The return of the LTIP

Paul McArdle | Talent & Recruitment Columnist | The Currency

Working on my more recent assignments, I am seeing the rise of the LTIP (Long Term Incentive Plan) as part of the salary packages on offer to candidates.

What is a LTIP?

LTIPs are a way of rewarding key employees as an extra incentive to retain them in your business in return for them helping increase your shareholder value. LTIPs are found in public companies and owner managed or private equity owned businesses. While a key employee can get shares or share options in a publicly quoted business, the LTIP lets privately owned businesses reward their key employees in a similar fashion without necessarily having an equity component.

Often in owner managed businesses, the owner does not want to release equity. However they recognise that some of their employees are integral to the success of their business. The LTIP can be a powerful retention tool as well as an attractive incentive to new employees.

The LTIP can be constructed to provide a material level of reward to your employee without you as the owner releasing any of your equity. It focusses your employee(s) to meet certain targets that are related to increasing your shareholder value.

A lot of the private equity owned businesses use the LTIP as a mechanism to reward key employees if/when there is a liquidity event. As PE companies acquire businesses to scale them for sale, normally within a five year time frame, the size of the LTIP reward is often directly linked to the sale price of the business. PE companies love paying big LTIP payments, the more they pay, the more they make.

How does a LTIP work?

• Criteria are set to be met by employees over a fixed-term time period, normally 3 to 5 years.
• The LTIP reward (if the goals of the LTIP are met) are paid out after that time period or often paid out if a liquidity event takes place beforehand.
• The LTIP is normally set up in such a way that the employee still has to be in the business when the LTIP expires, to get the benefit of the LTIP, a powerful retention tool!
• If the LTIP criteria are met (% increase in EBITDA, increase in shareholder value, a sale price met over a certain price etc.) the employee is rewarded with a material bonus over and above their salary package.
• LTIPs come in many shapes and sizes and are tailored to reward the specific goals of the particular business.

Private equity companies are expert in putting together LTIPs. If you are a business owner considering implementing a LTIP plan, it is best to get proper advice for both you and your key employees whom you are looking to reward. You are looking to get a LTIP that balances driving the material increase in your shareholder value while incentivising the key employee to make it worth their while to stay, and do the actions required for them to increase your wealth (and theirs).

If you are an employee with a LTIP, you have considerations to think about to.

• Do I want to be locked into a long term incentive that keeps me with this company for X more years?
• Is the LTIP achievable?
• Is the reward material to me?

Participation in a LTIP does not only give you a financial incentive to stay/join a business, it also massages your ego. You are wanted. You are seen as being integral to the success of the business. You are getting skin in the game.

During a recruitment process, the inclusion of a LTIP into the equation has a few effects. The candidate is usually more engaged and of a higher calibre. It also elongates the recruitment process, something both employers and employees need to factor in.

You can get agreement on all the other aspects of the offer, however the due diligence on the LTIP from the candidate’s perspective usually takes more time. Both parties need to invest their time at this stage, the prospective employer to explain the mechanics and sell the rewards of the LTIP, the candidate to sense check the whole thing.

In some of the processes I have been involved in, the candidate has been asked to take a view on sacrificing some of their base salary requirements in return for a better LTIP reward. This again adds complexity to the negotiation process. I have found that both the candidate and the client are normally flexible when they are trying to strike a balance between the salary and long term reward. Both parties look at the total compensation package and negotiate accordingly. I have had candidates take the higher base salary and sacrifice some of the LTIP potential to de-risk the proposition, other have negotiated the opposite for themselves.

When I am talking to prospective candidates about roles, the candidates who already have a LTIP with their present employer often will not engage. Those that do engage are likely to be so early into the LTIP it is not material in their decision making or they are about to be paid out on their current LTIP plan. It is a very powerful retention tool for employers.

Private companies also have more flexibility in how they construct their LTIPs. Public companies normally have to be more prescriptive and have less room to tailor their LTIPs. That is not to say that public companies do not tailor them, particularly at “C” suite level, but they are likely to have more issues on setting internal precedents than a private company has.

It is also much harder to value a privately owned business as opposed to a publicly traded one, where you have visibility at all times on the share price.

If the LTIP is related to a future liquidity event and the price your company is sold for, the math can be straightforward enough, with a fixed % of the sales price normally the formula used.

Where you are a private business owner who wants to incentivise your team to increase your shareholder value, but you have no intention of selling your business, it can get more complicated. This is where good, independent professional advice for both the employer and the participating employees is essential.

In a market that is more candidate led by the day, the LTIP is a mechanism well worth considering for the purposes of employee retention and for attracting new talent into your organisation.