Too often, business owners discover that their key-employee compensation plans are sadly inadequate only after those key employees leave their companies for greener pastures. The departure of one or more key employees not only complicates the owner’s daily business life but also can slam the door on his or her plans to exit. Without experienced management in place, owners may find it difficult (if not impossible) to leave their businesses in style.
Key employees are aptly named because they are key to the efficient and profitable operation of a business, and because they are key to an owner’s successful exit. No one will want or be able to run the business without the owner unless key management remains after the business owner’s departure.
How Do Business Owners Keep Key Employees on Board?
Rather than tying key employees to the mast, many business owners install employee incentive plans that motivate key employees to stay. Incentive planning should motivate key employees to perform at a higher or more challenging level, but most importantly, it should help achieve one or more of an owner’s exit goals.
For that reason, if you don’t know or understand a business owner’s goals, don’t install an incentive plan until you do. If you know that the company must be more valuable in order for an owner to achieve his or her exit goals, incentive planning is a great tool.
4 Characteristics of Infinite Plan Variety
The four characteristics common to successful bonus plans are as follows:
- They are communicated clearly (i.e., specific, not arbitrary, and in writing).
- They use objective performance standards.
- They award substantial bonuses.
- They handcuff the key employee to the business.
Let’s look at each characteristic in further detail.
Clear communication between an employer and employee is best accomplished in writing. Nonetheless, it is important for owners to inform employees about the plan and explain how it works face to face, usually with advisors present to answer questions.
Objective Performance Standards
An incentive plan’s bonus should be tied to carefully considered, objective performance standards. Standards might include net revenues or taxable income above a certain threshold.
Whichever standards of performance the owner chooses should be ones that the employee’s activities can influence and that, when attained, increase the company’s value. For owners, without transferable business value, there is no financial security. Without financial security, there is no successful exit.
The principal method of increasing value and cash flow is via management performance. Well-designed incentive plans that use rewards to motivate management to increase cash flow and business value allow owners to exit successfully.
The size of the employees’ bonuses must be substantial enough to motivate them to reach their performance standards. Typical bonuses are 30% or more of annual compensation.
Handcuffs Employee to Business
By handcuffing the key employees to the business until and after the owner exits the business, owners reap their value-building contributions to the business and assure any buyer that the employees who made the company successful for one owner will likely stay and do so for new ownership. Since many buyers subject sale proceeds to earn-outs or require the former owner to carry a promissory note, it is in an owner’s best interest to make sure that the business’ cash flow after the owner exits is as healthy as possible. Again, retaining key employees is the best guarantee that cash flow continues uninterrupted after the owner leaves.
As an advisor, you play a vital role in explaining to business owners why motivating key employees increases cash flow and business value in general, and achieves their financial and departure-date goals.