In the last email, we discussed succession planning in the context of transitioning day-to-day control of the company to a non-family President while retaining ownership of the company. Regardless of the reason that the owner is retiring, it is important that the successor has the vision and capability to lead the company during the next phase of its life cycle. Whether the successor is a protégé who has been groomed internally or was hired from the outside, the owner must be confident that the new President shares a common vision for the company and will uphold the company’s core values.

Identifying the successor President is the first part of the challenge. Establishing a comprehensive compensation plan that will fairly compensate and motivate the successor President and is acceptable from the owner’s perspective is the second part of the challenge

Compensation plans typically include a number of components: 1) base salary, 2) bonus plan, 3) benefits such as healthcare insurance, a retirement plan, a deferred compensation plan, membership in a country club, among others, and 4) equity “incentives.” There is an established “market” for these components based on the company’s industry and size, experience of the President, etc; however, the equity incentive portion of the package lends itself to the most opportunities to be creative. The bottom line is to establish a compensation package that achieves the following:

The Owner’s and the President’s objectives are aligned and can be achieved concurrently. Said differently: What is good for the President is good for the company/owner and vice versa.
There are numerous forms of equity incentives. As for which option is “best,” the answer is, “it depends”. In addition, the form of the equity incentive may be limited by the organizational and tax structure of the company, i.e., corporation/limited liability company and “C” corporation/pass through entity (“S” corporation, partnership, LLC). What is important in designing the equity incentive portion of the compensation package, though, is offering something that the President perceives as valuable both economically and mentally. For example, it is important to some Presidents to be owners, while others prefer to be paid the highest compensation regardless of how it is structured.

Examples of equity incentives include 1) purchase/grant of common stock, 2) stock options, 3) phantom stock, and 4) profits interests.

Purchase/Grant of Common Stock: The President is offered the opportunity to purchase/is granted a specified number of shares of common stock from the outset or at specified times in the future.

Stock Options: The President has the right to purchase a specific number of shares of stock at a specified price for a period of years, typically up to 10 years.

Phantom Stock: Phantom stock is a bonus plan in which its value is based on a percentage of the increase in the fair market value of the company from the date that the phantom stock units are granted to a specified date in the future such as the sale of the company. The President is never a shareholder but participates in the appreciation of the company’s equity value.

Profits Interest: A profits interest is similar to phantom stock with important differences. Specifically, the President is granted membership capital in an LLC with a fair market value at the time of grant of $0. Like phantom stock, the President benefits from the appreciation in the value of the company. Unlike phantom stock, the President is an owner of a class of capital of the company.

It should be noted that each form of equity incentives has different tax implications. In addition, the equity incentives may have features/restrictions including voting/non-voting, a vesting schedule, and a different value based on how/when a liquidity event is triggered. Finally, the equity incentives may be further restricted by the terms of a shareholders’ agreement/operating agreement. All of these factors impact how the equity incentives are structured and the President’s perceived value of the equity incentives.

In conclusion, the owner should be thoughtful in determining how the new leadership will be incented and provide a comprehensive compensation package for the President that they perceive to be valuable and aligns the interests of the President and owner. Handing over the reins to a non-family successor President may not be right for every owner. However, careful planning and the appropriate compensation package can help facilitate a smooth transition of leadership and ensure that the successor will be a good steward of the company and the owner’s legacy as the company transitions to the next phase of its lifecycle.