1. Kathy Zehr LWBJ Capital Advisors
Incentive Programs
Kathy Zehr
LWBJ Capital Advisors

2. Incentive Program Topics
Types of Incentive Programs
Short-term
Mid-term
Long-term
Goals of Each Program
Participants in Program

3. Incentive Programs
Start-up companies often use stock as incentives since cash is sometimes tight and borrowing from banks somewhat costly and difficult to obtain.
More established companies will likely build more cash compensation in their overall mix.
Incentive programs very common and make your company competitive with larger employers vying with you for talent.
Plans also aid in employee retention.
Need to be mindful of overall compensation program strategy.

4. Comparing Incentive Plans
Short-term (1 year)
Mid-term (3 years)
Long-term
(>5 years)
Focus of measure
Operating performance
Longer-term performance
Shareholder/ owner value
Typical measurements
Revenues
Operating profit
EBITDA
ROE
ROI
TSR
Share price
Typical award base
Cash
Cash or shares
Options, SARs, shares

5. Determining Performance Measures
What measures are used by similar companies in my industry?
What are opinions of my accountant, investors and key managers?
Do I use the same or different measures for different groups of participants?
Do I reward group, individual or both types of performance?
What is the length of earn-out for the plan?

6. Short-term Incentive Plans
Virtually all plans are performance-based and should not become entitlements.
Bonus plans should be written documents shared with all participants.
Objectives:
Tied to realistic, quantifiable and achievable goals
Simple to understand
Easy to measure
Employer deducts these payments as business expenses.
Employee pays income tax when paid the bonus.

7. Short-term Incentive Plans
Important to define metrics and how they will be computed to ensure consistency.
Good to build in higher rewards for exceptional performances.
Clearly define employment conditions and how changes in status affect bonus.
Provide quarterly updates to keep participants focused on goals.
Annual review to insure plan remains relevant to current company initiatives.

8. Sample ST Incentive Plan
Target bonus 30% salary of $50,000
Target/Budget
Actual
Weight
90%
100%
120%
Results
Payout
Revenues
450,000
500,000
600,000
550,000 1
40%
3,000
6,000
9,000
7,500
Operating Profit
45,000
50,000
60,000
48,000 2
30%
2,250
4,500
6,750
3,600
Cash Flow
63,000
70,000
84,000 3 -
Total
15,000
22,500
11,100
Payouts of target bonus
50%
150%
1 - exceeds target
2 - below target
3 - below minimum acceptable

9. Mid-term Incentive Plans
Generally less common than short-term or long-term plans.
Same type of general rules as short-term plans
Bonus plans should be written documents shared with all participants
Objectives:
Tied to realistic, quantifiable and achievable goals
Simple to understand
Easy to measure
Virtually all MT plans are performance-based emphasizing teamwork (company) performance.
Can be set up as a cumulative measure (each year adds or subtracts towards three-year goal) or attainment of a goal at end of year three.

10. Mid-term Incentive Plans
Important to define metrics and how they will be computed to ensure consistency.
Good to build in higher rewards for exceptional performances.
Clearly define employment conditions and how changes in status affect bonus.
Provide at least annual updates to keep participants focused on the goals.

11. Sample MT Incentive Plan
Incentive plan to earn shares based on dollar value if company reaches targeted ROE (return on equity) of 15% at the end of a three-year period.
ROE is computed as year three after-tax earnings divided by total equity as determined by the annual audit.
Target value of shares is $40,000 over three year period for employee whose base is $60,000; or 22% of base pay over three years.
Eligible to all managers and above.
Employee must be employed by company on the date of the payout announcement – which must be within 75 days after the end of the third fiscal year.

12. Sample MT Incentive Plan
Participants’ rights to receive payment of shares under an award shall be determined based on the following schedule:
Actual performance over the period as a percentage of target
Target
Value of payment as a percentage of the target incentive
Payouts
<85% 0%
85%
12.75%
50%
$20,000
100%
15%
$40,000
115% or >
17.25%
150%
$60,000

13. Long-term Incentive Plans
Almost always equity-type awards.
Most common are
Stock options
Restricted stock
Phantom stock
Stock appreciation rights
Employee stock purchase plans
Accounting issues can be somewhat complex for certain equity awards.
Taxability issues vary greatly depending on type and terms of awards for both awardees and employer.

14. Stock Options
Right to buy a number of shares at a price fixed at the grant date at some date in the future.
Stock options can:
Vest based on a service period - over time or cliff vest
Vest based on performance - achieve a level of revenues
Once vested, options can be exercised at the grant price at any time up to the expiration date of the option.
Two kinds of stock options:
Incentive (ISO)
Tax advantages to defer taxation from the date of exercise until the date of sale and qualify for capital gains rate
Several conditions (including 10 year life, limited number available each year, and minimum holding period)
Non-qualified (NSO)
Taxed at ordinary income rates at exercise date

15. Stock Options Two primary ways to exercise stock options:
Use cash to purchase the shares.
1,000 options granted at $10, pay $10,000 for shares now worth $20 or $20,000
Use a cashless transaction requiring you to exercise enough options to cover the exercise price.
1,000 options granted at $10, stock price now $20, exercise the 1,000 options and sell 500 at the current stock price to get the $10,000 needed to exercise the options

16. Stock Options
Private companies do not have as much flexibility as publicly-traded firms.
They are the market for any stock option exercises.
Business valuations are required at the grant date and any exercise date and can be expensive.
Often times companies restrict the exercise or sale of the shares acquired through exercise until the company is sold or goes public.

17. Sample Stock Option Plan
1,000 NSOs awarded to each management team member at $10 per share.
Options cliff vest after three years and have a term of ten years.
Stock price at the end of three years is $ Employee would hold, since the option is “under water.”
Stock price at the end of four years is $12 – Employee could exercise since “spread is now $2 – Employee is taxed on $2,000 at ordinary income rates.

18. Restricted Stock Plans
Shares given to employees with specified restrictions as to ownership that lapse usually with passage of time.
Most common time periods are three to five years either ratably or cliff vesting.
Restrictions can also be tied to certain performance goals of the company.
May or may not receive dividends, right to vote or other shareholder benefits during the restriction period.

19. Restricted Stock Plans
Section 83(b) election allows taxability at ordinary income tax rates at the award date with any future appreciation receiving capital gains treatment.
Otherwise, employee must pay ordinary tax rates on the value of the total award at the vesting date when the stock may have risen in value.
Some risks with 83(b) election – if pay tax and restrictions do not lapse, no tax refund or stock. Also if stock price significantly declines, tax liability would be less at vesting.

20. Sample Restricted Stock Plan
1,000 shares of restricted stock awarded to each management team member when price is $10 per share.
Section 83(b) election made, pay tax on $10,000.
Each team member receives dividends and voting rights during the vesting period.
Shares cliff vest after three years when price is $12.
Avoid tax on extra $2,000 of award due to 83(b) election.

21. Phantom Stock Plans
Plans that grant the right to receive an award based on the value of the stock.
Provides cash or stock bonuses based on the value of a set number of shares to be paid out at the end of a specific time.
May provide dividend equivalents.
May be tied to service or performance.
When paid, the value is taxed as ordinary income.
If widespread issuance and designed to pay out at termination, may be subject to ERISA.

22. Sample Phantom Stock Plan
1,000 phantom stock units awarded to each team member when price is $10 per share.
Each team member receives payments that approximate dividends during the vesting period.
Phantom units cliff vest after three years when price is $12.
Each team member receives 1,000 shares of stock at the end of year three.
Taxes at ordinary rates due upon receipt of shares.

23. Stock Appreciation Right Plans
Similar to Phantom Stock but key differences include:
SARs typically provide the employee with a cash or stock payment based on the increase in the value of a stated number of shares over a period of time.
No dividend equivalent payments.
SARs may not have a specific settlement date and employees may have flexibility regarding exercise date.
Accounting treatment varies depending on whether SARs are settled in cash or stock.

24. Employee Stock Purchase Plans
Plans to allow employees to set aside after-tax payroll $ over an offering period to purchase stock.
Qualified 423 Plans – allow employees to take capital gains treatment on any gains with rules similar to ISOs. Rules include that most FT employees with >2 years service must be included in the offering.
If not qualified, becomes non-qualified with no tax advantages.
Stock purchases normally made at a discount of up to 15%. (A portion of this may be treated as compensation.)

25. Employee Stock Purchase Plans
Common to have a look-back feature in which the purchase price is based on the lower of the price at the beginning or end of the offering period.
Most offering periods are either six months or some multiple of six. If more than six months, common to have interim purchase periods.
Employees taxed when stock is sold. If hold the stock long enough, may get capital gains treatment, but discount always taxed at ordinary income rates.

26. Sample Employee Stock Purchase Plan
Start of offering period, stock price is $30.
One-year offering period, buy at 15% discount with look-back provision.
At end of one year, stock price is $40.
Employee A sets aside $2,550 after-tax dollars during the one-year period. She is eligible to buy 100 shares at $ %), 25 more shares than if had to use the $40 price.
Employee holds stock for two years, sells at $45. Capital gain on $15/share, ordinary income on $4.50/share.

27. Participants in Programs
Cash bonus programs are generally offered to larger employee groups rather than equity programs.
Any program that is offered to a broad base of employees and is tied to retirement may be subject to ERISA. Most onerous ERISA requirement is that some funding of the liability associated with the program is mandatory.
Be sure and check with legal counsel when designing an incentive program to ensure proper documents are in place.

28. Thanks for your time and interest
Questions?
Thanks for your time and interest