Non-equity LTI ideas?

searcher profile

November 21, 2022

by a searcher from University of Pennsylvania - The Wharton School in Miami, FL, USA

We're working to hire a GM for a portfolio company who will not be an equity holder. We would like to have some sort of long-term incentive that is linked to performance and motivates the executive to stay at the company long-term. There are manifold ways we could do this - I'm interested in learning from others what you have done and what has worked well/not worked?

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Reply by an investor
from New York University in New York, NY, USA
I've been involved with 2 non-equity LTIPs that might be of interest. One was based on phantom stock where the units would vest at an exit event if a certain valuation is achieved - so basically some of the proceeds would be diverted to the participants, "diluting" the actual shareholders. The other plan was purely cashed based and involved target cash payouts made in the future if certain financial targets (EBITDA) were achieved in line with an agreed upon strategic plan. For example, if the 2025 target EBITDA is achieved, then they receive a cash payout for that, either in early###-###-#### when the 2025 financials are done) or you could spread 50/50 over 2 years. You could have a payout planned for each year starting in 3-4 years.

For both types of plans, you could also provide some flexibility up and down based on the level of achievement. You could start at a cutoff level - say 85% - below which there is no vesting, then between 85%-100% achievement the vested amount (either units or cash) would flex from###-###-#### % of the target reward, and then above 100% you could provide some kind of sweetener above the target, with some kind of cap.

Phantom equity works well if there is alignment on an exit - management has to have confidence that the shareholders are interested in an exit at some point. If there is any uncertainty there, then you might consider some kind of liquidity option for the participants, though that gets complicated because then you need to have a valuation performed (and the interests of the participants and the shareholders will not be aligned). In situations where there is uncertainty about an exit, then a cash plan is more straightforward.

Hope this helps.
commentor profile
Reply by a professional
from Dartmouth College in Los Angeles, CA, USA
The two most common are incentives tied to financial performance and phantom equity, which tracks the growth of equity without actually granting equity to the employee and can have similar vesting provisions as actual equity. Typically paid on a change of control event, can depend on whether they participate in regular dividends. Has to be structured correctly though.
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