Executive Compensation and
Succession Strategies
Joel C. Farrar
Foster Swift Collins & Smith PC
517.371.8305
jfarrar@fosterswift.com
Executive Compensation
It’s not the employer who pays the wages.
Employers only handle the money. It’s the
customer who pays the wages. – Henry Ford
Beware of little expenses. A small leak will sink a
great ship. – Benjamin Franklin
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step One: Identify Business Goals
Strategic Planning
Increase revenue
■ Decrease expenses
■ Expansion and project-specific goals
■ Department goals
■ Retention goals
■ Customer service goals
■ Safety goals
■ M&A goals
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step One: Identify Business Goals
Categorize Goals
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Company-Wide
Department
Individual
Short Term
Long Term
Develop Metrics to Measure Improvements
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Two: Review
Compensation Structure
Base salary, bonus and incentive programs,
“qualified” plans, welfare benefits, severance
benefits, “non-qualified” programs, others
Evaluate current strategy in light of goals
Identify opportunities to improve
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Three: Develop Strategy
Group Employees
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“C-Suite” Executives
Other “top hat” executives
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“Select group of management or highly compensated employees”
Usually SVPs
Sometimes directors and top salespeople
Usually not managers and below
Mid-management
Administration
Movers
Evaluate each group’s ability to affect business goals
Select goals to incentivize for each group & key individuals
Prepare compensation philosophy and strategy
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Limitations on “non-qualified” benefits
ERISA – “Top hat” and funding issues (Rabbi Trust)
■ Section 409A – Exemption, compliance and
flexibility issues
■ Income tax and deduction issues
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Timing
Company investments
Pass-through entities
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Program Types
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Short-term bonus programs
Long-term incentive programs
Synthetic equity programs
Equity programs
Elective deferral programs
Change of control programs
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Short-Term Bonus Programs
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Available for all employees
Discretionary Annual Programs (Growing companies only)
Performance-Based Annual Programs
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Discretionary or non-discretionary performance targets
Performance period (1 to 3 years)
Performance targets
– Company-wide targets (profit, growth, peer group)
– Unit/Department targets (profit, expenses)
– Individual targets
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Targeted Incentive Programs
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Absenteeism
Customer satisfaction
Move Efficiency
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Long-Term Incentive Programs
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“Top Hat” only
Company credits – Long-Term Performance or
Excess Benefit
Vesting – Golden Handcuff & Non-Compete
“Deemed” Investments – ERISA and Tax Issues
Payment Events – Section 409A
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Synthetic Equity Programs
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“Top Hat” only
Performance Unit, Restricted Stock Unit & Phantom
Stock Plans
Stock Appreciation Right Plans
Form of LTIP – Different from True Equity Benefits
No Minority Shareholder Issues, But:
Complexity and valuation issues
 Reduced “ownership” mentality
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Equity Programs
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Available for all employees
Stock Options – Qualified or Non-Qualified; Valuation Issues
Restricted Stock – Tax and Liquidity Issues
LLCs – “Profits” or “Capital” interests
Advantage: “Ownership” Mentality
Disadvantages: Taxes and Minority Shareholder Issues
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Access to Information and Meetings
Voting Rights
Dissenter’s Rights
Shareholder Agreement Recommended
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Elective Deferral Programs
“Top Hat” only
■ Employee Deferrals
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Income tax deferral (watch owners)
Delayed tax deduction
Section 409A timing rules
“Deemed” investments
■ Payment events
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Evaluate Options
Change of Control Programs
“Top Hat” only
■ What happens if the company is sold?
■ Retention goal (pre-transaction through transition)
■ Amount of benefit?
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Fixed amount?
Treat like a shareholder?
Double or single “trigger”?
■ Section 409A issues
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Five: Implement Strategy
Select Mix of Benefits
Prepare formal program documents
Section 409A Issues
■ ERISA Issues (120-day letter)
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Communicate programs to employees regularly
to maximize incentives
Review and refine together with strategic plan
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Succession Planning
Failing to plan is planning to fail.
– Benjamin Franklin
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Why is Succession Planning
Important?
Succession is inevitable and often catastrophic
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70% of business fail to survive the second generation
85% fail to survive the third generation
Proactive planning allows us to:
Avoid business disturbances
■ Avoid problems with customers, suppliers and employees
■ Improve successor retention
■ Mitigate tax and legal issues
■ Minimize disputes, particularly in family-owned businesses
■ Avoid surprises
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
What is Succession Planning?
It means different things to different people:
“Selling” or “Getting Out”
■ Keeping a business “in the family”
■ Retiring from a continuing business
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Process to formally transition management and
ownership between generations or to a buyer
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Practical Considerations
Outstanding Debt
Value in land, buildings and equipment
Owner’s retirement income needs
Treating children “fairly”
Common solution – Life Insurance
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step One: Identify
Potential Successors
Co-owners
Family members (Family issues? Estate
planning issues?)
Current employees
New hires
Potential buyers (Competitors)
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Two: Determine Goals
Retirement assets and income
Keeping the business “in the family”
Family’s goals
“Getting out”
Business continuity
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Three: Plan for
Management Succession
Identify and groom successors
Transitioning responsibilities, authority and
relationships
■ Evaluations, feedback and training
■ Retention strategies (discussed previously)
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Restructure management
Dividing responsibilities (checks and balances)
■ Formalizing positions, reporting and responsibilities
■ Outside board of directors?
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Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Four: Plan for
Ownership Succession
Estimate cash needs and cash flow
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Can the business support both the owner and the successors?
How will estate taxes be paid? Consider life insurance
Determine transaction structure
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Earn-in (stock purchases, profits interests, executive compensation plans)
Earn-out (installment sale of stock, leveraged buy-out)
Gifting (annual exclusion $14k; unified credit $5.43M)
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Viable for smaller businesses
“Two-stage” transactions preserve discounts
Estate freezing techniques (GRAT)
ESOP
Third party sale
Formalize plan in connection with estate planning
Consider appraisals and minority discounts
Executive Compensation and Management Succession Strategies
January 28, 2016
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 2016, Foster Swift Collins & Smith PC
Step Five: Prepare the Business
Formalize policies and procedures, legal forms,
operating procedures and recordkeeping
Corporate Restructuring
Entity conversions
■ S corporation election (10 years)
■ Asset divisions and spin-offs
■ Structure future capital investments
advantageously (leases, asset purchases, etc.)
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Executive Compensation and Management Succession Strategies
January 28, 2016
24
 2016, Foster Swift Collins & Smith PC
Executive Compensation and
Succession Strategies
Joel C. Farrar
Foster Swift Collins & Smith PC
517.371.8305
jfarrar@fosterswift.com