A long-term investment plan (LTIP) is a compensation plan that businesses offer to help employees achieve specific performance goals. It creates a symbiotic relationship where an executive receives compensation for aligning their goals with the company's long-term growth plan.
LTIPs can provide incentives to retain top talent in a competitive market while enhancing the company's performance in profitable directions.
What are Long-Term Incentive Plans?
LTIPs are compensation programs that reward employees for meeting specific performance goals. The plan offers incentives beyond an employee's basic salary to motivate them to reach the company's goal of increasing shareholder value.
In a typical LTIP, the compensation for specific employees is deferred and spread over 3 to 5 years to encourage progress. The plan usually requires executives to meet certain conditions and requirements to receive capped options and stock rewards.
Eligibility Requirements
Long-term incentive plan eligibility depends on an employee's role, tenure, and performance. These plans are usually offered to key employees, executives, and high performers to align their interests with the company's long-term goals.
Eligibility criteria may include:
- A minimum period of service.
- Meeting specific performance targets.
- Holding a particular position within the organization.
The Purpose of Long-Term Incentive Plans
LTIP is a win-win strategy with the following purposes.
- Focus on Long-Term Benefits. LTIPs align employees' personal goals with the company's performance objectives, promoting sustained growth over time.
- Attracts and Retains Top Talent. By offering lucrative compensation, LTIPs help attract and keep key employees, allowing them to share in the company's success.
- Saves Money and Time On Hiring Senior Employees. Retaining senior employees through LTIPs reduces the costs and time associated with hiring and training replacements.
Types of Long-Term Incentive Plans
Long-term incentive plans (LTIPs) encompass various strategies to align employee interests with company goals over an extended period. These plans often include 401(k) plans, stock options, and other incentives to encourage sustained performance and company growth.
401(k) Retirement Plan
A 401(k) retirement plan is a long-term incentive plan where a business can match a percentage of an employee's salary to increase their retirement savings.
In addition, it has a vesting schedule that calculates the total retirement contributions the employee may take while leaving the company.
Typically, the company retains part of the retirement contribution over the first five years of the worker's employment. Once the amount is fully vested, the employee owns the retirement contribution from that point forward.
Stock Options
- Restricted Stock Units (RSU). RSUs grant the right to receive company stock at a future date, subject to meeting specified conditions like tenure. They align employee interests with company performance without requiring the purchase of shares upfront.
- Restricted Stock Awards (RSA). RSAs are where companies grant shares of their stock outright, subject to certain conditions like vesting periods or performance goals. Unlike Restricted Stock Units (RSUs), RSAs immediately confer ownership of the shares upon grant.
- Employee Stock Option (ESO). Employees with ESOs can purchase company shares at a predetermined price in the future, typically at a discount compared to the market price. This arrangement enables employees to buy shares at a lower cost and then sell them at market value, potentially generating a profit.
- Performance Shares. Employees receive actual shares instead of an option to receive shares in the future. The employees can resell the shares for profit at a future date.
Vesting Schedules and Potential Financial Benefits
A vesting schedule determines when and how the long-term incentive plan pays out, typically after employees meet their performance goals or complete a specified performance period, usually lasting 3 to 5 years. Two main types of vesting schedules dictate the timing of benefits:
The period before the employees receive 100% of the long-term incentive plan depends on two main types of vesting schedules:
- Cliff Vesting: This schedule grants employees full benefits on a specified date.
- Graduated Vesting: This schedule releases a fixed award amount per year until the entire benefit is vested, with no benefits received in the initial years as per the schedule.
Employees pay taxes on the shares received under the LTIP once they are fully vested.
Takeaway
Businesses can offer long-term incentive plans based on employees' employment status and performance. They are a great way to attract and retain top talent while improving the company's long-term performance.