Construction is a competitive industry. And contractors aren’t just competing for projects; they’re also competing for a dwindling supply of new management talent and other skilled workers. To combat this problem, consider incentives that can help you attract, retain and motivate quality employees, such as equity-based compensation.
A Powerful Tool
Among the most powerful tools for engaging employees and aligning their interests with those of your business is equity-based compensation. Sharing ownership — by granting stock options or restricted stock awards, for example — is a time-tested strategy for maintaining long-term relationships with employees.
Doing so may not be a viable option for closely held construction companies, however. Owners may be unwilling to dilute their ownership and control of the business. Many privately held companies have buy-sell agreements and other restrictions on their ability to transfer shares or issue new stock. Family-owned construction companies may also restrict ownership by non-family members.
Fortunately, there are ways to leverage the economic benefits and motivational power of equity without transferring shares to employees.
Phantom Stock
Phantom stock is designed to mimic the economic benefits of a restricted stock award. Employees receive bonuses (usually in cash, though stock can be used) based on the value of a specified number of shares of the company’s common stock (or other ownership unit). Some plans even permit employees to receive dividends or other benefits of ownership.
Typically, payments are made at a specified point in time or upon a specified event, such as termination of employment or sale of the business.
Stock Appreciation Rights
Stock appreciation rights (SARs) are like phantom stock, but they’re designed to mimic the economic benefits of stock options rather than stock awards — with one significant advantage: Employees need not put up the cash to purchase shares of stock.
Rather than tie bonuses to the value of the firm’s stock, SARs pay out cash awards (or, in some cases, stock) based on the appreciation in value of a set number of shares. As occurs with phantom stock, payouts are usually made at a specific time or a specified event.
Flexible Planning Tools
Phantom stock and SARs offer a great deal of flexibility in designing incentive compensation plans to meet a construction company’s needs. Although both tools use the term “stock,” they aren’t just for corporations. Partnerships and LLCs can take advantage of similar tools tied to ownership “units.” And unlike profit-sharing, 401(k) and employee stock ownership plans, phantom stock and SAR plans can limit participation to key employees.
You can also build in features designed to tie employees to the company long term and motivate them to improve business performance. For example, you can establish vesting schedules for phantom stock rights or SARs, or tie payouts to performance goals, such as reaching certain revenue or earnings targets. It’s even possible to vary vesting schedules and performance targets on an employee-by-employee basis.
Downsides Exist
Phantom stock and SARs aren’t without downsides. The biggest one is that awards are usually paid in cash, which can drain a construction company’s cash flow. In addition, awards are usually taxed at ordinary-income tax rates, whereas stock options and restricted stock may offer certain tax advantages for employees. If you’re interested in equity-based compensation, be sure to discuss the idea with your EFA professional today.
