There are circumstances where a contingency bridge just will not get the job done. When a key manager who is vital to management succession has a "brain lock" on being a stockholder, do not waste your breath talking about contingencies. You will run the risk of losing this hotshot if you do not develop a plan that provides stock ownership or stock ownership options from the outset. The Key Man Equity Succession Bridge is the first of two hotshot programs that provides tangible incentives for achieving equity ownership goals for special selected managers who feel they can not achieve career gratification without stock ownership.
Utilizing equity as the bonding for a Bridge is an advancement in the Succession Bridge concept, and is simpler than the Contingency Bridge because there is no alternative funding structure. There is no Supplemental Executive Retirement Plan to design, document, and fund for the non-equity purchasing contingency. The Equity Bridge immediately introduces the complexities of an outside partner in an otherwise family enterprise. The bedrock transaction is an immediate opportunity for the key man to own stock in the business. Before you suffer heart palpitations, do not jump to the conclusion that stock is just handed over to the key manager. Nothing could be farther from the case. Generally the key manager is provided an opportunity to earn or purchase equity in the business. He or she is not just given stock. Regardless of how outstanding their skills may be or how valuable they are to the business, making a gift of stock to a key manager is contradictory to building a vested interest and a proprietary attitude. Predictably, less respect will be given to business equity that did not cost anything in terms of either money or time. Furthermore, any stock obtained by the key manager is subject to ironclad stock transfer restrictions and buy back agreements.
The fundamental concept of the Key Man Equity Bridge is the conveyance of an opportunity to own equity in the family business in exchange for a long-term career commitment by the special manager to continue in the service with the business and to maintain business prosperity until family members come of age. The equity opportunity is the handcuff to the business; the incentive to grow the business and realize a portion of that growth on their financial statement is the prospective gold. With this in mind, it is important that we discuss some of the methods through which the key man or woman obtains equity in the business.
The Equity Bridge typically conveys 5% to 35% of stock, with the most common key man ownership at 20%. My personal theory is that in order for a key manager to work his or her way into more than 35% of the business equity, they better wear tights and leap tall buildings with a single bound. Unfortunately there is not an overabundance of these caped crusaders. The business world would be a better place if there were. By and large, the amount of equity a manager receives is contingent upon the service history of the key manager, the value of the business, and the earning history of the executive. The longer a manager has been a key player in the business and the greater the contribution to business success, the greater the stock reward. The greater the value of the business, the lower the percentage of stock the key manager can afford to purchase. And the earnings of the key manager impacts the amount of the stock that can be purchased or how much income tax he or she can afford to pay on stock bonuses. These factors dominate the determination of what would be a feasible purchase or addition to income.
A Succession Bridge generally provides an opportunity for the key manager to convert sweat equity into real equity. This sweat equity conversion is usually predicated upon a long-term service commitment, a bargain sale, and reasonable stock purchase terms. The long-term commitment is the essence of a Succession Bridge endeavor. We are trying to lock in the key manager so that he or she will continue to diligently lead the business and so that they can (if needed) serve as mentor and guide to developing family successors. The specific stock acquisition provision of the Succession Bridge program generally converts sweat equity over the upcoming ten to twenty years.
In a recent negotiation with the non-family president (the key manager) of a family owned bank, the young president responded to our Succession Bridge proposal of stock options that vest over the upcoming twenty years by saying that he appreciated the stock options that would give him a chance to purchase stock in the future, but the program did not recognize his prior 22 years of service. He wanted us to bonus him stock immediately so he would have something to show for his past hard work. My reaction was that any immediate vesting of stock ownership was counter productive to the intent of the golden handcuff aspect of the Succession Bridge. I continued and cut short his otherwise sensible argument by stating that the invitation for him to participate in the program and the bargain option price was recognition for the past 22-years of quality service. I pointed this out by inviting him to look around the bank and even look around the banking community to determine who was being offered opportunities of this nature. I further emphasized my point and concluded by informing him that acquisition of the stock would be dependent upon his continuing in his same quality performance groove.
The price designated for the transfer of equity (via bonus, sale, or other technique) is generally an emotional subject because stock represents cash value, income, and creativity accomplishment. A reflection of many discussions with a dear client, Jeff Dealer, can shed some light on this subject. Jeff has difficulty with the terms "gift" or "bargain" with reference to an automobile dealership that he has struggled for 15 years to develop into a respected, profitable business. Regardless of the lengthy explanations, Jeff could not accept that the bargain price aspect of a Succession Bridge is not a gift. No one gave him anything while he was just struggling to survive and although he felt that he really needed to lock this key man into his business, due to his hang-up we had to find a way that did not involve a gift. In order for a manager such as the bank president mentioned above to qualify for an Equity Bridge opportunity, he or she must have earned their position with exceptional service and loyalty for which they were relatively underpaid. We call this accumulated good will. In order to motivate the manager to accept the responsibility and long-term commitment of a Bridge, the price of the stock must represent value that will be attractive to a key manager with highly marketable skills. Good managers know what good businesses are worth. They see the earnings and they quickly interpolate the value of those earnings to what they believe is a reasonable value for the stock.
Loyd H. Rawls, CFP, CLU, ChFC, MSFS, of The Rawls Company specializes in family estate and succession planning for closely-held family-owned business. If you have specific questions or require more information about this subject, please check the appropriate box on the reader response form on page 3.#