Crystal Faulkner & Tom Cooney, Partners, MCM CPAs & Advisors
For most business owners, their company is their most valuable asset. Therefore, understanding the current value of a business is one of the first steps we take when we work with our clients in developing a business exit or transition plan. We then help business owners develop strategies to maximize the value of their organizations to achieve their financial objectives.
A well-designed incentive plan for key employees can be a powerful and effective strategy to motivate employees to meet specific goals. As a result, the company is made more valuable and potentially more marketable in order to achieve business transition/exit planning objectives. Key employee incentive planning can be a win-win for business owners and their top employees.
Who are key employees?
The first undertaking is to identify exactly who are key employees. Most employees work for, and are motivated by, typical benefits which might include: a positive work environment, a stimulating job, good wages and benefits, and job security. Key employees, on the other hand, fit into a different category altogether – they act and think more like business owners. They thrive on challenges and opportunities and want to grow and prosper as the company does. The difficult task is to determine whether or not the people who are in key positions are actually key employees. Take the time to review the key positions on the organizational chart and then make sure the individuals who fill those slots are critical to the business and its success.
Performance goals and incentive plans.
Key employee incentive plans should include specific and measurable performance standards and goals. Those goals must result in a quantifiable increase in the value of the company in order to be effective. For example, if the goal is to increase revenue or diversify customer base, outline the specifics of the goals using numbers, percentages and deadlines. Once the goals are achieved, employees will receive their incentive bonus. Tying compensation to increasing the value of the business allows rewards for employees and achieves stated objectives.
Keep in mind that the financial incentives awarded to employees must be substantial in order for them to be motivated enough to improve or change current work habits. Generally, monetary awards range from 10 to 30 percent of annual compensation. In addition to substantial awards, successful incentive plans often incorporate a deferred component to create a “golden handcuffs” feature through vesting. In other words, instead of paying employees the entire bonus in cash, a portion of the performance award could be deferred and be subject to vesting requirements. By structuring incentive plans this way, key employees would be subject to forfeiting a portion of their bonus if specific agreements were violated. For example, if a key employee quits early, violates a valid non-compete agreement or takes trade secrets, they would forfeit any unpaid deferred compensation balances. Having forfeitures like this in place will help protect the company’s assets. Be sure the incentive plan is communicated in writing and is carefully explained so that all employees understand all of the plan aspects.
Non-Qualified Deferred Compensation.
A non-qualified deferred compensation plan (NQDC) is another effective incentive plan. It is basically an agreement to pay benefits on a future date based on current or past performance, as long as certain requirements are met.
Two examples of NQDC are Phantom (Virtual) Stock Plans and Stock Appreciation Right (SAR) Plans. In a Phantom Stock Plan, owners give employees “virtual” stock that can grow in value and be turned into cash—it acts just like stock, but is not “real” stock. Typically, phantom shares corresponding to shares of stock (but not actual equity) are allocated to the participating employees’ accounts. As the value of true stock increases, so does the value of the phantom shares.
An SAR plan is similar to the Phantom Stock plan in that the value of the benefits in the SAR plan is tied to the value of the company’s equity. Unlike phantom stock however, the employee under an SAR plan is only entitled to receive appreciation on a certain percentage of SAR units valued against the corporation’s stock, not the entire principal value.
Incentive planning has many complex implications, so financial and legal professionals should be engaged to assist in evaluating which incentive plans will be the most effective for the business. Once the plan is implemented, take the time to review, evaluate and adjust as needed.
Tom Cooney and Crystal Faulkner are partners with MCM CPAs & Advisors, a CPA and advisory firm offering expert guidance and beyond the bottom line thinking for today’s public and private businesses large and small, not-for-profits, governmental entities and individuals. For additional information, call 513-768-6796 or visit us online at www.mcmcpa.com.