Perspectives

Private companies should step up their use of long-term employee incentives

Ways private companies can incentivize their employees

With the labor market strengthening further every month, private companies are finding it more difficult to land top talent and keep their most-prized employees from heading elsewhere. One of the main challenges private companies face is the inability to match the hefty pay packages offered by public companies.

Private companies should step up their use of long-term employee incentives

September 22, 2015

A blog post by Michael S. Kesner, leader, National Compensation Practice

With the labor market strengthening further every month, private companies are finding it more difficult to land top talent and keep their most-prized employees from heading elsewhere. One of the main challenges private companies face is the inability to match the hefty pay packages offered by public companies.

Deloitte has long counseled the private companies we work with to focus on the qualities that make private companies great places to work–increased access to leadership, more flexible work environments, and a greater commitment to maintaining a work-life balance. But there is another valuable inducement that too few companies are taking advantage of: long-term incentive plans. According to a recent survey conducted by WorldatWork and Vivient Consulting, long-term incentives can make up more than 50 percent of an executive’s total compensation at public companies, but that number shrinks to about a third at smaller, private companies.1

This fact flies in the face of private companies’ natural advantages in the use of long-term incentives. For one, they don’t need to be nearly as focused on short-term results since they aren’t obligated to focus on quarterly earnings and other regulatory burdens. In addition, the growth potential of private companies is often greater because their owners are able to sacrifice short-term profitability for investment in the long-term future of the business.

Despite this, the vast majority of private companies – as high as 97 percent – turn to short-term incentives to reward employees and keep them motivated.2 There is nothing wrong with incentivizing employees over the short term but doing so without complementing these efforts with longer-term remuneration may leave key employees vulnerable to poaching by competitors for talent. Moreover, the lack of long-term incentives can create a disconnect between owners and management, as management is only rewarded for achieving annual results.

This is an opportune time in the economic cycle for private companies to conduct a 'clean slate' review of their compensation program to evaluate if their compensation strategy includes the right mix of incentives to add and retain valued workers. Every private company is different, and your organization’s preferred vehicle for long-term incentives will depend on the short- and long-term objectives of the business, as well as retention, cost and accounting considerations. Other factors to consider will be the type of long-term incentive vehicle that best fits your organization, when to provide opportunities for employees to cash out, and who should be eligible in the first place.

The good news is, there is a variety of ways companies can incentivize their employees over the longer term, and one of four common practices should fit your business’s needs. Long-term cash bonuses are the most common inducement used by private companies because they eliminate the need for business valuations. But three other incentive plan practices are gaining favor:

  • Phantom restricted stock: Provides the cash equivalent of employer stock with service-based vesting restrictions while mirroring the look and feel of real equity.
  • Phantom stock appreciation rights (P-SARs): Provides the participant the right to the appreciation in stock value from the time of grant to exercise.
  • Profits interest: Provides an interest in a partnership that is not a capital interest, entitling the holder to a percentage of post-grant partnership interest and gains.

Finding the right path for incorporating long-term incentives in your compensation plan might seem complex but it doesn’t have to be. Such inducements can be a fit for private companies as they gear up to compete for talent in an increasingly tight labor market. Taking some deliberate steps now can help ensure your key employees can look, feel, and act like owners of the company – a quality that is likely to make potential or existing employees think twice about working anywhere else.

1 WorldatWork and Vivient Consulting, 'Incentive Pay Practices Survey: Privately Held Companies,' February 2014
2 Id

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