David Cassady, Chief Growth Officer, Cassady Schiller & Associates
At age 30, you and a partner took an enormous leap out of your comfortable, corporate-level well-paying job to start your own business. With limited resources and a small line of credit, you hired your first employees and began working to develop your new business. You remember parting with your first significant profit as it was used to make payroll that first year. Slowly but surely, your hard work paid off. Today that two-man shop is now home to 100 employees.
Over time, you’ve delegated down the responsibilities of operations and human resources to trusted employees so that you could focus on the strategic goals of the company. In your leadership team, you know where the holes are that need to be filled as well as identified the individuals who you see taking over when you retire. This leaves you with one of the biggest questions maturing businesses face: how do I attract, retain and incentivize my key talent to transition over the business?
The starting line is often easily identifiable. Make a list of individuals who demonstrate the culture, drive, and strategic thinking that is needed to transition from employee to owner. The next step is more challenging; identifying the short term and long term needs of those individuals. As owners of businesses, it is crucial to understand that the ownership being transferred is at a significantly higher value than what it was when you started the business—a testament to your hard work and success. Additionally, the current cash flow needs of younger employees (kids’ college tuition, mortgages, retirement planning, etc.) is different than that of a 60 year old owner.
The greatest challenge in developing incentives and retention plans is balancing the short term and long term needs of the company to promote growth and stability over time.
Before getting out the checkbook, there is more to the scenario that needs to be addressed. The greatest challenge in developing incentives and retention plans is balancing the short term and long term needs of the company to promote growth and stability over time. In other words, how does one incentivize an employee today while maintaining their focus on continued long term growth? Secondly, the company’s stock price is much higher today than when the company was founded. Most of these key employees cannot reach into their pockets and discover piles of available cash to pay for an ownership stake—so how are they going to pay you? And, equally important, how will you incentivize them to stay?
Succession planning utilizes several techniques that incentivize key individuals while providing “golden handcuffs” to ensure retention. There are several methodologies and commonly-used practices for family-owned and closely-held businesses to develop plans. These plans are created for the company’s leaders and essential individuals who are deemed irreplaceable. The specifically-identified employees can be referred to as the company’s “special forces.” For closely-held companies, deferred compensation plans, long term incentive plans, and other similar plans can be customized for these individuals.
Deferred compensation plans are used to supplement an executive’s retirement benefits, make up for reductions in benefits due to qualified retirement plan limitations, defer taxable income, and provide other incentives. Under these plans, the company enters into an agreement to pay a significant benefit to the key employee(s) over time, or at a later date, which is above and beyond their normal salary. These plans provide key individuals financial peace of mind in their current role so they can focus on increasing the value of the business.
Similarly, long term incentive plans (also known as “LTIPs”) provide various levels of performance-based compensation in order to drive behavior, enhance retention of key employees, and reward employees for the increasing company value. These non-qualified plans are developed and aimed at participants who have control of or an impact on revenue, cost, and asset optimization as well as risk mitigation. Each plan is customized for a specific industry and is usually tied to the current value of the company. They also include a vesting period for which the employee is incentivized to focus on growth, or accretion in value, of the company. At the conclusion of the vesting period or at a defined retirement age, the company will distribute rewards as stated in the plan.
Long term incentive plans provide the employee short term and long term motivation to continue acting in the best interests of the company. They are focused on aligning the individual’s personal goals with the company’s strategic plans. These rewards can also include ownership in the company. This allows the individual to either purchase shares or be rewarded with ownership in lieu of payment, as well as compensate them so that they are financially capable of purchasing shares. The flexibility in these plans makes them an attractive option for many business owners. However, to be successful, sufficient time is required to develop and properly implement the plan and require qualified legal expertise so they are drafted in accordance with IRS regulations.
That small one-room business you started 25 years ago is now a living, breathing culture that 100 people call home. As you prepare for your own retirement no longer so far down the road, it is important to think about those right-hand men and women who help make the business thrive. These people will be entrusted to continue the legacy you have created. If you have not given adequate thought to succession planning, it certainly is something to consider.