Road Test

January 31, 2012 11:52 PM
Road Test

Farms put phantom stock plans through their paces

Editor’s Note: The two dairy managers who shared their experience with this strategy preferred to use false names in this story to protect the privacy of their workplaces.

Retaining exceptional employees and transferring farm ownership across generations are two daunting tasks made easier by the use of phantom stock.

Attraction and retention is the primary focus of Farmer Jones’ phantom stock profit-sharing plan for key management people on his 1,800-cow dairy. Ten years’ experience with the plan has provided real stability to the employee and management base on his farm, located in a dense dairy area where competition for personnel is robust.

"Nobody [in the plan] has left and it’s not likely that they will, because most years a pretty good chunk of money is being added to their accounts [in the form of units]," Jones says. "It makes them feel tied to how the business is doing."

Once a year, Jones meets privately with each participant to discuss the farm’s profit or loss in the past year and to evaluate the employee’s account status. Employees leave the meeting with a document that shows their account balance at the beginning and end of the year.

"I go very carefully," Jones says. "It’s difficult to know just how much of the farm finances to share with them. I share different pieces depending on the person, and I always try to imagine that it’s myself on the other side of the table."

Key to the process is helping workers understand that principal payments on debt and cash for new investments must come out of the business gains as well as profit-sharing for top managers and owners.

Creating the 10-page legal document that outlines the phantom stock agreement didn’t take long. Choosing participants takes a lot longer, Jones says.

"What we want is an excellent manager with the intellect and ambition to make the tough decisions. I think about it a lot and let [a candidate] rattle around in my brain for about a year before I’m sure.

"You can be talking about sharing a substantial amount of money," he adds, "so you want to really feel good about who participates."

For the most part, key employees are on the payroll for at least five years before Jones even talks about profit-sharing with them. Then he lays out a five-year vesting schedule and the method that is used to calculate earnings.

Jones’ accountant creates the annual document for each participant and does the math for the entire plan.

Years like 2009 prompted Jones to add an addendum to the published plan. By all rights, a loss for the business would subtract some of the phantom units accumulated in each participant’s account.

"But especially for those participants who had just recently joined the plan," Jones explains, "it wouldn’t feel very good to lose half of what you’d earned the year before, for example."

So Jones chose to ignore the loss and add a separate document to the agreement with a vesting schedule. Any participant who left the business in 2011, 2012 or 2013, etc., would have his account reduced by a set amount. The longer he stayed on staff, the smaller the reduction.

Farm succession concerns more than 10 years ago prompted Farmer Smith to call in advisers for a strategy session at his 1,100-cow dairy.

"To bring in the next generation, we needed to know how to compensate family fairly as well as retain and reward our best employees," he says. "Elwyn Voss [of the Voss Group, Norwich, N.Y.] enlightened us about the phantom stock plan."

Smith says it took several months to:

  • get comfortable with the idea of profit-sharing in this way;
  • craft the plan that was best for the future of his farm and workforce;
  • figure out how to incorporate the plan into his 10-year-old buy-sell agreement; and
  • decide whether to offer phantom stock to the original partners as well.

"As our dairy businesses get larger and more compli-cated," Smith suggests, "we need to offer more sophisticated compensation packages."

He likes the phantom stock option because it provides the next generation an opportunity to realize some of the appreciation in value that comes along in profitable years. "They have also suffered the loss in poor years—it’s a double-edged sword," he says.

Smith feels this is a more fair and consistent program than the traditional gift of cattle. His only regret is that he hasn’t communicated all the nuances of the plan to all generations on a consistent basis. "It could be an even better tool," he says.

Neither farmer has established a funding source for the phantom payouts, believing their businesses will continue to be profitable enough to generate the cash necessary.

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