Using Long-Term Incentive Compensation as a Succession Planning Tool
Published on by Eric Goodman, Tyler Noel, in Construction, Consulting
A recent FMI/CFMA Ownership Transfer and Management Succession Industry Survey revealed that many contractors were in the process of transferring ownership prior to the start of the pandemic. As the pandemic subsides and normalcy resumes, companies are looking for ways to jumpstart those transition plans that have gone dormant over the past year. A unique consideration for doing this is to look inside the company and create a long-term incentive compensation plan to retain existing talent while coaching them towards the potential of ownership in the future. These plans are usually based on cash payments rather than stock but are commonly awarded and accumulated as synthetic equity, such as phantom stock. These plans extend beyond one year, with 5 years being the most common vesting period, and the awards are typically not taxable until the payout to the employee occurs.
Long-term incentive compensation plans are not one size fits all and are not always appropriate. Certain companies will find them to be invaluable though, particularly when one or more of the following circumstances is present:
- An external sale is not an option for new ownership. While the pandemic created many merger and acquisition opportunities, this isn’t true for all businesses. Those who cannot find a third party to purchase the business may want to look within the organization.
- A present owner wants to carry on their legacy, but the next generation is not prepared. The company then might partner up with another employee to run the company in the meantime, using long-term incentive compensation to retain them and to facilitate the transition to the next generation.
- The company has strong individuals in leadership roles that may make good owners. All effective leaders aren’t necessarily effective owners. If current executives have the qualities that show a promise of being good owners, long-term incentive compensation will help retain those individuals.
- Prospective owners don’t have the resources to purchase new stock when the time comes. A long-term incentive compensation plan would allow future owners to be compensated for adding value to the business over time and then use the proceeds to purchase stock when the ownership transfer occurs.
- The timeline for transfer is long. A long-term incentive plan would act as a motivator for the next generation of owners to work hard and prepare for their position, while allowing the current owners to exit when they planned.
If a company is considering instituting a long-term incentive compensation plan, it’s important to keep a few things in mind when designing one:
- Awards should be performance based. It isn’t advantageous to simply overcompensate employees so they can buy stock in the future. They should be incentivized to improve the organization and rewarded for their strong performance.
- Awards should be competitive and reasonable. Unless there’s a tight timeline, awards should be made conservatively over time in a manner consistent with the performance of the individual and the organization.
- Consider requiring a personal contribution by the new owner. This could be in the form of personal funds or a company loan. This creates additional incentive as the prospective owner takes on some additional risk.
Additional Resources
Barnes Dennig, North Side Bank and Trust, and USI Insurance collect compensation, benefits, and benchmarking data from regional contractors every other year. Want to learn more or use the construction compensation benchmarking report to create a competitive advantage? Download a copy of the full report now.
Want to learn more about using long-term incentive compensation as a succession planning tool? Talk with a Barnes Dennig construction industry expert to go beyond the numbers in finding ways to build a more successful future. We’re here to help.
