Long Term Incentive Plans (LTIPs) incentivize employees to meet specific goals and targets in the long term by linking rewards to performance. They can help to propel your company forward to success. This is why, when setting long-term goals, whether at an overall company, department, team or individual level, it’s important to not only look at specific outcomes, but to make sure these are measurable too.
What is a long-term incentive plan (LTIP)?
A long-term incentive plan (LTIP or LTI plan) is a compensation program that offers employees incentives beyond their basic salary for achieving predetermined goals. The payment is deferred and usually spreads over 3-5 years to stimulate ongoing progress. This simple guide is to help you find the best long-term incentive plan design that suits your company.
Who is eligible to get LTIPs?
LTIPs are often reserved for executive-level and above whether it’s a private or public company, but companies are also starting to grant them to employees below the executive level. According to the Pearl Meyer Report 2024, approximately 53% of public company respondents make some grants below the vice president (VP) level.
However, due to restrictions around stock liquidity, private companies’ long-term award opportunities for both executives and broad-based employees are often used less than in public companies. Our Trends in Equity Compensation Report showed that 97% of public companies offer their executives either fully equity or blended (cash and equity) based incentives.
Why do companies use LTIPs?
LTIPs can be a win-win strategy for both employers and employees. 97% of public companies and 68% of private companies offer LTIPs to their senior executives, according to the same study.
– Focus on long-term profits/benefits
LTIPs can align your company’s interests with the interests of your employees over a long period. They’re not only trying to hit targets for this year, but also moving the company forward to sustain its growth in multi-year strategies.
– Help attract, incentivize and retain talent
With LTIPs, your employees have the opportunity to earn additional financial rewards to share in the wealth of a company, which can be ideal for attracting skilled people when recruiting.
It’s also more likely for employees to stick around longer as their long-term pay holds them accountable for implementing it over the next couple of years.
– Offer flexibility in compensation structure
LTI plans are flexible. They can take many forms such as options, restricted stock and cash. What option you choose and how your employees are rewarded can be tailored to best suit your own business needs.
– Save time and money on hiring senior employees
When a business replaces a salaried employee, it costs six to nine months’ salary, on average, to train their replacement. This is more of an issue these days with trends show that many employees only remain with their company for two years.
At J.P. Morgan Workplace Solutions, our LTIP management solutions can help you to reduce the LTIP setup and administration burden – from implementation to granting, task tracking, trading, compliance, tax, participant experience and everything in between.
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Different types of long-term incentive plans
There are essentially four different types of long-term incentive plans.
| Appreciation-based award | Time-based award | Performance-based award | Cash-based award | |
|---|---|---|---|---|
| Meaning | The amount depends on how much the company’s value increases over time. | Only available to employees after a certain amount of time in the company | Only available to employees when certain performance and service conditions have been met | Given to employees as a cash bonus |
| Examples | Stock options | Restricted stock units (RSUs) | Performance shares/units | Performance -based cash |
| LTI prevalence among executives in public companies* | Options: 33% | RSUs: 85% | Performance shares/units: 76% | N/A |
| LTI prevalence among executives in private companies* | Options: 25% | RSUs: 10% | Performance shares/units: 8% | Performance cash: 46% |
Which one is right for you?
Depending on your industry and your jurisdiction, your company might be better suited to one of these over the others, so it’s important to understand the positives and negatives of each one.
Appreciation-based awards (e.g. stock options)
✓ PRO: Appreciation-based awards can have monetary upsides for employees in the case of company stock price appreciation, particularly in startups and growing companies.
✓ PRO: This type of award is also very flexible. You can decide when and how often your employees receive the awards.
✓ PRO: Employees may qualify for preferential tax treatment.
✖ CON: Employees, however, need to pay for their stock options at the pre-set price (exercise price) when they decide to exercise (i.e. purchase) their options.
✖ CON: There is a risk with these awards, e.g. they can potentially be worthless should their value drop below the exercise price (i.e. underwater stock option)
Time-based awards (e.g. RSUs)
✓ PRO: In the case of an RSU – a full value award, employees almost always will receive some positive value as long as the shares don’t go below zero. So, RSUs are considered less risky than stock options.
✓ PRO: RSUs are usually granted for free, so employees don’t need to pay for the grant.
✓ PRO: You can customize the process of making them available to employees, e.g. when and how often your employees receive the awards.
✖ CON: Employees cannot control the timing of taxation with RSUs as ordinary income tax is due once they vest. But with stock options, tax is only due when they decide to exercise stock options.
Performance-based awards
✓ PRO: To receive their bonus, the employees need to hit certain targets, with Total Shareholder Return (TSR), Earnings per Share (EPS), Return on Investment (ROI), and Revenue being among the popular. It’s easy to see why this is an enticing plan for companies.
✓ PRO: Performance shares help align the goals of executives and other employees with those of shareholders.
✖ CON: If the targets are not set correctly or prove too difficult to achieve, the employees could lose morale as they won’t receive anything.
✖ CON: Performance tracking and communications with your executives can be complex, especially when multiple targets are involved. If you do it in spreadsheets, it’s even more manual and error-prone. Contact us to learn more about how to streamline the admin process, enabling you to view the real-time status of all targets at any time and helping your executives understand the value of their awards.
Cash-based awards
✓ PRO: Cash is the most reliable form of bonus without ownership dilution issues.
✓ PRO: It is a popular LTI award for private companies as they have little liquidity and their equity valuation is often more complicated.
✖ CON: It’s best to avoid these if cash flow is important to your company.
✖ CON: Employees receiving cash may not feel as invested in the company as those receiving stock.
When and how are LTIPs paid out?
Vesting determines when and how an LTI award is paid out.
Vesting means the waiting period before receiving the LTI ownership.
There are two common ways to vest your shares – cliff vesting and ratable vesting. Cliff vesting is a process where a participant receives full award ownership on a given date while ratable/graded vesting allows a participant to gain award ownership in intervals.
| Full Year(s) of Service | 3-Year Cliff Vesting | 6-Year Graded Vesting |
|---|---|---|
| 1 | 0% | 0% |
| 2 | 0% | 20% |
| 3 | 100% | 40% |
| 4 | Nil | 60% |
| 5 | Nil | 80% |
| 6 | Nil | 100% |
An example of a long-term incentive plan
Say for example a company adopts long-term incentive plans to satisfy multiple business goals. They include: 1/ encouraging equity ownership and executive retention, 2/ reinforcing the need for long-term sustained financial performance, and 3/ aligning the interests of executives and stockholders.
Their long-term executive equity incentives come in the form of stock options (CEO only), RSUs, and performance-RSUs:
- Options: Reserved for the CEO, these might vest 25% per year over four years, providing additional retentive value through annual cliff vesting.
- RSUs: Allocated to both the CEO and other NEOs, these might vest over four years.
- Performance-RSUs: These may decide to offer these awards to their NEOs (Non-Executive Officers) to drive the achievement of key financial, operational, and strategic objectives. They vest based on target achievement at the end of the three-year performance period.
To learn more about how to develop an LTIP that suits your business best, head over to our guide to ”Create an LTIP step by step” or LTIP best practices.
Contact J.P. Morgan Workplace Solutions
To make the most out of LTIPs, you and your teams need to plan from program design to plan implementation and administration, target tracking, tax, reporting, employee engagement and above board.
At J.P. Morgan Workplace Solutions, our automated LTIP technology and a team of experienced equity professionals spend all day coming up with ways to help our clients launch and manage their LTIPs on a daily basis.
Contact us to learn more about how we can help manage yours.
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