The old saying that a company is only as good as its people could not be more true for design firms. Despite the reputation and vision of its principals, the firm will ultimately live or die by the quality of work and level of service that project personnel bring to their clients. Qualified employees are difficult to find and even harder to retain. What can principals do to keep their best people?

Ross

An initial reaction might lead principals to simply throw money at prospective and valued employees. However, a purely cash-based approach will only turn employees into a commodity both in the marketplace and in their attitude towards their employer. Principals can address this issue by structuring compensation packages to include competitive salaries and bonuses as well as enhanced benefits, such as increased health care contributions, additional vacation time, and more lucrative retirement plans.

Most design firms address these issues in varying degrees. They offer vacation time and health care packages based on industry standards. Many firms also provide 401(k) plans for retirement. While these are important benefits for the employees, the fact that they are so commonplace has reduced their value from a competitive advantage to the cost of doing business.

To up the ante, some firms have even offered equity-based compensation to their employees. An example of one of these programs is the Employee Stock Ownership Plan (ESOP).

Employee Stock Ownership Plan: An ESOP creates a trust fund for participating employees, which can be structured to give company ownership to employees. Typically, the ESOP purchases shares from the current owners of the company. The shares are then released to accounts owned by the trust on behalf of employees on an annual basis, over a period of time. The shares are allocated to employees each year based upon their level of compensation.

Contributions to the ESOP are tax deductible, an appealing feature of the program. However, principals enacting an ESOP should be aware of certain drawbacks to the program as well. Should a vested employee leave the firm, the firm must buy back his/her stock at the current fair market value. To accomplish this, privately held firms are required to have another company make a valuation of the price of their shares on an annual basis.

A problem that all forms of equity-based compensation have in common is that they dilute the current shareholders' ownership and control of the business. This may even be restricted by a firm's buy-sell agreement. Additionally, direct stock ownership may provide employees with legal rights or access to confidential information that principals would prefer their employees not to have.

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There are other long-term incentive programs that design firms can use to align the interests of owners and key employees without handing over ownership rights. Two such vehicles, stock appreciation rights (SARs) and phantom stock, give employees a stake in the company's performance without granting them actual equity interests.

Stock appreciation rights: SARs provide employees with some of the economic benefits of stock ownership and the incentives that go along with it without actually transferring any shares. SARs grant employees the right, at a specified future time, to receive cash awards equal to the appreciation in value of their allocated portion of the company's stock.

SARs are similar to stock options with one definite advantage: The employee enjoys the appreciation in the stock's value without having to put up cash to purchase the stock and without becoming an actual stockholder.

Phantom stock: Phantom stock is the economic equivalent of a stock grant. The company sets up employee accounts using compensation units tied to the value of the company's common stock. Phantom stock is similar to SARs, except that the employee receives the stock's underlying value in addition to appreciation. Also, phantom stock plans can also be devised to allow phantom stock holders to share in "dividend" payments and other economic benefits of stock ownership. A common feature of SARs and Phantom Stock programs is that they may have set timetables for vesting. Since employees can only realize the full benefits of these programs over time, they are generally effective tools in retaining employees for the duration of the vesting period.

In addition to SARs and Phantom stock, there are other incentives that firms can use to have their employees invest in their long-term success. For more information on such plans, speak with your accountant or consultant.

Phillip M. Ross chairs the Architecture and Engineering Services Group at Anchin, Block & Anchin, LLP, New York City. He may be reached at 212.840.3456 or at phillip.ross@anchin.com.

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