Case Study: Long-Term Incentive Program Meets Employer’s Needs

Challenge

The sole owner of a consulting firm with 80 employees would like to sell his firm within five years and retire. The owner, who is extensively involved in the business, understands that the sale price of the firm is directly related to the revenue generated by the firm. The firm has six key employees aside from the owner, and a purchaser of the firm would want to hire those employees—they are the face of the firm to many of the firm’s clients.

The owner came to us seeking to devise a program for those key employees that would (1) motivate them to increase sales (2) incent them to stay with a new employer upon a sale and (3) reward them if a sale of the firm occurred.

Solution

We met with the owner several times to understand his needs and desires regarding this program. In the course of our discussions, we helped the owner focus on several issues—how much he needed to receive from the sale of the firm so that he could comfortably retire; what the revenue of the firm would need to be to generate a sale for that amount; and how long he believed it would take the firm to reach that level of revenue. We also learned that the owner had a concern that several of the key employees might leave and take some of the firm’s clients with them. Finally, we learned that the owner wanted to hire a new key employee from a publicly traded organization but did not know how to create a comparable compensation package.

We discussed different methodologies for long term incentive programs—programs that would give key employees a significant payment if they remained in the firm’s employ for a number of years—and the impact that each method would have on the firm, the owner, and the employee.
Proposed solution:

We designed a stock appreciation right (SAR) program for the key employees. This program awarded a number of SARs to each key employee. Each SAR was equal to 1% of the difference between the eventual sale price of the firm and the value of the firm on the date the SAR was awarded. We assisted the owner in creating a valuation formula to value the firm as of the date of SAR grant. The program provided that to be able to receive a payment, the key employee had to be employed on the date of sale of the firm; and that, the key employee would not receive the full payment unless he/she stayed in the employ of the purchaser for one year if the purchaser so desired. We also helped the owner decide how many SARs to give to each key employee, so that (1) the key employee would view the SAR as valuable and (2) the owner would have enough funds remaining after the SARs were paid to meet his retirement goal.

Results

We designed the SAR program and worked with the owner’s outside legal counsel to prepare the necessary documentation. We created employee communication packages that explained the program and provided projections of what the SAR would be worth at different levels of firm revenue. We met with each key employee individually to explain the program. We created a methodology so that the key employees would receive annual updates as to the value of their SAR.

The program had some additional benefits to the firm and the owner:

  • Each key employee had to sign a non-competition agreement to participate in the program, thereby eliminating the owner’s concerns about key employees leaving and taking firm business. The key employees had refused to sign non-competition agreements in the past.
  • The SAR package was sufficiently attractive to the potential new key employee—he accepted employment with the firm.
  • The key employees were excited about the ability to share in the proceeds of the eventual sale of the firm—they knew that a sale would occur at some point—and had an understanding of how their efforts to increase revenue would directly benefit them.
  • The owner has no cash outlay until a sale occurs, and no obligation to make any payment unless the sale price exceeded the initial value of the firm.
  • The owner did not share actual ownership in the firm, and does not have to disclose sensitive financial information about the firm’s results.

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