John Brown Attorney and Founder of BEI Employee Ownership Conference Minneapolis, MN :  April 20-22, 2010 Dan Walter Presi...
Introduction <ul><li>Exit Planning and Equity Compensation </li></ul><ul><li>Basic Question:  Why should I consider incent...
Overview: Equity Based Compensation Design Considerations <ul><li>Who </li></ul><ul><li>How much </li></ul><ul><li>When </...
Exit Planning Perspective <ul><li>Owner-managed companies in transition.  </li></ul><ul><li>Baby Boomer business owners.  ...
Seven Step Exit Planning Process <ul><li>Step 1 – Identify Owner Exit Objectives  </li></ul><ul><li>Step 2 – Quantify Busi...
ESOP Perspective: <ul><li>Should ESOP Trustees approach equity ownership decisions in same way as owners interested in exi...
Advantages of Equity Based Incentive Compensation. <ul><li>More effective than cash in motivating or retaining the key emp...
Advantages of cash based incentive compensation <ul><li>More effective than stock in motivating and keeping key employees....
Benefit Formulas <ul><li>Performance based. </li></ul><ul><li>Usually calculated annually. </li></ul><ul><li>Performance s...
<ul><li>What do we mean by “Who should get how much”? </li></ul><ul><ul><li>Who are the stakeholders? </li></ul></ul><ul><...
What is meant by “Equity” <ul><li>eq·ui·ty, n. pl. eq·ui·ties  </li></ul><ul><ul><li>1.  The state, quality, or ideal of b...
Is Equity Compensation truly “Fair”? <ul><li>Fair, adj. </li></ul><ul><ul><li>1 . free from discrimination , dishonesty, e...
Can Equity Compensation be “Just”? <ul><li>Just, adj. </li></ul><ul><ul><li>1. Honorable and fair in one's dealings and ac...
Common Reasons for Equity Compensation <ul><li>Private Co. </li></ul><ul><ul><li>Someday go public </li></ul></ul><ul><ul>...
<ul><li>Define the stakeholders </li></ul><ul><li>Define corporate goals </li></ul><ul><ul><li>Understand impact of equity...
<ul><li>Performance was always the stated “reason” for offering equity. </li></ul><ul><ul><li>“ We want people to share in...
The Equity Compensation Dilemma 1988-1999 the “no lose” zone  (and the period of the greatest   growth in the use and valu...
<ul><li>Virtually all market data currently available is based on the assumption created by the “no lose” market </li></ul...
<ul><li>Past (assuming non-founders):  </li></ul><ul><ul><li>CEO Ownership at pre-IPO companies: 2.40%-4.60% </li></ul></u...
<ul><li>Must determine maximum % of ownership that will be “gifted” to each level (as opposed to purchased) </li></ul><ul>...
<ul><li>More emphasis being put on linking equity explicitly or implicitly to financial, operational, team an individual p...
<ul><li>Focus first on your corporate goals, before you focus on market data </li></ul><ul><li>Design plans based on “just...
Questions  Contact Us. John H. Brown, President Business Enterprise Institute, Inc. 888-206-3009 jbrown@exitplanning.com  ...
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Equity Comp - Who and How much to give

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This presentation covers the topic of equity compensation from two disparate perspectives. 1) the point of view of an exit planning specialist 2) the point of view of a companies looking for long term executive and broad-based equity compensation solutions.

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Equity Comp - Who and How much to give

  1. 1. John Brown Attorney and Founder of BEI Employee Ownership Conference Minneapolis, MN : April 20-22, 2010 Dan Walter President and CEO Performensation
  2. 2. Introduction <ul><li>Exit Planning and Equity Compensation </li></ul><ul><li>Basic Question: Why should I consider incentive equity compensation for my company? </li></ul><ul><ul><li>Advantages of equity as an incentive. </li></ul></ul><ul><ul><li>Advantages of cash as an incentive. </li></ul></ul>
  3. 3. Overview: Equity Based Compensation Design Considerations <ul><li>Who </li></ul><ul><li>How much </li></ul><ul><li>When </li></ul><ul><li>Why </li></ul><ul><li>How to measure, basis for award, performance standard. </li></ul>
  4. 4. Exit Planning Perspective <ul><li>Owner-managed companies in transition. </li></ul><ul><li>Baby Boomer business owners. Most want to exit . </li></ul><ul><li>Need management team and other key employees motivated to stay after owner leaves and to grow value. </li></ul><ul><li>Size of Company: 15 employees – 500 or so. </li></ul><ul><li>What does it take for an owner to be able to exit – via ESOP or any other path? </li></ul>
  5. 5. Seven Step Exit Planning Process <ul><li>Step 1 – Identify Owner Exit Objectives </li></ul><ul><li>Step 2 – Quantify Business and Personal Financial Resources </li></ul><ul><li>Step 3 – Maximize and Protect Business Value </li></ul><ul><li>Step 4 – Ownership Transfer to Third Parties </li></ul><ul><li>Step 5 – Ownership Transfer to Insiders </li></ul><ul><li>Step 6 – Business Continuity </li></ul><ul><li>Step 7 – Personal Wealth and Estate Planning </li></ul>
  6. 6. ESOP Perspective: <ul><li>Should ESOP Trustees approach equity ownership decisions in same way as owners interested in exiting their businesses? </li></ul><ul><ul><li>ESOP Trustees represent ownership and much like departing owners may not be actively involved in the day to day business. </li></ul></ul><ul><ul><li>ESOPS want management and key employees to: </li></ul></ul><ul><ul><ul><li>Stay through owner’s exit; </li></ul></ul></ul><ul><ul><ul><li>To have the same incentive to grow business as does ownership. </li></ul></ul></ul><ul><ul><ul><li>To grow business value long term & continually. </li></ul></ul></ul>
  7. 7. Advantages of Equity Based Incentive Compensation. <ul><li>More effective than cash in motivating or retaining the key employee. </li></ul><ul><li>It is part of the owner’s exit strategy to transfer ownership to key employee(s). </li></ul><ul><li>It is cashless. </li></ul><ul><li>It is in anticipation of a third party sale and the owner wishes to benefit selected employees with capital gains treatment. </li></ul>
  8. 8. Advantages of cash based incentive compensation <ul><li>More effective than stock in motivating and keeping key employees. </li></ul><ul><ul><li>If they have to pay for equity, most employees prefer cash to ownership. </li></ul></ul><ul><li>Owner’s do not want more owners. </li></ul><ul><li>More Flexible. </li></ul><ul><li>Owner’s exit path is third party sale or transfer to family. </li></ul>
  9. 9. Benefit Formulas <ul><li>Performance based. </li></ul><ul><li>Usually calculated annually. </li></ul><ul><li>Performance standard benefits the owners. </li></ul><ul><li>Subject to “vesting”. </li></ul><ul><li>Usually long term goal is to grow value to a certain level or over a certain time based on owner’s exit objectives. </li></ul>
  10. 10. <ul><li>What do we mean by “Who should get how much”? </li></ul><ul><ul><li>Who are the stakeholders? </li></ul></ul><ul><ul><li>Is Equity Fair and/or Just? </li></ul></ul><ul><ul><li>Is How much defined as: </li></ul></ul><ul><ul><ul><li>Amount in “money” </li></ul></ul></ul><ul><ul><ul><li>Amount in “shares” </li></ul></ul></ul><ul><ul><ul><li>Amount in “ownership percentage” </li></ul></ul></ul>The Other Side of Equity
  11. 11. What is meant by “Equity” <ul><li>eq·ui·ty, n. pl. eq·ui·ties </li></ul><ul><ul><li>1. The state, quality, or ideal of being just, impartial, and fair . </li></ul></ul><ul><ul><li>2. Something that is just, impartial, and fair. </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>4. The residual value of a business or property beyond any mortgage thereon and liability therein. </li></ul></ul><ul><ul><li>5. a. The market value of securities less any debt incurred; b. Common stock and preferred stock. </li></ul></ul><ul><ul><li>6. Funds provided to a business by the sale of stock. </li></ul></ul><ul><li>Source: www.freedictionary.com </li></ul>
  12. 12. Is Equity Compensation truly “Fair”? <ul><li>Fair, adj. </li></ul><ul><ul><li>1 . free from discrimination , dishonesty, etc.; just; impartial </li></ul></ul><ul><ul><li>2. in conformity with rules or standards; legitimate a fair fight </li></ul></ul><ul><ul><li>3. (of the hair or complexion) light in colour </li></ul></ul><ul><ul><li>4. beautiful or lovely to look at </li></ul></ul><ul><ul><li>5. moderately or quite good a fair piece of work </li></ul></ul><ul><ul><li>6. unblemished; untainted </li></ul></ul><ul><li>Source: freedictionary.com </li></ul>
  13. 13. Can Equity Compensation be “Just”? <ul><li>Just, adj. </li></ul><ul><ul><li>1. Honorable and fair in one's dealings and actions: a just ruler. </li></ul></ul><ul><ul><li>2. Consistent with what is morally right; righteous: a just cause. </li></ul></ul><ul><ul><li>3. Properly due or merited : just deserts. </li></ul></ul><ul><ul><li>4. Law Valid within the law; lawful: just claims. </li></ul></ul><ul><ul><li>5. Suitable or proper in nature ; fitting: a just touch of solemnity. </li></ul></ul><ul><ul><li>6. Based on fact or sound reason ; well-founded: a just appraisal. </li></ul></ul><ul><li>Source: freedictionary.com </li></ul>
  14. 14. Common Reasons for Equity Compensation <ul><li>Private Co. </li></ul><ul><ul><li>Someday go public </li></ul></ul><ul><ul><li>Someday get acquired </li></ul></ul><ul><ul><li>Focus is extended period growth </li></ul></ul><ul><ul><li>Ensure strong shareholder support if there are other investors </li></ul></ul><ul><ul><li>Not planning to go public </li></ul></ul><ul><li>Public Co. </li></ul><ul><ul><li>Attract, Motivate and Retain high quality staff </li></ul></ul><ul><ul><li>Align staff with management and shareholders </li></ul></ul><ul><ul><li>Provide wealth-building potential </li></ul></ul><ul><ul><li>Create owners, especially among those who may not otherwise buy stock </li></ul></ul><ul><ul><li>Provide upside potential commensurate with growth in company stock price / market </li></ul></ul><ul><li>Any Co. </li></ul><ul><ul><li>Drive and reward success of stakeholders </li></ul></ul>
  15. 15. <ul><li>Define the stakeholders </li></ul><ul><li>Define corporate goals </li></ul><ul><ul><li>Understand impact of equity plans on each type of goal </li></ul></ul><ul><li>Define acceptable risk/reward profiles for immediate needs and projected against “success” </li></ul><ul><li>Determine market pay requirements </li></ul><ul><li>Determine best case and worst case scenarios </li></ul><ul><li>Document plan for at least three paths </li></ul><ul><ul><li>Acceptable growth </li></ul></ul><ul><ul><li>Shrinkage </li></ul></ul><ul><ul><li>Outperform </li></ul></ul>Determining Who and How Much
  16. 16. <ul><li>Performance was always the stated “reason” for offering equity. </li></ul><ul><ul><li>“ We want people to share in the success and growth of the company” </li></ul></ul><ul><ul><li>NOTE: Very little mention of failure and demise of the company </li></ul></ul><ul><li>Is performance simply stock price? Total Shareholder Return? </li></ul><ul><li>When does the progression of stock price no longer provide a reasonable link to pay? </li></ul>Linking Equity to Performance
  17. 17. 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)
  18. 18. <ul><li>Virtually all market data currently available is based on the assumption created by the “no lose” market </li></ul><ul><li>Data from prior to that period is invalid due to the limited use of equity </li></ul>Our Data is Old and Flawed
  19. 19. <ul><li>Past (assuming non-founders): </li></ul><ul><ul><li>CEO Ownership at pre-IPO companies: 2.40%-4.60% </li></ul></ul><ul><ul><li>Other C-Level: 0.25%-1.95% </li></ul></ul><ul><ul><li>Hire on grants </li></ul></ul><ul><ul><ul><li>CEO: 0.78%-2.50% </li></ul></ul></ul><ul><ul><ul><li>Other C-Level: 0.11% - 0.93% </li></ul></ul></ul><ul><ul><li>All based on then current number of shares. </li></ul></ul><ul><ul><ul><li>Does not take into account future values </li></ul></ul></ul><ul><li>Assumption that equity would grow in value, but continued new grants assumed that ownership was transitory and had to be replenished </li></ul>The “How Much” of the Past
  20. 20. <ul><li>Must determine maximum % of ownership that will be “gifted” to each level (as opposed to purchased) </li></ul><ul><li>Must determine risk/reward profile for company </li></ul><ul><ul><li>Too little or too much equity can discourage risk, which is essential for growth and innovation </li></ul></ul><ul><li>These decisions must factor in the expected and possible exit strategies </li></ul><ul><li>Programs must incorporate reasonable indicators of performance for grant, earning, vesting and or release </li></ul><ul><ul><li>These factors must be frequently reviewed as adjusted during the early years of a company </li></ul></ul><ul><ul><li>Levels of pay and relation to ownership percentages and potential value of equity must be frequently reviewed and adjusted as a company evolves </li></ul></ul>Dealing with the New Volatile Market
  21. 21. <ul><li>More emphasis being put on linking equity explicitly or implicitly to financial, operational, team an individual performance. </li></ul><ul><ul><li>Not always “performance-based equity” </li></ul></ul><ul><ul><li>Often “justification-based equity” </li></ul></ul><ul><li>Multiple studies link better corporate performance with higher levels of management ownership </li></ul><ul><li>Studies commonly show a link between broad-based ownership and improved corporate performance </li></ul><ul><li>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 </li></ul>Equity Evolution
  22. 22. <ul><li>Focus first on your corporate goals, before you focus on market data </li></ul><ul><li>Design plans based on “just” compensation levels, rather than “fair” compensation levels </li></ul><ul><li>Today’s answers may not be valid a year or two from now, so don’t write too much in stone </li></ul><ul><ul><li>The 10 commandments are short and so is the US Constitution. </li></ul></ul><ul><ul><li>Your Rules should define and guide, not dictate and control </li></ul></ul>Planning for Equity Compensation Success
  23. 23. Questions Contact Us. John H. Brown, President Business Enterprise Institute, Inc. 888-206-3009 jbrown@exitplanning.com Contact Us. Dan Walter, President and CEO Performensation 877-803-9255 x. 700 [email_address] Skype: performensation Twitter: @performensation www.performensation.com
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