Long Term Incentive Plan or LTIP
Long Term investment Plans are an essential part of many corporations hiring plans, and help them manage and retain high quality talent in the firm
Like the name suggests, long term incentive plans (LTIPs) are a vehicle that offers people with extra time to earn company incentives (often more than a year). Companies use it as a tactical compensation tool for obtaining long-term retention and meeting their various organizational goals. These plans often serve as a bridge to align the interest of the company with that of the employee, making them part owners in the company. There are different long term incentive plan types and each of them come in handy for different types of employees.
Long Term Investment Plan (LTIP)
Long Term investment Plans are an essential part of many corporations hiring plans, and help them manage and retain high quality talent in the firm. But first it’s good to understand the fundamentals of long term investment plans and what they are all about.
What is a Long Term Investment Plan or LTIP?
At its core, a long term incentive plan is essentially a comprehensive reward system created to better the long term performance of employees. It does so by giving them rewards that are separate from their organization’s share price.
In traditional long term incentive plans, an executive tends to fulfill the various requirements and conditions to prove they played a part in improving the overall shareholder value. It would be fair to say that this type of incentive plan mostly leans towards executive compensation, as that’s the place where they mostly apply.
However, after the financial crisis happened, companies have been using them broadly to connect the compensation of employees with long term success, as long as it is in sync with various shareholder demands. That is precisely where LTIPs prove to be an excellent long term tool in the sense that its performance period could range anywhere between 3 to 5 years (you will receive the payout once the period is over).
Why is a Long Term Incentive Plan Important?
Getting new employees on board is not as easy as it seems. What’s more, replacing executives also tends to be incredibly costly, and often costs around 9 to 10 times their salary. You may be wondering why these costs are so high – well, the answer is quite simple. First off, there is a high amount of training and recruitment needed to find the right fit for an organization.
Besides that, the company’s senior employees have to dedicate most of their work hours in search for replacements, which reduces their productivity, and directly impacts profitability. A long term incentive plan provides organizations a way to retain and stimulate talent in immensely competitive environments.
As mentioned earlier, it offers employees with rewards for their contributions towards their company, whether it is reaching strategic objectives or any other long term goal. It is a great way to acknowledge their contributions, making them realize their importance and value.
Vesting Schedules for LTIP
Long term incentive plans come with vesting periods. If you are new to LTIPs, you may not be aware of what this means. However, it is relatively straightforward to understand. A vesting period or schedule means that grantees have equities but they don’t own it. They can only become owners of the equity after the completion of the vesting period.
It is the main reason why organizations utilize long term incentive plans for retention, unless the grant receiver fulfills the vesting requirement. There are two main vesting types used by organizations: ratable and cliff. Employees receive cliff vest awards at once, as soon as the predetermined time period concludes. On the other hand, awards vesting ratably pay out a portion at a time.
For instance, if an employee decides to terminate before the last vesting periods conclusion, they will still own the already-vested portions. Like we discussed earlier, long term incentive plans range between 3 to 5 years before the grantee receives its complete benefits. Contrary to popular belief, you may not get the total incentive right away, as it depends on the particular award’s vesting schedule. Let’s look at two main vesting schedule types.
- Graduated Vesting – Graduated vesting takes place with the grantee receiving a certain percentage of their award each year. This is not as uncommon as you might think. The employee does not receive any benefit initially (the first two years in most cases). However, in the subsequent years, they would get a part of their asset, until it becomes completely vested down the line.
- Cliff Vesting – In this vesting schedule type, the employee receives the right to the complete benefits at a particular point, instead of equally over the period.
In both cases, employees only obtain the reward’s benefits if they stay with their organizations until the vesting period finishes. It is a big reason why long term incentive plans are able to motivate employees to perform well and stay at their companies.
It is worth keeping in mind that LTIPs are not single-time incentives. Instead, they are yearly, and an individual may receive a completely new long term incentive award each year.
Types of Long Term Incentive Plans
There are different types of long term incentive plans utilized by companies, and each of them has something unique to offer. Let us discuss some of them below.
Stock options are a common long term incentive plan type used by companies. After a particular length of employment, employees can buy the company’s stock at discounted rates while their employer settles the remaining balance. The employee’s seniority in the company increases with the amount of shares they own.
Be sure to have a 409a valuation done for your company to price the option’s exercise price.
In some cases, companies provide founders or key employees with restricted stock. As each year passes, the employee may receive the rights to a further 25% of the stock gifted to them. Once the 4 year period is over, the Restricted Stock becomes fully vested.
401(k) Retirement Plan
The renowned 401(k) retirement plan is another type of long term investment plan utilized by companies. When an organization matches the percentage present on their worker’s paycheck, it improves their motivation to work for their employers until retirement.
This is another type of long term incentive plan, but it is quite different compared to others. Why? Because it is an allocation of the organization’s stock reliant on the company’s overall performance criteria. The main purpose of doing this is to match the interests of shareholders and executives, ultimately maximizing their overall value.
By taking advantage of performance shares, executives can get actual shares instead of the options to purchase them at set prices, only to make profits by reselling them.
Companies also grant cash awards. They can be long term or short term grants. In the former, grantees receive the cash payout only after the conclusion of the vesting period. In most cases, private companies provide these grants because of the difficulties associated with share valuation.
Phantom stocks are well-renowned contractual agreements where an organization offers to provide employees with cash payments as long as they can fulfill certain conditions. You may be wondering what the purpose behind this is. Well, similar to stock warrants, phantom stocks are excellent for creating the ownership mentality. It also rewards important employees for their contributions towards improving the business’ value.
Example of an LTIP
Long term incentive plans can be hard to understand, which is why you will find plenty of long term incentive plans online. However, the one we are about to discuss below will clear everything up.
Let’s say in July 2018, an organization’s board of directors agreed to offer a share based long term incentive plan to an important employee, Jessica Thomson, in the form of 6,000 restricted stock on a 4 year vesting period with a 1 year cliff. This means that Jessica would not receive any shares until the 1st year cliff has passed, and would receive shares regularly afterwards (in this case, let’s say quarterly). The vesting schedule would look like:
|Date||Shares||Total Shares||% Ownership|
As you can see, the total 6,000 restricted stock would be completely vested by the end of June 2022. Let’s say that later in 2022 Jessica decides to sell all her shares when the share price of the company reaches $7. This would mean after the 4 year period, she can sell her shares for an extra $42,000 before taxes. And this LTIP example can illustrate how the employees can benefit by gaining ownership in the company, and how the business can benefit by longer tenancies of their key staff members.
Long Term Incentive Plan Tax Treatment
The long term incentive plans tax treatment can be incredibly complex. In addition, they are always subject to change, making them all the more difficult to comprehend. It is important to keep in mind that all the circumstances and facts of every participant could impact the implication.
In most cases, the provision of non-qualified stock options doesn’t impose income taxes at the grant. These options are not taxable when the stock option is vesting. However, they are taxable when you exercise them.
Long Term Incentive Plan on Eqvista
You can create and implement long term incentive plans on the Eqvista app, and manage all of your LTIP plans for your shareholders from one spot. After creating these plans, you can mass apply them to many shareholders at one time, and even stop and start vesting for different shareholders based on your schedule.
Here is how to set up an LTIP plan on the Eqvista App:
From the dashboard go to “Cap Table” on the sidebar, and click on “Vesting and Plans”. From this page you can click on the button “Create Vesting Plan” which will bring you to the following page:
On this page you can set up the details of your vesting plan (Time based, milestone based or hybrid), and also the vesting schedule for the plan.
Once the vesting plan is set up, you can go to the “Actions” bar under each plan and apply them to many grants at one time. In this case we applied them to different Founder Shares (common shares) in the company.
Once the vesting plan is applied to a grant, you can go the grant and view how total shares vest through time from the vesting start day until today. In this case 1,062 shares of the 2,000 shares in the grant have vested, with the completion date of the grant on February 21st, 2022.
Long term investment plans can offer you a lot if you know the fundamentals, and companies offer different types of LTIPs according to their goals. These plans are quite useful for organizations in the long run, as it minimizes the cost required to hire and train new employees. Do you run a company and are having trouble managing your equity transactions?
Eqvista is a user friendly, state of the art equity management tool specially designed to help companies manage their incentive programs. Save time and money by using our app to help you manage all the details for your company equity.
For more information about how our equity management system can help you, contact us today!
FAQs on Long Term Incentive Plan (LTIP)
Here are some frequently asked questions on Long Term Incentive Plan or LTIP.
Can LTIP rewards be forfeited?
There is a vesting time attached to the long-term rewards. Until the vesting term on the LTI ends, the grantees do not officially own the stock they were awarded. As a retention tool, LTI grants are forfeited until the recipient has met all vesting conditions. For instance, if performance targets are met, the employee must stay with the organization for a certain amount of time. If an employee leaves the firm before the vesting term ends, he or she will still hold any vested stock that has not yet been distributed.
How are LTIPs disclosed to shareholders?
The company intends to provide its Long-Term Incentive Plan (LTIP) to its shareholders via a disclosure document. It is a compensation strategy that includes cash or company stock rewards to senior employees upon achieving predetermined objectives. Typically, the objectives are designed to be long-term, spanning 3-5 years, to encourage sustained advancement, as opposed to short-term goals that last only a few months. The product possesses an integrated retention feature.
How are LTIP rewards taxed?
Employees must include the whole value of their long-term incentive plan as income when filing their taxes. Depending on the kind of LTI award, taxes may be due at various points in the LTIP’s lifecycle, including at the time of Grant, Vesting, Exercise, and Sale. For instance, when it comes to ISO awards, you won’t have to pay taxes until you sell them, but when it comes to NSO awards, you’ll have to pay income taxes when you exercise them.
Who is eligible for an LTIP?
Long-term incentive plans (LTIPs) are available to all employees, although they are typically reserved for those at the executive or officer level and higher. The long-term reward potential for essential personnel in private firms is, however, around 50% lower than those at public companies due to their liquidity. Every firm has its requirements for how an employee qualifies for the LTIP. Typically, employees become eligible to receive benefits after a period of three to five years, provided they fulfil their performance objectives outlined by the company.
What are the risks of an LTIP?
Based on research findings, executives exhibit a preference for less risky options in contrast to Long-Term Incentive Plans (LTIPs). Additionally, they prioritize present pay considerations and place significant value on non-monetary factors such as teamwork and accomplishments. Executives also tend to look for immediate compensation for completed work over the prospect of a larger payout based on meeting performance goals.