This
article carries forward the theme started with a question about what to
do when a company can’t or doesn’t want to offer stock options. My
first response, “Competitive Compensation Without Stock Options,”
covered units, phantom awards and appreciation rights. The world of
Long-term incentives (LTI) is vast. Some companies get comfortable with
one “family” of LTI and use it to augment every total reward program
they touch. It’s sort of like putting catsup on every meal. Catsup might
be great, but it isn’t ALWAYS great (although my wife and I often
disagree on this issue).
This article provides an overview of Profit Sharing and Employee
Stock Ownership Programs (ESOPs). These programs are similar in many
aspects, but totally different in critical areas. First, some equity
compensation programs are used to share profits. Other equity
compensation programs are used to share ownership. Second, outside the
U.S. the acronym “ESOP” is often used to refer to Employee Stock Option
Plans. Third, smaller companies often fund their bonus or other variable
compensation programs using profits. To be clear, this blog won’t be
covering any of that stuff.
Profit-sharing programs are most often designed as a retirement
benefit, but can offer a wide variety of vesting schedules. These are
funded programs that generally require trusts to hold contributions,
investment decisions, formal plan documentation, designated fiduciaries
and other structural components. These programs create a direct link
between one definition of success (profits) and employee compensation.
They may disengage employees from other success measurements, so they
often used to augment, rather than replace other plans.
From a compensation philosophy, these types of profit sharing
programs focus participants on 1) profits (duh) 2) long-term employment
with the company. While these plans are a legitimate alternative to
stock options they obviously serve a very different purpose. If you are
trying to link compensation over the next 1-5 years to some type of
corporate success profit sharing, these programs are unlikely to be your
solution.
ESOPs provide employees with a piece of a large block of company
shares. These are also designed as a long-term program with payout
available at retirement or other vested leave date. Company shares are
purchased or contributed by the company and held in a trust fund. They
provide support of a real ownership culture and also offer potential tax
benefits to the company. These programs are often established when the
owners of a closely held company wants to “cash out” on some or all of
their ownership without giving control to some outside organization or
the public at large.
The downsides to ESOPs are not insignificant. The cost to set up an
ESOP can be prohibitive for a small company when compared to the set up
costs to other LTI/LTB programs. There is also the real risk that if the
company performs very poorly an employee may lose their job and
retirement funds at the same time.
The upsides to ESOPs are well documented. ESOPs offer significant tax benefits for both employees and companies. The National Center for Employee Ownership
(a great resource) also says that ESOP companies generally outperform
their peers in many categories. Lastly, I have worked with and been
around many ESOP companies over the years and they tend to have very
involved and passionate staff members. While true engagement can often
be hard to measure, sometimes you can just a get a “feel” for it and
ESOP companies often have the feel.
Your long-term incentive programs needs to be custom fit along with
the needs of your company. You also need to be willing to explore new
solutions as your goals change. When a program that has worked for a
decade stops working, it might not just need a new paint job, you might
need to trade it in. And, if your company has unique limitations on the
use of certain types of pay tools (cash, equity etc.), you may need to
speak to more than one expert to get to the right solution. Don’t wait
to start that exploration. Even if everything is working great today, it
is great to have your toolbox stocked with future solutions. I will
touch on a few other LTI alternatives in my next post and then return to
my standard, irreverent, analogy-filled posts.
Dan Walter is the President and CEO of Performensation
an independent compensation consultant focused on the needs of small
and mid-sized public and private companies. Dan’s unique perspective and
expertise includes equity compensation, executive compensation,
performance-based pay and talent management issues. Dan is a co-author
of “The Decision Makers Guide to Equity Compensation”, “If I’d Only Know That”, “GEOnomics 2011” and “Equity Alternatives.” Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts,
a free networking group. Dan is frequently requested as a dynamic and
humorous speaker covering compensation and motivation topics. Connect
with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay