By Verlyn De Wit
He is always on time. He takes care of your dairy as if it were his own. If you need to go away for a few days or a few weeks, you rest easy. This key employee is crucial to the success of your business. Let’s call him Frank.
You’d like to see Frank stay with your dairy for the long run. But you know that other opportunities are bound to come his way. How do you fairly compensate Frank and motivate him without selling him ownership in your business? Perhaps you’re a little strapped for cash right now but you would like to paint a big picture for Frank’s future.
To regular readers of this column, you may have the feeling that you’ve already met Frank. A few years ago we discussed a concept called “Golden Handcuffs.” (See below) But for some employees, the future is NOW and golden handcuffs are too far off to hold their attention.
A typical “Golden Handcuffs” agreement might promise Frank that:
• If he stays with the dairy until age 60, you will continue to pay his salary of $40,000 per year for 5 continuous years after his retirement.
• If he dies before age 60, you will pay his salary of $40,000 per year for 5 continuous years to his family.
• If he becomes disabled before age 60, you will continue his salary at $25,000 per year until retirement.
Some operators award bonuses based on specific measurements. You could give Frank a percentage of your dairy’s cash flow, or a percentage of the profits. Maybe you decide to award a bonus based on milk production levels or cull rates – you name it. This allows you to focus on one or more specific areas that you think need improvement in your operation. However, in motivating or keeping your key employee over the long term, these approaches may become ineffective and isolated from the total picture.
Is your operation strapped for cash right now? Perhaps you should consider a Phantom Stock Plan. Essentially, a Phantom Stock Plan provides an employee with a bonus based on the increase in the value of the business. Giving Frank a bonus based on paper profits may be like the carnival barker’s shell game – creative accounting can make profits disappear and Frank is grudgingly holding an empty bag. But Phantom Stock would take all issues into account. The value of livestock, inventories on hand, and debt (just to name a few) are used to determine the value of your business, and Frank’s Phantom Stock bonus.
Check the numbers
For example, let’s say your dairy has a market value after debt of $4,000,000. You agree that if Frank is still working for you three years from now, you will give him 1 unit or 1% in the business. While this unit does not technically represent ownership in your dairy, it does contractually allow Frank to: 1) cash it in at this point for $40,000, or 2) keep it as long as he works for you in hopes that it will increase in value. Use your own imagination here, but you could offer Frank a unit, or one-half unit, of the business every third year he stays with you. If your operation is short on current liquidity but long on growth, Frank enjoys the ride with you. His units continue to grow in value.
Pick and choose
Another advantage of Phantom Stock is that it is not a qualified plan. You can pick and choose who you offer the plan to, Frank may be the only employee you give this special benefit to.
The state of California requires the filing of form 25102(o) within 30 days of the issuance of a regular stock option. Phantom Stock Plans do not require such filings. One difficulty with Phantom Stock plans is that a method of valuing the dairy will need to be established. Over time, other issues such as subsidiary operations and removing equity to start a second enterprise may cloud the picture and require modification of your terms with Frank.
Taken to its desired conclusion, Frank works for you 30 years and gains 10 units or 10% of the operation in our example. Any cash eventually paid to Frank is reported as expense to you and income to Frank.
Lower cash outlays for you now and a big long-term picture for Frank. The Phantom Stock Plan offers some very appealing benefits.
■ Verlyn De Wit helps successful dairy producers make smart decisions about their money. He can be reached toll-free at 1-888-468-1728 by e-mail at email@example.com or snail-mail at 1270 Eastside Dr., Sioux Center, IA 51250. Securities offered through Sammons Securities Co., LLC. 4261 Park Road, Ann Arbor, MI 48103. Member FINRA and SIPC.
■ Neither Western DairyBusiness nor Verlyn De Wit is qualified to offer legal or tax advice. Consult your attorney and/or tax professional for a qualified opinion regarding your personal situation.