The term Long Term Incentive Plan (LTIP) is used to describe a wide variety of incentive arrangements which are usually granted to senior executives to incentivise them to build value for shareholders.
An LTIP can be structured in a number of ways, including arrangements relating to equity in a business or rewards based on cash payments to senior executives.
The rewards granted under an LTIP can be substantial. It is therefore important that the terms of the plan are structured correctly so that it acts as an effective incentive while fairly building value for shareholders.
These are our top seven elements of an effective LTIP.
1. Set clear targets and align the plan with your company’s objectives
Successful LTIPs need to align with your company’s strategic objectives. The plan should support the company’s long-term vision, business goals and plans, ensuring that employees are motivated to drive performance in key areas.
It is important to establish clear and measurable objectives which create a direct link between employee performance and company success.
2. Target population and eligibility
Defining the target population for the LTIP is essential. Typically, plans are designed for senior executives, managers and key contributors whose roles significantly impact the company’s long-term performance.
Clear eligibility criteria should be established to ensure the right employees are included.
3. Set performance metrics and measurement
Selecting appropriate performance metrics is crucial to the success of an LTIP. Metrics should be tied to the company’s strategic goals and be clear, achievable and measurable.
Common metrics include financial measures such as revenue growth, earnings per share (EPS) and return on equity (ROE), as well as non-financial measures such as market share, customer satisfaction and innovation milestones.
The appropriate metric for each participant will depend on their specific role and responsibilities.
4. Vesting period and payout structure
The duration over which employees must meet performance targets should be long enough to encourage sustained performance, but not so long that it becomes demotivating.
Typical vesting periods range from three to five years. The payout structure should also be clearly defined, specifying how and when rewards will be delivered.
This may include share options, restricted stock units, cash bonuses or a combination of these.
5. Equity vs. cash compensation
Deciding between equity-based and cash-based incentives is a key consideration.
Equity-based incentives, such as stock options or restricted stock, align employees’ interests with those of shareholders and encourage long-term commitment. Cash-based incentives may provide more immediate rewards.
A balanced approach, often combining both, can support both short-term and long-term objectives.
6. Leavers
Effective LTIPs must include provisions to protect the company while remaining reasonable for employees.
Plans often differentiate between leavers depending on whether the LTIP has vested and the circumstances of the employee’s departure.
7. Communication and transparency
Clear communication about the LTIP’s objectives, mechanics and benefits is essential. Employees need to understand how the plan works, what is expected of them and how they can maximise their rewards.
If employees do not understand how they can benefit from the LTIP, it is unlikely to act as an effective incentive.