Last year's financial performance numbers are in and many a tire dealership owner is probably asking: ``How can I make my employees more focused on the profitability and growth of this organization?''
There are a few standard answers, such as incentive compensation tied to profitability and performance appraisals, with goals tied to growth and profitability. However, one area that is often overlooked when trying to encourage employee commitment is an Employee Stock Ownership Plan (ESOP). Stock ownership provides a potentially broad continuum for employee participation.
This type of plan is a vehicle aimed at obtaining commitment from all employees, if a broad-based ownership option is the direction you've chosen to take. It also can solidify the business owner's relationship with a limited number of employees, if a key employee stock option plan is the company's chosen avenue.
This article will provide an overview of the different plans available for employee stock ownership. It should give your company's management a general understanding of these options and prepare the owner to meet with the dealership's accounting and law firms. While these plans can be crafted in principle with your human resource personnel and your accountant, there are many legal landmines to avoid, and consulting with an attorney is always a good idea.
If your company is interested in involving all or most of your employees in stock ownership, a broad-based employee ownership program should be considered. The broad-based options include:
* A 401(k) program, which is a tax qualified plan that typically includes all full-time employees who meet pre-determined age, service and vesting requirements.
It is a retirement plan that provides your employees with a vehicle to achieve a diversified portfolio of investments. The company may elect to match a percentage of the employee's contribution. For many employees, this is their only ``savings for retirement.'' However, there are discrimination limits placed on the plan to prevent those who are highly compensated from contributing more than a certain percentage above the other employees.
It is important to give serious consideration to your age and service requirements. If the dealership has high personnel turnover, the company may want to have at least a one-year waiting period before employees can participate. That will preclude those ``revolving door'' workers from artificially pulling down the contribution percentage because they were eligible but not participating in the plan. Additionally, the company has a fiduciary responsibility to ensure that employees have a diverse portfolio in which to invest their contributions.
Company stock may be offered as an employee investment option or may be used as the company's match. If a 401(k) plan is combined with an ESOP, it is called a KSOP. Nowadays, a 401(k) plan has become an almost expected employee benefit, similar to health care. Employees appreciate these savings vehicles but are often very vocal if the plan does not produce what they think the expected return should be.
Anyone who has been a plan administrator during economic downturns will tell you that employees unrealistically expect their retirement plans to withstand economic downturns.
* An ESOP is a tax-qualified plan wherein most or all of the assets are invested in company stock.
An ESOP program typically has age and service requirements. In this type of plan the company rewards employees' service by contributing its own shares to the plan, contributing cash to buy its own stock, or most commonly has the plan borrow money to buy stock. The company repays the loan later.
This option has significant tax benefits for the company and the employees. It provides employees with an opportunity for equity ownership. In many instances, the company stock may be the only equity investment the employee possesses. The employees' stock will vest to a pre-determined schedule and they will receive their benefits upon termination if there has not been a company ESOP distribution at an earlier date. Most employees view this option as an unexpected gift.
* A Stock Option Plan gives all or key employees the right to buy company stock at a certain price during a specified period-once the stock option has vested.
This is an excellent way to tie key employees into the success of the company. For example, if an employee has an option on 100 shares of stock at $20 per share and the stock price increases to $40, the employee can exercise the option and buy them at $20, then sell them for $40 each and pocket the difference. However, if the stock price never rises above the option price, the employee may not exercise the option. Although this plan may be offered to all employees, typically it is offered to key employees or the executive team.
* An Employee Stock Purchase Plan (ESPP) allows employees to buy stock through payroll deductions during an ``offering period'' (a three- to 27-month period).
Typically, the employee purchase price is discounted up to 15 percent from the market price. As with a Stock Option Plan, employees can turn a quick profit or elect to hold onto the stock. Companies usually design these programs as tax qualified ``Section 423'' plans-which means that all full-time employees with two years or more of service are qualified to participate.
My experience has been that a company typically views an ESPP as a better benefit than its employees do. Many employees who have this option do not take advantage of the plan because it requires them to use their own money.
* Phantom Equity provides employees with phantom stock that lets them capitalize on stock appreciation. Companies become interested in phantom stock because it is a method of substituting phantom equity for real equity. However, if a plan acts like a form of a retirement plan, it may be subject to all the rules of the Employee Retirement Income Security Act (ERISA) of 1974. Basically, phantom stock provides employees with a bonus based on the company's stock performance. Phantom stock is best suited for executive plans and, in my opinion, should be avoided for broad-based plans.
Beware of pitfalls
There are many legal pitfalls to avoid in whichever stock option plan you choose. Here are four common issues that surface in lawsuits. Knowledge of these concerns can help your company avoid these potential problems.
* Careful plan design: Your human resource representative, your accounting firm and an attorney must be involved in the design process. However, while it is tempting for any corporate attorney to claim to be able to set up a stock option plan, don't fall prey to this common mistake. There are attorneys who specialize in employee benefit plans and often in retirement savings programs. It is well worth the time and money to hire one of these experts.
First, they have the experience to ask questions that you may not have considered. Additionally, they will have standard ``plan language'' that can be altered to meet your needs. To ensure that you have found the correct attorney, ask for a list of client companies for whom they have set up similar plans-and then call those references.
Also, your dealership's management may want to ask the lawyer if he or she belongs to any professional organizations-such as the National Association of Stock Plan Professionals-or if the attorney has written any articles on the topic.
* Plan for acquisition: I know, I know...you're going to keep your dealership in the family for generations to come. But humor me on this one. Just in case your son or daughter doesn't want to be in the tire business and they elect to sell in the event of your retirement or death, it is prudent to plan for this option today!
When your plan is designed, it is prudent to consider what happens to the stock options should there be an acquisition. Consider these questions:
A. Will options vest immediately and become fully exercised? (Your employees will be in favor of this approach, but a potential buyer may not!)
B. If options do not automatically vest, what happens to the unvested options?
C. Can unvested options be translated into an option in the acquiring company's stock?
D. For options that are vested, are they immediately exercisable?
E. If options are exchanged, how will the exchange value be set?
Anyone who has read my columns in the past knows I always favor flexibility over rigidity. Therefore, although most plans will outline what will specifically happen during an acquisition, the company is granted more flexibility in its negotiations if these issues are left unanswered and the plan outlines who will make these decisions.
Of course, employees may be concerned if this discretion is left solely to senior management, so a small committee or an independent fiduciary may be the ``appointed'' decision maker. Although I am a proponent of flexibility, make sure you are fair. Otherwise the decision may be legally questioned.
* Employee termination rules: What happens when an employee leaves the company-either by choice or termination?
The dealership's management must consider what will happen to the employee's stock options if one of your key staff members decides to leave to go work for the competition; is terminated for cause; leaves without a professional amount of notice; or starts a competing business.
These all are potentially emotional issues that need to be considered in an unemotional manner. Some plans state that unexercised but vested options are canceled if an employee is terminated for cause or goes to work for a competitor. Make sure you ask your attorney if there are employment laws specific to your state that need to be considered in your plan.
* Rules for transferring options: This is a simple problem to avoid. Your plan needs to explain who has a right to unvested or unexercised options. More than 50 percent of marriages end in divorce, so your company's plan needs to address whether options are transferred to divorced spouses.
Regardless of which plan your company chooses to implement, remember: An employee stock plan may go virtually unnoticed unless the company provides an excellent communication program for your employees. In my next column I'll review the components of an effective communication program.
Mary Miles can be reached via e-mail at [email protected]