How To Compensate Top Tier Talent For Retention And Reward

From the book: "Is This Any Way To Run Your Business"

Manager Compensation (Chapter 22)

In many cases, if properly structured, reward/incentive compensation can help a company's revenues and profits increase. They align the company's managers' goals with the company's owners' goals, and they can also be used to keep those managers from leaving for another job.?

If the incentives are effective, the increase in a manager's pay makes it difficult for another company to match their total salary and bonus. Furthermore, both incentive compensation and stock options have the potential to vest over time.

If a key employee left your company before the vesting period ended, those vesting provisions would penalize them. This is a type of "Golden Handcuffs" that can be valuable as well. It is this incentive compensation among other growth opportunities that attracts and retains top talent.?

?Hence it is crucial for you “engineer” your company’s growth. However, incentive compensation has a cost in addition to the cash payments to participating managers. No incentive is effective unless it is simple for the person receiving it to comprehend. Furthermore, that individual must be able to calculate his or her progress toward the incentive, as well as the amount of the incentive earned, at any given time.?

?This necessitates providing each manager with the financial data required to make those calculations. However, as I previously stated, you should share all of your company's financial statements with all managers who have the ability to influence its financial performance.?

?Don't hoard the information that your managers can use to identify problems, make corrections, and boost profits. (See also Chapter 8.) In terms of bonuses, you must decide who should participate in addition to the structure and amount. In general, I believe that bonus compensation should be extended to all employees who have a direct impact on a company's financial performance.?

?Structure bonuses as annual payments at the highest levels of management. Base a portion of the bonus on the results of the department or function under the manager's direct supervision and control, as well as a portion on the company's overall performance.?

This structure not only rewards the manager for individual performance, but it also encourages collaboration with other departments and concern about the overall operations of the company. If you want to use vesting as part of your bonus plan, you can pay the majority of the bonus when it is earned but set aside a portion for payment at a later date, provided the manager is still employed at the time.

?Quarterly bonuses may be more appropriate for lower-level managers than annual bonuses. Employees at lower levels of a company are generally best rewarded over shorter periods of time. A foreman may find that a payment made within three months is more effective than a payment made over the course of a year.?

?Bonus payments for hourly or non-management employees should typically be made monthly and based on a single performance objective, according to my experience. For example, I got one of my clients to pay a monthly bonus to all hourly employees who exceed a certain level of production per man-hour.?

?Another of my clients, who owns a number of retail stores, now rewards store employees for monthly sales levels that exceed a certain threshold.The manufacturing company posts the production level each week on a large sign in the shop to make these lower level bonuses effective. Each week, each shop employee can see if they are on track to reach the bonus level. In each employee's weekly payroll check, the retail sales company calculates the store's month-to-date sales. You can do it for safety protocols too.

?If you're concerned about the cost of such bonuses, keep in mind that if they're structured properly, the increase in your company's profits will more than cover the cost of the bonus. Would you prefer a hundred percent of $10.00 or a ninety-five percent of $12.00? That isn't a difficult question to answer.?

?Stock options should be reserved for executives who can clearly understand the long-term benefits of owning stock in a company. Those executives should be able to comprehend not only an increase in equity value over time, but also think like a business owner rather than a worker.

?I usually structure stock options for closely held, private companies so that the executive can exercise the option at any time after it vests, up to seven to ten years after the original award. I also stipulate that the executive can sell the company's shares back to it at a set price. This allows the option holder to benefit from an increase in value without having to wait for another "liquidating event," such as the sale of the entire company.

?In addition, I frequently include a vesting period with stock options, which can be as long as five years. This would typically be a 20 percent annual vesting of the executive's options. All non-vested options would be forfeited if the executive left the company, and he or she would only have a limited time to exercise all vested options.

?For example, the option holder might be required to exercise his or her options within sixty days of leaving the company, and then resell the shares to the company or its other shareholders. All unexercised options would be canceled, and he or she would be required to resell to the company all previously purchased shares at no more than their book value per share if an option holder was terminated for "cause" as defined in the option agreement.

?Stock options reward executives for their company's long-term performance over a period of years, and they're especially good at extending the executive's planning scope and performance to include the entire period.In lieu of stock options, I've had a number of clients suggest awarding "phantom stock" instead of actual options for the purchase of common stock over the years. In general, I am opposed to the use of phantom stock as a motivator.?

?One of the main goals of a stock option plan is to train executives to think like owners of the company. The phantom stock concept not only defeats this goal, but it also informs the executive that the company's owners do not want him or her to join them in ownership. That is the incorrect message.

?Of course, if you have even the slightest chance of becoming a minority shareholder in a closely held company, you should have a Stockholders' Agreement in place to govern the subsequent disposition of the shares. (Contact me directly for a template.)?

?In the next chapter, I'll go over the terms of those agreements. In the meantime, think about how you can use bonus plans and stock options to boost your company's profits and enterprise value while rewarding the employees who help you get there.(See Chapter 72 for a discussion of Equity Capital Accounts as a viable alternative to stock options.)?

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