For some time now, government contractors have been operating in a holding pattern due to the threat of sequestration, tenuous funding for existing contracts and the unresolved debt ceiling crisis.

Absent any intervening forces, sequestration will take effect March 1, the continuing appropriations resolution funding the federal government will run out on March 27 and the debt ceiling deal will expire on May 18.

Regardless of the outcome of these events, government contractors are likely to face more challenging times ahead--including fewer contract awards, spending delays for awarded contracts and an uptick in protests of any awarded contracts.

...”Regardless of the outcome of these events, government contractors are likely to face more challenging times ahead”

Conserving cash and shoring up relationships with key employees are two important tools government contractors could wield to brace for these challenges ahead, to navigate them and to perhaps even come out stronger on the back end.

Use of Incentive Plans

A company’s success, particularly in challenging times, turns in large part on its ability to attract, retain, reward and motivate key employees.

Companies often use “equity sharing incentives” to achieve these goals. Equity sharing incentives more closely align key employees’ financial interests with the company’s. These equity sharing incentives can take different forms and can be more retention-oriented or recruitment-and-motivation-oriented, or both.

Some equity sharing incentives provide for sharing “real” equity, such as employee stock purchase plans or stock option plans.

“Some equity sharing incentives provide for sharing “real” equity, such as employee stock purchase plans or stock option plans.”

Others, however, are “equity-linked” sharing incentives, such as phantom stock and stock appreciation rights (SARs) which typically do not provide a path to ownership. Rather, these equity-linked sharing incentives provide for key employees’ participation in the financial and economic-upside success of the company, without any actual ownership interest in the company.

In most cases, phantom stock is used as a “retention” tool and SARs are used as recruitment and motivational tools.

For example, if the company were to be sold, the “phantom stock” payout would be pegged to and paid out based on the full company per-share value; whereas, the SARs payout would be pegged to and paid out based on the company per-share value above a specified floor price.

Importantly, whether the company uses “real” equity sharing incentives or “equity-linked” sharing incentives, they generally altogether avoid or defer the company’s parting with cash, and they incentivize key employees to remain with the company and build up its value with the hope of experiencing a “monetizing” (for example, sale of the company) event down the road.

Regulatory Considerations

For “small business” government contractors, ongoing compliance with applicable eligibility and/or size regulations is paramount. In that regard, if a company participating in the Small Business Administration’s 8(a) program was to grant “equity-linked” sharing incentives--which, as noted above, do not result in actual ownership interest--the company would not have to concern itself with running afoul of the SBA’s present effect rule or otherwise providing notice to or requesting approval from the SBA for a “change of ownership.”

Likewise, if a service-disabled veteran-owned small business that has been verified by the Center for Veterans Enterprise at the Veterans Affairs Department was to grant “equity-linked” sharing incentives, the firm would not have to re-apply to be re-verified by the veterans enterprise center.

In light of the above-described current economic uncertainties, equity sharing incentives could be a brick in a strong foundation that enables companies to successfully navigate the challenging times ahead.

Companies should be willing to share in the upside success but need to be careful and creative in the process to protect their downside too. To that end, equity sharing incentives should be granted under terms and conditions (including, but not limited to, vesting, forfeiture and liquidity events and timing of payments) that balances the companies’ and employees’ interests and can be communicated to employees in a way that the employees believe there is actual value to be earned and realized. Sound professional legal (and CPA) advice is a key component of developing and implementing such equity sharing incentives.

Dean S. Nordlinger is a partner of PilieroMazza PLLC in Washington, DC and heads the firm’s Business & Corporate Law Group. For over 25 years, PilieroMazza has helped small and mid-sized businesses to successfully navigate a diverse array of legal matters, with a primary focus on government contracting and the SBA’s procurement programs. Visit www.pilieromazza.com.