By Dean Nordlinger, Partner, PilieroMazza
The purpose of an employee incentive plan, regardless of the specific type or form that it takes, is to more closely align a key employee’s financial interests with the company’s. In developing and implementing an employee incentive plan, the company’s owners’ challenge is to strike the right balance between allowing key employees’ to share in the company’s upside success, while protecting the company’s downside risk in the event one or more of the key employees fails to deliver the anticipated value based on which the equity sharing is provided.
The following hypothetical scenario illustrates how selecting the right employee incentive plan can be a tricky process for a company’s owners. Three individuals (Owners) joined together and formed a company to perform government contracting work. The Owners have grown the company into a multi-million dollar annual revenue company. However, they believe the company has reached a plateau (at level “x”) and in order to take the company to the next level (level “y”), the company will have to attract new key employee talent with some form of equity sharing incentive (and, in fact, certain key employee candidates have signaled to the Owners that in order to join the company they would need a “piece of the pie”).
The company (1) is not in start-up but rather emerging growth mode; (2) is currently valued at $5 million; (3) has a strong contracts backlog and is positioned to realize significant profit and growth over the next three years; (4) is structured as an “S corporation” for tax purposes (which makes the company a pass-through entity but it can only have one class of stock); and (5) will award the equity sharing incentives to the key employees for current and future valuable services that the key employees will provide.
Because the Owners feel the need to provide real equity to these certain key employees, they intend to implement a restricted stock plan. Is this likely to work well for the company (and Owners)? Perhaps not, and let’s see why.
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