Phantom Stock, Deferred Comp and Succession Planning

Here’s a question I get asked quite a bit from business owners who are looking forward to their business succession: “Can I use phantom stock as a way to facilitate my transition out of the business?”

Their intuition is pretty good. Phantom stock and other forms of deferred compensation can be part of the toolkit you should consider—especially if your exit plan might include a sale to existing employees. Here’s how an internal sale usually happens.

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Unleash Animal Spirits in Your Company

Ok, I borrowed part of the title from this great article in last week's Wall Street Journal . It’s by Jeff Ubben, head of an activist investment fund. His main point? Corporate America pays its executives to be too cautious. Why? They orient their pay packages to short-term performance factors and they've moved away from stock options in favor of restricted stock units. Executives, endowed with this short-term perspective, become less concerned with growing actual market value.

To me, this means that private companies are in a better position to pay their executives than their public peers. By “better” I don’t necessarily mean “more.” (Although that could result as well.) “Better” to me means “more aligned;" i.e., better for bjoth the shareholders and for the employees.

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Worst Phantom Stock Plan Ever? Ask 24 Hour Fitness

Here’s a great story at Bloomberg.com. The former chairman of 24 Hour Fitness has sued the company for failure to pay what she claims was owed under a phantom stock award. We’re only talking $23 million here! Seems like reasonable fees for serving six years on the board, don’t you think?

Apparently the company alleges that the payment “is not a valid obligation of the company.”

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Do Employees Value Phantom Stock?

I spoke with a business owner today who asked an important question about employee satisfaction with phantom stock: “Do employees value phantom stock as much as they would actual stock?”

In my view, nine times out of ten, phantom stock is better for employees than actual stock. This applies particularly for stock options as well. Therefore, explained correctly, employees should value phantom stock more than actual stock. This is a complex subject so allow me to highlight the main factors.

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Phantom Stock—Matching Shareholder and Employee Expectations

What do shareholders want from a compensation arrangement for management?

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So What Does a Phantom Stock Plan Do For You?

As I wrote last time, a phantom stock plan should not be implemented if the goal is to improve employee motivation. Then why do it?

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Does a Phantom Stock Plan Improve Employee Motivation?

You might be surprised by my answer.

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Why Not Use Stock Options Instead of Phantom Stock?

Today I spoke with a business owner interested in uniting key employees around long-term growth goals. After discussing phantom stock he asked, “Why wouldn’t I want to use traditional stock options instead?”

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Why Do a Long-Term Incentive Plan? Reason #4

The most important perception to avoid in any company’s compensation programs is a sense of unfairness. Once employees believe that compensation plans are unfair, engagement and productivity will immediately begin to decline.

Owners and CEOs seek to rally employees around the organization’s growth objectives. Employees understand that growth in sales, margins and profits produce wealth for the shareholders. Those employees who recognize that they directly and meaningfully contribute to growth will begin to wonder how and when they get to participate in this value. Successful companies don’t let this happen. They send the right message: “At ABC Company, you participate in the value you help create!”

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Why Do a Long-Term Incentive Plan? Reason #3

Successful companies find creative ways to attract and retain premier employees. They don’t settle for top 25% quality, or even top 10%. They are committed to the presentation of a value proposition that appeals to the top 2% caliber talent. Many factors beyond compensation must be included in this proposition. But the compensation offering must resonate with them and differentiate from competitors. For this reason, growth-committed organizations utilize incentive programs that enable top performers to build meaningful wealth. Phantom stock plans, along with other forms of long-term incentive plans, are designed to produce this result.

A well-structured phantom stock program that is linked to a growth oriented business plan can send the right message. Key employees can visualize the potential value that can be earned over time. This allows the company to communicate the uniqueness of its value proposition in a concrete way.

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Why Do a Long-term Incentive Plan? Reason 2

The financial objective of nearly all businesses is value creation—the ultimate dual meaning term. By creating value for customers, a well-run business also creates value for shareholders. Profits and improving equity demonstrate whether a company is achieving the financial purposes for its existence. Business owners are constantly asking “how do we improve our business value” whenever they revise their business model or business plan, hire new employees or strive to improve execution.

Not-so-obvious questions arise when considering the allocation of resources within the business: Should we invest in new equipment or a new bonus plan? Should we expand our marketing territories or upgrade our pay levels to market standards? Should we develop new products or adopt a phantom stock plan?

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Why Do a Long-term Incentive Plan? Reason #1

What business purposes do you want to achieve when you adopt a long-term incentive plan such as phantom stock?

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If You Expect to Grow You Need a Phantom Stock Plan

I was speaking with a Senior HR Leader in a $150 million private company today. He was describing his company’s performance incentive plans—bonuses, STIPs, etc. I asked him what these plans were expected to support. You know, why do you have them?

His response: “We want to reward people for achieving our annual goals.”

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