting period and upon meeting any other stipulated conditions, the employee can 'exercise' the incentive. In the context of stock options, for instance, this means purchasing company shares at a predetermined price. For cash bonuses, it might mean receiving a lump-sum amount.

5. Post-Exercise Dynamics

After exercising, there might be further decisions or conditions. For example, if an employee exercises stock options and becomes a shareholder, they might face decisions about holding or selling the acquired shares. Additionally, there could be tax implications to consider, which vary based on the LTI type and jurisdiction.

6. Clawback Provisions

Some LTIs come with clauses that allow companies to retract or 'claw back' the incentives under certain circumstances, like a breach of contract or significant company losses due to employee actions. While not universally applied, it’s an aspect that emphasizes the reciprocal nature of commitment.

In a nutshell, the LTI process is a symbiotic journey. For the employee, it's a path of commitment, performance, and eventual reward. For employers, it's a strategy to ensure stability, alignment, and shared success. When mapped out well, LTIs become more than just a compensation tool; they evolve into a shared roadmap for the company's future.

Eligibility Requirements for Long-Term Incentives

Diving into the realm of Long-Term Incentives (LTIs) may stir questions of 'Who qualifies for them?' and 'What sets the criteria?' Understanding eligibility is paramount, both for employers structuring these incentives and for employees hoping to benefit from them.

✔ Position within the Company

Traditionally, LTIs were the domain of top executives and key personnel, ensuring their alignment with company goals. However, the modern perspective has broadened. Startups, in particular, have democratized access to LTIs, sometimes extending them to all employees as a part of their compensation packages. Still, the nature and amount of the incentive often differ based on the rank and role of the employee.

✔ Tenure and Performance

LTIs are future-oriented, but past performance can play a pivotal role in eligibility. A track record of consistent achievement might make one a prime candidate for LTIs. Furthermore, tenure, or how long an employee has been with a company, might also be considered. It's not uncommon for companies to reserve LTIs for those who've been aboard for a minimum period.

✔ Future Potential

It's not just about looking back. Companies also assess the future potential of an employee. Those deemed to have a high growth trajectory or those whose skills are seen as critical for the company's future might find themselves on the LTI list.

✔ Contractual Agreements

Sometimes, the eligibility for LTIs is cemented right at the hiring stage. Especially for senior roles or specialized skills, contracts might stipulate LTIs as a part of the compensation package, with clear benchmarks and conditions defined.

✔ Organizational Strategy

The overarching strategy of a company can influence eligibility. A tech startup focusing on innovation might prioritize LTIs for its R&D team, while a sales-driven enterprise might channel them toward its top salespeople.

✔ Regulatory and Compliance Factors

Particularly relevant for public companies or those in regulated sectors, external rules might dictate or influence LTI eligibility. Certain governance guidelines may prescribe who can and cannot receive stock-based incentives, for example.

✔ Market and Competitive Pressures

In highly competitive industries or job markets, companies might be compelled to offer LTIs to retain talent and stay attractive as employers. Here, eligibility becomes a function of market dynamics.

It’s pivotal to grasp that it's not a one-size-fits-all concept. It’s a mix of internal evaluations, external pressures, and strategic foresight. For companies, it’s about striking a balance between reward, motivation, and business imperatives. For employees, understanding these facets can pave the way to better negotiations and clearer career trajectories.

The Four Types of Long-Term Incentive Plans

It's essential to understand that Long Term Incentive Plans (LITPs) aren't a monolithic entity. Depending on the company’s goals, the industry it operates in, and the employees it seeks to incentivize, different types of LTIs can be employed. 

1. Appreciation-based Incentives

These incentives are rooted in the idea that if the company grows and prospers, so should the rewards for its stakeholders. Typically, they don't have an intrinsic value at the time of grant. Instead, they derive value from the growth or 'appreciation' of a certain metric, often the company's share price. Stock options are a classic example. When an employee is granted stock options, they're given the right to buy shares in the future at a set price. If the company performs well and the stock price rises, the options have greater value, aligning the interests of the employee with the long-term success of the company.

2. Stock-based Incentives

Unlike their appreciation-based counterparts, these LTIs offer an immediate tangible value. It’s all about direct ownership or the promise thereof. Restricted stock units (RSUs) are a popular choice here. An RSU grants employees the promise of shares or the equivalent cash value at a future date, contingent upon certain conditions, usually including staying with the company for a set period. It’s a way of saying, “Stay with us, and you'll truly be a part of us.”

3. Performance-based Incentives

This type of LTI is tightly linked to the achievement of specific objectives. It's not merely about longevity with the company; it's about tangible results. Performance shares, for instance, are allocated to employees based on the achievement of set targets, like a certain Return on Equity or Earnings Per Share. It's a way for companies to say, “Your rewards are directly linked to how well we, as an entity, perform.”

4. Cash-based Incentives

While stock and ownership are common LTI themes, sometimes the promise of cold, hard cash can be just as motivating. These incentives come as future cash bonuses that employees can earn based on longevity, performance, or a mix of both. For companies wary of diluting equity or those that aren’t publicly traded, cash-based LTIs can offer a simpler but still potent motivation tool.

Tax Treatment for Long-Term Incentive Plans

The realm of LTIs isn't just about aligning corporate and employee ambitions; it also has significant tax implications. Grasping the basics of tax treatments for different LTIs ensures both the company and the employee can maximize benefits and avoid any unpleasant financial surprises.

For Appreciation-based Incentives

Take for instance the common example of stock options. When you exercise stock options, the difference between the market price of the stock at the time of purchase and the price at which it was granted (the strike price) constitutes taxable income. Depending on the jurisdiction, this 'gain' could be treated as ordinary income or capital gains, with each having its own tax rate. Furthermore, the timing of when you sell the acquired shares can impact the kind of tax you owe. Selling them shortly after exercising might push the income into a short-term capital gains bracket, while holding onto them for longer could qualify them for long-term capital gains treatment, often at a lower rate.

For Stock-based Incentives

Consider Restricted Stock Units (RSUs). Typically, the value of RSUs becomes taxable when they vest, that is when there are no more conditions attached and you truly own them. The taxable amount is based on the market value of the shares at the time of vesting. They are usually considered ordinary income, and the employer will often withhold some shares to cover the tax liability. However, some jurisdictions might offer elections to defer or alter tax treatment, so it's essential to be proactive and informed.

For Performance-based Incentives

With performance shares or units, the tax implication often mirrors the RSUs. The point of taxation is usually when the performance condition is met and the shares or units vest. The value of the shares or the cash equivalent at that time determines the taxable amount. Being tied to performance metrics, it's vital for employees to understand when those metrics are deemed achieved, as this impacts the timing of the tax liability.

Cash-based Incentives

These can be straightforward. The bonus amount is usually treated as ordinary income in the year it's received. Employers will typically withhold taxes, much like they would with a regular salary. However, depending on the size of the bonus and other income sources, there might be room for tax planning to optimize the net benefit.

Beyond these general insights, it's paramount to note that tax laws are subject to change, and they can vary significantly from one jurisdiction to another. Additionally, individual financial situations can impact tax implications. Therefore, both employers offering LTIs and employees receiving them should seek guidance from tax professionals to navigate this intricate landscape.

The Importance of A Well-Crafted Long-Term Incentive Program for Your Startup

LTIs can help build a culture of ownership. When employees stand to gain from the company’s success, they often go the extra mile.

Similarly, in the competitive startup world, a robust LTI can tip the scales in your favor, drawing in top-tier talent.

For some startups, cash flow remains the king. LTIs can be structured to provide competitive compensation without straining cash resources.

A well-crafted LTI ensures everyone’s eyes are set on the same prize—the long-term success of your startup. Fortunately, this route enables vision alignment.

In essence, a Long-Term Incentive Plan is not just a tool in your compensation toolkit; it's a strategic ally. It bridges the gap between individual aspirations and company goals. As you nurture your startup, an LTI plan nurtures commitment and loyalty among those who matter most—your team.

Remember, the success of your startup is not just about the present achievements, but also about setting the foundation for future glory. And a well-implemented Long Term Incentive (LTI) program can be that solid foundation. So, invest time in understanding and crafting a plan that aligns with your vision, values, and goals.

Want to try how RSUs work as a Long Term Incentive (LTI) plan? Book a demo with Upstock today and join dozens of startups and early-stage companies that already reaping its benefits.

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