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Long-Term Incentive Plan Design

Long-term incentive plans (LTIPs) are market competitive tools intended to attract, motivate and retain current and future key employees for the long-term growth of the company. An important component in a company’s overall compensation strategy, the long-term incentive is considered a form of variable compensation where payout is associated with the nature of the designated long-term incentive vehicle used to provide the award.

How Do Long-term Incentive Plans Work?

NFP Compensation Consulting designs or recommends restructuring of long-term incentive programs for public, private or not-for-profit organizations with the intent to:

  • Support the company’s long-term growth, goals and objectives
  • Ensure executive/shareholder alignment
  • Create plans that are simple to understand and communicate
  • Provide a long-term incentive for select key employees to receive awards for achieving long-term performance goals
  • Provide key employees the opportunity to share in value creation and be motivated to create maximum shareholder value
  • Provide key employees with meaningful, market-competitive long-term wealth building opportunities
  • Provide liquidity opportunities for award recipients upon the satisfaction of a vesting period
  • Provide a material retention handcuff to key employees
  • Provide the company with the flexibility to administer the Plan such that capital is conserved in a manner to ensure long-term growth goals and objectives are achievable.

Long-term Incentive Plan Basics

Establishing long-term incentive plans should be tailored to the organization and require the technical expertise of an experienced advisor. NFPCC utilizes tried and true strategies to help manage existing or new LTIP seamlessly.

Cash vs. Equity-based LTIP

There are certain advantages and disadvantages for each strategy. The overall prevalence continues to be equity-based plans. Cash-based awards can be granted when valuation is difficult and potential for stock growth is limited, however this becomes a challenge for companies that are trying to manage cash-flow and liquidity. Cash awards are more prevalent in private entities, but most companies will pursue a long-term incentive strategy that includes a cash component. NFPCC’s experienced advisors can help you develop the best strategy for your unique situation.

Importance of Peer Group Development in LTIP Design

The peer group selection process is key in the overall development of effective pay programs. The same level of importance applies when designing long-term incentives to more accurately correlate pay and performance. Carefully selected peer groups play an important role in evaluating the reasonableness and effectiveness of incentive plan components. Therefore, the criteria used in the selection of peer must include not only the obvious factors of size and industry but also other non-traditional alternatives such as performance, geography, and human capital. In many cases it’s necessary to expand the criteria even further in an effort to create more accurate and relevant plans that align with the organization’s specific goals and growth strategy. Long-term incentive targets or grant-date fair value, obtained from peer company disclosures and published survey data, will be combined with Target Total Cash Compensation to formulate the Target Total Direct Compensation.

Long-term Incentive Plan Examples

  • Restricted Stock – There are two main types of Restricted Stock: Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs)
  • Incentive Stock Options (ISOs)
  • Phantom Stock
  • Stock Appreciation Rights (SARs)
  • Stock Option Plans (SOPs)
  • Non-Qualified Stock Options
  • Performance Stock Units (PSUs)
  • Deferred Compensation Plans

Types of Performance Metrics

  • Relative TSR (Total Shareholder Return)
  • EPS (Earnings Per Share)
  • ROIC (Return On Invested Capital)
  • ROA (Return On Assets)
  • ROE (Return On Equity),
  • EBITDA Growth
  • Cash Flow Growth

Relative TSR continues to be the dominating metric used in LTI plans, followed by ROIC and EPS metrics.

NFPCC Long-term Incentive Plan Process

Step 1: Analysis
Upon gaining a better understanding of the company’s goals, NFPCC will conduct an external market analysis to provide prevalent long-term incentive plan trends and alternatives. Using this information, NFPCC will work with and aid the company in determining the most appropriate and effective provisions.

Step 2: LTIP Financial Modeling
To ensure the plan design is both market-competitive and financially feasible, NFPCC will conduct modeling that will highlight the financial impact and the targeted incentive value for the participants, inclusive of the performance level necessary to meet the target. Consideration should be given to the tax treatment, the accounting impact, and any dilution impact.

Step 3: Collect Feedback
Once the market analysis and financial modeling have been completed, NFPCC will present the long-term incentive plan design alternatives and then solicit feedback based on the information provided.

Step 4: Review of Plan Document and Award Letters
Once approved, NFPCC will provide the final terms of the long-term incentive plan to counsel to draft the plan documents and award letters. NFPCC will ensure the documents are consistent with the design and provisions of the plan and include market best practices.

Long-term Incentive Plan Specialists

As compensation experts and incentive plan design specialists, NFPCC believes in the importance of long-term incentive plans as a means of developing a measurable and competitive equity program aimed at aligning compensation from a pay-for-performance perspective and retaining key talent. As such, NFPCC will work collaboratively with organizations to ensure the plan will accomplish the desired objectives.

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