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John BrownAttorney and Founder of BEI
Employee Ownership Conference
Minneapolis, MN : April 20-22, 2010
Dan WalterPresident and CEOPerformensation
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Introduction
Exit Planning and Equity Compensation Basic Question: Why should I consider incentive
equity compensation for my company? Advantages of equity as an incentive. Advantages of cash as an incentive.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Overview: Equity Based Compensation Design Considerations
Who How much When Why How to measure, basis for award, performance
standard.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Exit Planning Perspective
Owner-managed companies in transit ion. Baby Boomer business owners. Most want to
exit. Need management team and other key employees
motivated to stay after owner leaves and to grow value.
Size of Company: 15 employees – 500 or so. What does it take for an owner to be able to exit – via
ESOP or any other path?
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Seven Step Exit Planning Process
Step 1 – Identify Owner Exit Objectives Step 2 – Quantify Business and Personal Financial
Resources Step 3 – Maximize and Protect Business Value Step 4 – Ownership Transfer to Third Parties Step 5 – Ownership Transfer to Insiders Step 6 – Business Continuity Step 7 – Personal Wealth and Estate Planning
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
ESOP Perspective:
Should ESOP Trustees approach equity ownership decisions in same way as owners interested in exiting their businesses? ESOP Trustees represent ownership and much like
departing owners may not be actively involved in the day to day business.
ESOPS want management and key employees to:○ Stay through owner’s exit; ○ To have the same incentive to grow business as
does ownership.○ To grow business value long term & continually.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Advantages of Equity Based Incentive Compensation.
More effective than cash in motivating or retaining the key employee.
It is part of the owner’s exit strategy to transfer ownership to key employee(s).
It is cashless. It is in anticipation of a third party sale and the owner
wishes to benefit selected employees with capital gains treatment.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Advantages of cash based incentive compensation
More effective than stock in motivating and keeping key employees. If they have to pay for equity, most employees
prefer cash to ownership. Owner’s do not want more owners. More Flexible. Owner’s exit path is third party sale or transfer to
family.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Benefit Formulas
Performance based. Usually calculated annually. Performance standard benefits the owners. Subject to “vesting”. Usually long term goal is to grow value to a certain
level or over a certain time based on owner’s exit objectives.
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
What do we mean by “Who should get how much”? Who are the stakeholders? Is Equity Fair and/or Just? Is How much defined as:
Amount in “money”Amount in “shares”Amount in “ownership percentage”
The Other Side of Equity
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
What is meant by “Equity”
eq·ui·ty, n. pl. eq·ui·ties 1. The state, quality, or ideal of being just,
impar tial , and fair. 2. Something that is just, impartial, and fair. 3. Law a. Justice applied in circumstances covered by law yet influenced
by principles of ethics and fairness; b. A system of jurisprudence supplementing and serving to modify the rigor of common law; c. An equitable right or claim; d. Equity of redemption.
4. The residual value of a business or proper ty beyond any mor tgage thereon and l iabil ity therein.
5. a. The market value of securities less any debt incurred; b. Common stock and preferred stock.
6. Funds provided to a business by the sale of stock.
Source: www.freedictionary.com
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Is Equity Compensation truly “Fair”?
Fair, adj. 1. free from discrimination, dishonesty, etc.; just;
impartial 2. in conformity with rules or standards; legitimate a fair fight 3. (of the hair or complexion) light in colour 4. beautiful or lovely to look at 5. moderately or quite good a fair piece of work 6. unblemished; untainted
Source: freedictionary.com
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Can Equity Compensation be “Just”?
Just, adj. 1. Honorable and fair in one's dealings and actions: a just
ruler. 2. Consistent with what is morally right; righteous: a just
cause. 3. Properly due or merited: just deserts. 4. Law Valid within the law; lawful: just claims. 5. Suitable or proper in nature; fitting: a just touch of
solemnity. 6. Based on fact or sound reason; well-founded: a just
appraisal.
Source: freedictionary.com
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Common Reasons for Equity Compensation
Private Co. Someday go public Someday get acquired Focus is extended period growth Ensure strong shareholder support if there are other investors Not planning to go public
Public Co. Attract, Motivate and Retain high quality staff Align staff with management and shareholders Provide wealth-building potential Create owners, especially among those who may not otherwise buy stock Provide upside potential commensurate with growth in company stock
price / market Any Co.
Drive and reward success of stakeholders
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Define the stakeholders Define corporate goals
Understand impact of equity plans on each type of goal Define acceptable risk/reward profiles for immediate
needs and projected against “success” Determine market pay requirements Determine best case and worst case scenarios Document plan for at least three paths
Acceptable growth Shrinkage Outperform
Determining Who and How Much
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Performance was always the stated “reason” for offering equity. “We want people to share in the success and
growth of the company” NOTE: Very little mention of failure and demise of
the company Is performance simply stock price? Total Shareholder
Return? When does the progression of stock price no longer
provide a reasonable link to pay?
Linking Equity to Per formance
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
The Equity Compensation Dilemma
1988-1999 the “no lose” zone (and the period of the greatest growth in the use and value of equity compensation plans)
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Virtually all market data currently available is based on the assumption created by the “no lose” market
Data from prior to that period is invalid due to the limited use of equity
Our Data is Old and Flawed
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Past (assuming non-founders): CEO Ownership at pre-IPO companies: 2.40%-4.60% Other C-Level: 0.25%-1.95% Hire on grants
CEO: 0.78%-2.50%Other C-Level: 0.11% - 0.93%
All based on then current number of shares.Does not take into account future values
Assumption that equity would grow in value, but continued new grants assumed that ownership was transitory and had to be replenished
The “How Much” of the Past
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Must determine maximum % of ownership that will be “gifted” to each level (as opposed to purchased)
Must determine risk/reward profile for company Too little or too much equity can discourage risk, which is
essential for growth and innovation These decisions must factor in the expected and possible exit
strategies Programs must incorporate reasonable indicators of
performance for grant, earning, vesting and or release These factors must be frequently reviewed as adjusted
during the early years of a company Levels of pay and relation to ownership percentages and
potential value of equity must be frequently reviewed and adjusted as a company evolves
Dealing with the New Volati le Market
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
More emphasis being put on linking equity explicitly or implicitly to financial, operational, team an individual performance. Not always “performance-based equity” Often “justification-based equity”
Multiple studies link better corporate performance with higher levels of management ownership
Studies commonly show a link between broad-based ownership and improved corporate performance
Companies are starting to come off the euphoria and false conclusions caused to the “no lose” decade and starting to accept the combined impact of expensing, a volatile market, equity programs failures and increased shareholder activism
Equity Evolution
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Focus first on your corporate goals, before you focus on market data
Design plans based on “just” compensation levels, rather than “fair” compensation levels
Today’s answers may not be valid a year or two from now, so don’t write too much in stone The 10 commandments are short and so is the US
Constitution. Your Rules should define and guide, not dictate
and control
Planning for Equity Compensation Success
Employee Ownership Conference 2010 : Minneapolis, MN : April 20-22
Questions
Contact Us.John H. Brown, President
Business Enterprise Institute, Inc.888-206-3009
Contact Us.
Dan Walter, President and CEO
Performensation
877-803-9255 x. 700
Skype: performensation
Twitter: @performensation
www.performensation.com