Incentive Programs for Restaurateurs: Part 3

As discussed in the first two parts of this series, short-term incentive (STI) plans and long-term equity based incentive plans may not be the right choice for every restaurateur. For some, granting equity via long-term incentive plans is not an option due to partner obligations, bank covenants or other restrictions. As an alternative, there are two widely used pseudo-equity incentives which allow key employees to share in the long-term growth of the business while also incentivizing them to stay: long-term cash plans and phantom stock awards.

Long-Term Cash Plans (LTCP)
LTCPs are similar to the STI plans discussed in the first installment of this series with one main difference: LTCP incentives are not paid out every year like STI plans. Instead, the value accrues in an account over the performance period (for LTCP plans, the performance period is multi-year, typically ranging from three to five years) and the value becomes payable once it vests.

Other benefits to the restaurateur are that the vesting component of this plan acts as a powerful retention tool for key employees, and the value of the plan is easily understood. An additional benefit is that the accounting is very similar to a short-term incentive plan, which is generally well understood.

Phantom Stock
Phantom stock is another type of pseudo-equity incentive. This is the closest option to granting a restricted share to a key employee. Under a typical phantom stock arrangement, an employee is granted a right to receive a cash payment at the end of a defined term equal to the value of a share of stock at the end of the term.  Another common structure allows the employee to receive a cash payment equal to the appreciation in the value of a share of stock during the term, which is often also called a stock appreciation right (SAR).  To the employee, it will look and act like stock, but a phantom stock award does not carry voting or dividend rights because it does not represent an actual equity instrument. The employee will, however, be able to realize the value of the stock because phantom stock can mimic the fluctuations of restricted stock without diluting the restaurateur’s ownership interest. Additionally, phantom stock has tax and accounting implications that are different from restricted stock, which can have an impact on both the restaurateur and the employee.

It’s important to note that the company must record a compensation charge on its income statement as the employee's interest in the award vests, and as the value of the award increases. Similar to accounting for grants of restricted stock or stock options, from the time the grant is made until the award is paid out, the company must record the value of the promised shares as they vest, pro-rated over the term of the award. However, unlike awards which are paid in shares of stock, for phantom stock awards, each year the value is also adjusted to reflect the any adjustments to value arising from the rise or fall in share price, which may require a valuation to be performed if the company doesn’t have an easily determinable stock price.  

In some cases, phantom stock awards may contain performance conditions as well as service conditions. For example, a phantom stock award may vest upon three years’ service plus achieving a profit target. Unlike accounting for awards with only time-based vesting conditions, for phantom stock and SARs that include performance conditions, increases are recognized as they become probable. For example, when the vesting is triggered by a performance event, such as a profit target. In this case, the company must estimate the expected amount earned based on progress towards the target. The accounting treatment is more complicated if the vesting occurs gradually because each tranche of vested awards should be treated as separate. Appreciation is allocated to each award pro-rata to the time over which it is earned.

If SARs or phantom stock awards are settled in shares, however, their accounting is slightly different. The company must use a formula to estimate the present value of the award at grant.

Choosing The Right Plan
There is a wide array of incentives restaurateurs are using today to attract, retain and incentivize key employees. Deciding which type of incentive is right for your business may be difficult. It may help to consider the following questions when thinking about incentives that may work best for your business:
  • What will your operation look like three to five years from now?
  • What will you focus on each year to reach that goal?
  • How will you define your philosophy to reward incremental (annual) achievements, long-term achievements, or both?
  • Are you willing to grant ownership in your business to your key employees?
The topics covered in this series are not meant to be all-inclusive. For more information on incentive programs for restaurants, contact Randy Ramirez at rramirez@bdo.com.
 
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