Top seven elements of an effective Long Term Incentive Plan

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, which include arrangements relating to equity in a business, or rewards based on cash payments to senior executives.

The possible rewards granted to senior executives under an LTIP can be substantial, and it is important that the terms of the plan are structured correctly to ensure that it acts as an incentive whilst 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 your 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 help 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, LTIPs are designed for senior executives, managers, and key contributors whose roles significantly impact the company's long-term performance.

You should establish clear eligibility criteria 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 your company's strategic goals and should be clear, achievable, and measurable.

Common metrics include financial targets like revenue growth, earnings per share (EPS), and return on equity (ROE), as well as non-financial targets such as market share, customer satisfaction, and innovation milestones. The appropriate metric for each participant will depend on their particular role and responsibilities.

4. Vesting period and payout structure

The duration over which employees must meet performance targets to earn their incentives 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, and the payout structure should be clearly defined, specifying how and when employees will receive their rewards, whether through 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 critical consideration.

Equity-based incentives, such as stock options or restricted stock, align employees' interests with shareholders and encourage long-term commitment, but cash-based incentives may provide more immediate rewards.

A balanced approach, often combining both forms of compensation, can effectively address both short-term and long-term objectives.

6. Leavers

Effective LTIPs must include provisions to protect the Company from leavers, while also being reasonable for employees. Often LTIPs will have different implications for leavers dependent 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 vital for its success. Employees need to understand how the plan works, what is expected of them, and how they can maximise their rewards.

If an employee does not understand how they can be rewarded by the LTIP, then it is unlikely to act as an incentive.