The CEO and majority owner of ACME Food Supply (a hypothetical S corporation) makes the following request for help:
“My executive compensation program is a mess. Our legacy management makes too much and our new leaders are upset that they do not share in the increasing company value. We have an employee stock option program – but as the company has grown from $70M to $300M in value, very few executives have the cash to exercise the options for stock. As a result, many of the options expire worthless – making our program feel like a “tease”. Due to new requirements, we need to disclose the pay packages for our top five executives (required as a government contractor) and I fear the inequality of the pay packages will further stir the pot.
Furthermore, at 68 years old, I will be stepping down in three years and I do not have succession management squarely in place. Our top management and my co-owners all want ACME to be a perpetual company and I need a plan that gives me the most options to satisfy our family estate planning and the needs of future leaders. We implemented a minority ESOP over the last few years and the new plan needs to be ESOP friendly. Can you help?”
The sentiment shared by the business owner above is all too common. Many business owners feel that they are suffering from the scarcity of talent, scarcity of cash, and scarcity of confidence in their business succession plan. An integrated executive compensation plan including synthetic equity can certainly help to achieve consistent high performance.
In the ACME case above, the advisors designed an integrated business succession plan supported by a new executive compensation plan. Owners, next generation leadership, and advisors clarified the business requirements across talent, performance metrics, cash flows, and succession.
A meritocracy performance-based pay plan was implemented to replace the employee stock options and high annual cash compensation for select legacy leaders. The advisors and owners froze the employee stock option plan and replaced it with two plans: a value band unit plan for the company leaders where 1/3 of the value pays out in 6 years – giving succession leadership a strong team unified target. The remaining value is paid out upon the earlier of a separation of service or change in control. Secondly, a cash-settled SARs plan using a 10 year time certain payout to incent long-term performance across the top leaders was established. Overall, the plan was customized to meet the 3, 7, and 15 year time horizon reflecting the needs of the current major owners, succession management, next generation of leadership, and the ESOP itself.
Working across multiple disciplines, the executive compensation plan was integrated with the owner’s estate, gifting and philanthropic planning. The advisors stress-tested the plan via scenario planning, considering the likely and extreme outcomes around the pre and post-tax cost of the program. The combined executive compensation plan, exit sale to the ESOP, and management succession plan collectively gave the various stakeholders confidence that the company’s high performance culture would continue once the next generation of management began to lead the company.
As said earlier in the paper:
Do you want to do a better job building a talent pool, rewarding high performance, optimizing cash and empowering succession? Consider employing synthetic equity solutions in your organization.