Do you wonder what is the easiest, least expensive, and most flexible approach an owner/founder/operator can use to attract and motivate top talent? This post introduces Mark C Bronfman’s article on using Profits Interests vs Options to install simple, flexible, and highly effective executive incentive plans.
Profits Interest and why we need it
Founders who still own and run their businesses may bring on executives to get to the next level and/or to free themselves from being a slave to their success. The challenge is how to provide incoming executives with attractive upside at low cost, risk, and complexity to the owner, founder.
Profits Interests, an ownership and incentive planning solution under current US tax law, are often the right and best approach. This powerful equity incentive plan requires no buy-in; is not taxable at grant or vesting; and, its capital liquidations are taxed as capital gains
In his article: The Profits Interest, now available as an IntelliVen Insight, Mark C. Bronfman, Founder of Bold Value and affiliated with Sagemark Consulting, describes how Profits Interest can convey a true ownership interest without the friction of paying for the capital of the past.
To borrow a concept from architectural engineering, the profits interest is a “cantilevered” approach to equity transfer a la Frank Lloyd Wright. Essentially, profits interests extend a stake in the economic future of a company to key executives without requiring payment for the underlying capital interest foundation.
Profits interest offer many design advantages, since:
- Profits interests are accretive: The value of a profits interest accrues from the future success of the business with no value at grant. Hence, owners and founders can be assured that they are only giving away a portion of the upside growth of their companies.
- Profits interests are taxed as capital gains: When designed properly, the recipient pays no tax at grant and no tax at vesting. Recipient pays capital gains taxes upon liquidation. In these regards, the profits interest is a truly unique tax vehicle in the realm of long term incentives.
- Profits interests are flexible: All profits interests are composed of two parts: an annual profit allocation and a liquidation value upon certain triggering events. Based on design, different and creative combination can be a powerful yet flexible tool.
Profits interests also provide high performance incentives as they share in the success of future achievement. They facilitate leadership and owner succession via equity transfer. And they strengthen high-performance cultures by promoting equity and fairness, helping to attract and retain the right key employees.
Qualifications and costs
To qualify for the tax and design benefits profits interests, the grants must pertain to a privately-held partnership or an LLC taxed as a partnership, a form of ownership that has exploded in popularity over the past 20 years. Several other qualifications must be met as well.
Given certain costs and concerns, profits interests are not for all companies or situations. Profits interests are issued without any cost to the executive so there is less “skin in the game”. The variety of profits interest design options and choices for can create complexity.
The set-up and maintenance costs of profits interests can be relatively high as compared with alternatives such as synthetic equity. The grants need to be drafted with consideration of changing tax laws. Still, many of these costs concerns can be mitigated by using an experienced advisory team.
We expect profits interests to become increasingly popular as many more middle market companies choose to be structured as an LLC taxed as a partnership. Designed properly, profits interests offer many advantages despite potential cost and other complexities.
Submit any questions via reply to this post below or contact firstname.lastname@example.org to discuss your organization’s specific compensation and succession objectives.
About Mark C. Bronfman
Mark C. Bronfman is a private wealth advisor with Sagemark Consulting in Vienna, Virginia. Mark founded the BOLD Value service line, which is dedicated to the issues of executive compensation, corporate benefits, capital structure, business succession and personal/legacy planning for middle market businesses.
Prior to his affiliation with Sagemark, Mark served as an equity partner with Accenture with a specialty in Strategy and Business Architecture. He earned his MBA from the University of Virginia (Darden) and his B.S. in Accounting from Penn State. Mark is a frequent writer and speaker at industry events and is a non-practicing CPA.
The BOLD Value Service Line is dedicated to the specific needs of middle market business owners. Mark Bronfman and his team members of the Bold Value service line are registered representatives with Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer, Member SIPC. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. The BOLD Value trademark is personally owned by Mark Bronfman. BOLD Value is not an affiliate of Lincoln Financial Advisors Corp. The examples herein are not indicative of any particular investment or performance. There can be no assurances that all results will be similar. CRN-1645738-111616
Four paths to fair pay; also by Mark C. Bronfman.