Advanced Business Planning
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Tying incentive pay to company value aligns employees' interests with those of shareholders and can drive behaviors that boost long-term growth and sustainability. Here are common methods to structure incentive pay based on company value:
PHANTOM STOCK PLANS
Structure: Phantom stock is a type of deferred compensation plan that provides employees with benefits that mirror stock ownership but without giving away actual equity. Employees receive "phantom shares" that are valued based on the company’s stock price or overall value, enabling them to benefit from company growth.
Valuation Tied to Company: Phantom stock value goes up or down with company value, so if the company grows, employees see the benefit in their phantom stock holdings. At a predetermined time, such as retirement or the end of an employment period, employees receive a cash payout based on the current value.
Benefits: This allows employees to participate in growth without diluting ownership. It’s ideal for private companies that don’t want to give up equity but want to provide equity-like incentives.
STOCK APPRECIATION RIGHTS (SARs)
Structure: SARs give employees the right to receive a cash (or stock) payout based on the appreciation in the company’s stock price from the time of grant to the time of exercise. SARs can be structured similarly to options but don’t require an initial outlay or dilution.
Valuation Tied to Company: SARs are directly tied to company value; the higher the stock price at exercise, the greater the benefit to employees. If company value declines, the payout is reduced, making this an effective incentive for growth.
Benefits: SARs align employees' interests with company success, as they benefit only if the stock price (or company value) appreciates.
PERFORMANCE SHARES / UNITS
Structure: Performance shares (for public companies) or performance units (for private companies) are incentive plans that grant "units" or "shares" based on the company achieving certain value-related metrics. This could be based on revenue, EBITDA, or enterprise value (for private companies).
Valuation Tied to Company: Payouts in performance units are typically based on the increase or decrease in company value over a period (e.g., three years), so they directly correlate with the company’s financial performance.
Benefits: These plans offer clear targets and focus employees on driving metrics that increase company value.
CASH-BASED LONG-TERM INCENTIVE PLANS (LTIPS) LINKED TO COMPANY VALUE
Structure: Cash-based LTIPs tie bonus payouts to company value over a multi-year period. This could mean a payout based on reaching a certain valuation milestone or a percentage of EBITDA growth over three to five years.
Valuation Tied to Company: Cash payouts vary depending on company performance, typically following set metrics. If the company achieves certain financial growth or valuation targets, employees earn more, aligning incentives with long-term value.
Benefits: Cash-based LTIPs provide flexibility without issuing equity, which is beneficial for companies aiming to retain ownership while incentivizing employees.
MARKET-VALUE-BASED BONUS PLANS
Structure: Employees receive a bonus based on the increase in company market value or enterprise value. This is common in both public and private companies where a specific valuation metric (e.g., revenue multiples, earnings growth) is used to determine payouts.
Valuation Tied to Company: Market-value-based plans go up and down with company valuation metrics. Employees are rewarded as value grows, directly tying financial incentives to the overall business value.
Benefits: Simple and clear to understand, this plan type provides a direct link between employee incentives and overall company performance.
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WHAT IS IT?
Corporate-Owned Life Insurance (COLI) is a policy that a company purchases on the lives of key employees or executives. The company is both the policy owner and beneficiary. In the context of funding SERPs, COLI is used as a financing strategy to generate tax-advantaged cash values that can offset or reimburse the future retirement benefits promised to these executives.
WHY USE COLI FOR SERP FUNDING?
Policy Purchase: The company purchases life insurance policies on select executives as part of a long-term funding strategy for retirement benefits.
Cash Value Growth: Over time, the policy’s cash value grows on a tax-deferred basis, allowing the company to accumulate significant assets that can be earmarked to fund future retirement benefits for the executive.
Informal Funding: While the cash values are not legally restricted for the SERP, companies often maintain them specifically for future executive benefits. This is considered an “informal” funding mechanism, as there is no formal trust or legal obligation to set aside these funds solely for the SERP, giving the company flexibility.
Death Benefit: In the event of the insured executive’s death, the company receives a tax-free death benefit, which can serve as a final source of SERP funding or as a recovery of the cost associated with providing retirement benefits.
EXAMPLE SCENARIO
A company wants to provide a supplemental retirement benefit to a key executive. It sets up a SERP, promising the executive additional retirement income. To fund this obligation, the company purchases a COLI policy on the executive. Over the years, the cash value of the COLI grows, allowing the company to have a tax-deferred pool of assets available when the executive retires. At retirement, the company can draw from the COLI cash value to pay the SERP benefits without dipping into other corporate funds.
CONSIDERATIONS
While COLI provides flexibility and tax advantages, it's critical to work with legal, tax, and insurance professionals to structure the policies and SERPs correctly, especially as tax regulations around these plans can be complex. Properly structured, COLI can be a powerful tool for companies to attract and retain top talent with competitive retirement benefits, all while maintaining corporate cash flow and balance sheet stability.
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Our President and Founder, Dan Crowley, a Certified Family Business Specialist (CFBSP) and Certified Business Succession Planner (CBSP), has guided over 50 U.S. companies in implementing innovative strategies to recruit, retain, reward, and retire essential employees. With tax-advantaged plans tailored to enhance personal wealth and company value—without requiring equity sharing—Dan's expertise helps businesses secure loyalty and long-term commitment.
Our SERP solutions are crafted to maximize retention and benefit both the company and the individual. Partner with us to design customized, tax-efficient plans that strengthen your company’s future.
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