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Employee Incentive Planning White Paper

Employee Incentive Planning White Paper

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Published by Ken McCaul

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Published by: Ken McCaul on Oct 14, 2009
Copyright:Attribution Non-commercial

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09/15/2010

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Few business owners will take anextended vacation much less throttleback without leaving behindmanagement capable of running thebusiness.No sophisticated buyer will seriouslyconsider acquiring a company that lacksa good management team.Many, if not most, businesses are soldto key employees.Transferring a business to children isespecially risky in the absence of keyemployees who will remain with the newownership.Each of the scenarios above highlights anowner’s need for motivated employees whostay with your company after you leave it. ThisWhite Paper describes how you can motivateemployees through various key employeeincentive programs.The beauty of a well-designed key employeeincentive program is that as your employeesmeet their physical and financial goals, youattain your Exit Planning goal of making your company more valuable and, perhaps, moremarketable. And, of course, you are able toexit!If there was ever a case of “win-win” for bothemployer and employee, it is key employeeincentive planning.The first task in key employee incentiveplanning is to identify exactly who your keyemployees are. Most of your employeesdo not fit into the “key” category.Instead, they are attracted to your companyand motivated by the usual items: a pleasantwork environment, a stimulating job, goodwages and benefits, and job security.Key employees, on the other hand, act andthink more like you do. They want morechallenges and opportunities. They want toprosper and grow as the company does. Inshort, they behave like owners. You may havekey positions in your organizational chart.Make certain the persons filling those slots arekey employees.Keep in mind that people in key positions arenot always key employees. If employees do notrespond well to the incentive plans described inthis White Paper, it is questionable whether such employees truly are key. With theseguidelines in mind, let’s look at how to motivatethis small, yet vitally important, group.
CHARACTERISTICS OF AN INCENTIVEPLAN
A well-crafted incentive plan is one that doesmore than make both owner and employee feelgood. In fact, five criteria are present in a well-designed plan:The plan provides substantial financialawards to key employees. A potentialbonus equal to, at least, ten to thirtypercent of annual compensation, isnecessary to motivate an employee tomodify performance.Performance standards are specific.There must be determinableperformance standards such as certaincompany net income or revenue levels.
Joseph Associates International, Inc. www.BrokerChicago.com
Employee Incentive Planning White Paper
 
Specific examples are examined below.Performance standards are tied directlyto increases in the company’s value. Asthe key employee achieves measurableobjective standards, the net income of the company increases. Put another way, unless the company’s net incomeincreases, the key employee does notreceive a bonus.Part of the bonus is deferred andsubject to vesting. This characteristic of incentive plans is commonly referred toas “golden handcuffs.” If the employeesevers his employment before he is“fully vested,” he forfeits at least part of the deferred compensation.The plan is communicated in writing tokey employees. In order to besuccessful, key employees mustunderstand exactly how the plan works.The plan must:be simple,be easy to read,be communicated face-to-face toemployees with advisors present toanswer any questions andcontain a summary for easyreference.Having identified the elements that make asuccessful plan, you (as an owner) and your advisors must determine whether a stock-based plan or a cash-based plan (or somecombination thereof) will best motivate your employees and cause them to stay with your company.
EQUITY-BASED PLANS
Providing the opportunity for stock ownership isone of the most powerful motivating – andretaining – factors a closely-held business canoffer to a key employee.Stock ownership motivates key employees for a number of reasons. The most commoninclude:Stock ties key employees to thecompany by making them part of thecompany;The plan can require employees to payfor ownership, thus investingthemselves, quite literally, in thecompany. Requiring employees to payfor stock demonstrates their dedicationand commitment to the company; andStock ownership provides strongincentive for increasing the value of thecompany and, therefore, increasing thekey employee’s benefit.These are great reasons to transfer stock. Wewould be remiss, however, if we leftunmentioned some of the “not-so-great”reasons that motivate owners to give stock toemployees.It is not uncommon for owners to reward anemployee with a small percentage of stockperhaps because the employee wasinstrumental in a start up or is integral to onefacet of the company. Unfortunately, theseowners fail to appreciate that even the smallestpercentage of stock carries with it significantrights. Shareholders enjoy more than the rightto a share of the growth of the company.They enjoy the right to access company
Joseph Associates International, Inc. www.BrokerChicago.com
 
books and records, the right to be informedabout the financial condition of the company(including your salary and “perks”) and often, aright to be consulted and given the opportunityto vote on major company decisions. Keep inmind one possible “major corporate decision” isa future sale of the corporation. You should befully aware of the voting percentagerequirements imposed by law, by your company’s articles or bylaws before unwittinglytying your hands.As ownership changes the outlook of theemployee receiving the stock (usually for thebetter), it can change the outlook of her coworkers who now perceive her status tohave changed. Co-workers may demandownership as well or may quit. In attempting toreward a key employee, you may inadvertentlyantagonize other competent, potentially key,employees.If you believe that stock is the appropriateincentive for your key employees, you thenmust determine if the time is right to make thataward. A decision regarding timeliness isbased on the presence of four conditions:1.Your key employee(s) has been withyour company for a sufficient time(usually several years) and is a “provencommodity.”2.The key employee(s) would be moremotivated by stock than cash.3.You are prepared to award theemployee(s) a
meaningful 
amount of stock. (Should you be unprepared tocommit a significant amount of stock ownership to an employee,a stock-based incentive is notappropriate.)4.You are willing to bring the employeeinto the company’s confidence, toprovide that employee with access to allinformation regarding the company(including your total compensation) andto allow the employee to participate inmajor decisions concerning thecompany.In addition to determining when to award stock,you and your advisors must consider thefollowing:How does the incentive plan affectparticipants in other existing plans?Can non-participating employeesparticipate in the future?What type of stock (voting or nonvoting)will be awarded?What amount of stock will be awardedboth at the outset and in the future?What valuation formula will you usewhen awarding and re-acquiring stockWhen will payments be made?What agreement is in place to buy backthe stock should the employee leave thecompany?What performance standard must beattained before the key employee hasthe right to a stock bonus or purchase?Assuming that you have determined that awell-designed, stock-based incentive plan willmotivate your employees and achieve your exitobjectives, how do you implement it?
ISSUING STOCK
Joseph Associates International, Inc. www.BrokerChicago.com

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