This post is co-authored by Kelly Wells and Teresa Foltz.
Many elements go into the formula for attracting, retaining and developing the right talent for your organization. In assessing how you’re doing across each of these elements, one of the questions you’ll undoubtedly want to explore is “What kind of long-term incentive plan should our business have in place?” Incentive planning is an exercise that often requires more work than you might expect, especially when trying to anticipate trends and not-yet-visible barriers.
In this post, we break down incentive planning best practices to help you minimize employee turnover, encourage development, and support goal achievement with the right collection of incentives and benefits.
Before you begin to look at long-term incentive plan options, it’s important to stop and ask yourself foundational questions such as:
One can see how these questions are linked to, and inform, one another. For example, if emphasizing revenue growth and increasing company value for an eventual sale is a strategic objective, the behaviors and efforts you incentivize should be aligned accordingly. After all, if you tell sales managers that the company is focused on long-term value but then tie their incentives to near-term profitability, they will inevitably focus on profitability. The key takeaway here is that there is no such thing as a one-size-fits-all long-term incentive plan. Ensure that yours is tailored to the specific goals and circumstances of your business and its employees.
One of the main objectives of long-term incentive plans is to create milestone-based enticements (e.g. bonuses, vacation time increases, commission jumps) that encourage employees to stick around. When speaking with clients about their long-term incentive plans, many are already convinced they need to give some form of equity, which may include:
The problem with such incentives is that they come with baggage. Giving equity introduces potential control issues as well as fiduciary obligations to shareholders (more on that shortly). Fortunately, other options come with fewer management headaches, such as:
In our experience, the reason decision-makers usually gravitate toward equity is that employees ask for it. Understanding the motives behind these requests is important, so it’s worth asking employees why they want the equity and what they are trying to accomplish. Chances are they simply want to participate in the success of the company. It also may be that an employee wants to obtain a “partner” or “principal” title. It’s usually in your best interest to pursue a non-equity option. Why? Consider two ramifications of giving up your shares:
The points above are why equity equivalents such as SARs or some form of performance incentive plan are more ideal for business owners. A performance incentive plan is especially convenient because it’s a non-equity plan tied to specific metrics that don’t require releasing financials or any additional fiduciary responsibilities. The big caveat with SARs, however, is that they require the business to release full financials to participants on an annual basis and complete some form of annual valuation. Therefore, being realistic about your comfort level regarding transparency is important.
The success of an incentive plan often depends on setting the vesting period appropriately. For example, structuring it so that the awards vest in a year or two is risky because people may feel comfortable leaving sooner than they would have otherwise. Similarly, setting the horizon ten years out would also be a risk because employees may not attach much value to such a distant incentive.
It’s also important to consider how payouts will be handles. If you don’t, you could suddenly be on the hook for a huge payment to an employee. For example, take an employee who decides to leave or retire after ten years with $500,000 vested. Big and unplanned payments like these can hurt and getting a loan to meet them is never a good option. That’s why you want to ensure that long-term incentive plans are set-up to pay out over multiple years at a reasonable, affordable rate.
Now that you understand the key considerations around long-term incentive plans, what should you do next? A good place to start is by exploring key questions such as:
In our work with companies across virtually every industry, we know the importance of long-term incentive planning and how much time and energy is invested in getting them right. Attracting and retaining the right talent in a way that’s rewarding for both your business and your employees makes it time well spent.
Are you facing challenges in attracting or keeping the right talent? Have questions on how to strengthen your incentive plans and broader HR functions? Reach out to the experienced HR team at vcfo for help working through the many variables and developing the right plan for your team.
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