Equity-Based Incentive Compensation Plans

“Incentive compensation” generally refers to special incentives granted to one or more key individuals to generate unique value for the employer organization and to encourage long-term loyalty of such individuals. The key elements of incentive compensation are:

Corporate governance (dilution of shareholdings of others, and conflicts between management incentives and accountability to shareholders for volatile earnings).
Tax optimization.
Accounting treatment relating to dilution of shares (increasing fully allocated shares as if converted), dilution of earnings per share, treatment of option shares as an expense, and variable accounting for “underwater” options where the share value is less than the option exercise price); and
Definition of goals and performance metrics, as well as ongoing evaluation of the suitability of such goals to the employer’s economics.

Initially, business owners may wish to focus on the tax treatment of incentive compensation structures for closely-held companies, including startups and SME’s, that need long-term services of key employees for growth and stability. Such plans require careful administration that may require the establishment of trusts, the compliance with fiduciary duty of trustees or with duties of non-discrimination among employees. In considering any type of incentives, the Board of Directors (or Managers) must consider a variety of issues.

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