Do you need help to keep your top-performing employees in your company? You’re not alone.
Many business owners realise that their compensation plans for key employees are inadequate only when those employees leave for greener pastures. Losing these employees complicates daily business life and can slam shut the door on your exit plans. After all, no one will want or be able to run your business without you unless key management remains after your departure.
So, what can you do to keep your key employees on board? One strategy is to install an Employee Bonus Plan that motivates them to stay. This way, you’re not only retaining your valuable employees, but you’re also working towards ensuring your own successful exit. But what does a successful bonus plan look like?
Successful bonus plans have four key characteristics in common:
1. Clear Communication
The plan should be communicated clearly by the employer and understood thoroughly by the employee. To be successful, employees must know that the plan exists and how it works. Plans should be explained to employees in face-to-face meetings, often with the owner’s advisors present to answer any questions.
2. Objective Performance Standards
The bonus should be tied to performance standards that are specific, not arbitrary, and are in writing. An owner often works closely with his advisors to determine which performance standards should be used for which employees. The performance standards that the owner chooses must be ones that the employee’s activities can influence and that, when attained, increase the company’s value.
3. Substantive Bonuses
The size of the bonus must be significant enough to motivate the employee to reach their performance standards. As a rule of thumb, a plan should create a potential bonus of at least 10 per cent of the key employee’s compensation. Anything less may not be sufficiently attractive to motivate the employee to modify his behaviour to make the company more valuable.
4. Handcuffs
The plan should handcuff the key employee to the business. This element aims to keep the employee with the company the day after and even years after the bonus is awarded. Owners typically use several techniques to create “golden handcuffs” for their employees, such as creating incentive plans or bonuses for their key employees that require them to stay with the company for a certain amount of time before receiving the total bonus.
Creating an effective bonus plan for your key employees requires a thorough understanding of what motivates them. It might not only be a bonus of some kind. Think about promotions or other rewards. Are they interested in equity or cash? The plan is only effective if your employees are motivated to achieve their rewards. The plan also becomes obsolete if the performance standards don’t increase the value of the business.
How did David do it?
To illustrate these characteristics in action, let’s look at an example.
David Manning, the owner of a engineering manufacturing business, found himself struggling to manage a particularly challenging employee – his chief engineer in the structural division, Henry. Henry was a talented and well-connected team member, but he was also temperamental and demanded more money despite the uneven profits of the structural engineering division.
David realised that he needed to find a way to incentivise Henry to keep the material and labour costs in line without compromising the manufactured products’ quality. So, with the help of his advisors, he designed an incentive plan that would reward Henry for staying within specific cost ranges.
Under the new plan, if quarterly material costs were between 32% and 36%, and labour costs stayed between 21% and 25%, Henry would receive incentive compensation equal to 0.5% of the structural manufacturing revenues for each cost category. He would receive 1% of the revenues if both cost categories were within range. This was a win-win situation for both David and Henry. If the structural manufacturing plant prospered, the revenues could exceed $8 million, and Henry could earn as much as $80,000 in incentives.
David understood that keeping Henry long-term was crucial for the business’s success, so he structured the incentive plan to include a deferred payout with a vesting schedule. Half of Henry’s bonus would be paid on 1 July each year, while the other half would be deferred and subject to vesting over a 3-year period. This would encourage Henry to remain with the company and work towards achieving the business’s long-term goals.
Ultimately, David’s incentive plan successfully kept Henry motivated and focused on the business’s goals. By aligning the interests of the company and the employee, David achieved both short-term and long-term success.
So how are you keeping your key employees motivated and entrenched in your business?
The information contained in this article is general in nature and is not legal, tax or financial advice. Contact a lawyer or a tax or financial professional for information regarding your particular situation. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. Clients should consult their legal, accounting, tax or financial professional in specific cases. This article is not intended to give advice or represent our firm as qualified to advise on all areas of professional services. Master Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice you need.
Any examples provided are for illustrative purposes only. Examples may include fictitious names and may not represent any particular person or entity. This article has been sourced from a licence agreement with Business Enterprise Institute, Inc.
