equity comp - who and how much to give

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.


Overview: Equity Based Compensation Design Considerations

Who How much When Why How to measure, basis for award, performance

standard.


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?


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


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.


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.


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.


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.


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


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


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


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


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


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


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


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)


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


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


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


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


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


Questions

Contact Us.John H. Brown, President

Business Enterprise Institute, Inc.888-206-3009

[email protected]

Contact Us.

Dan Walter, President and CEO

Performensation

877-803-9255 x. 700

[email protected]

Skype: performensation

Twitter: @performensation

www.performensation.com

mailto:[email protected]

equity comp - who and how much to give

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