16 Jan Why Business Owners Need Incentive Plans Now
In last week’s article, we mentioned that an important aspect of planning for a third-party sale was incentivizing key employees to stay with the business. Today, we will expound on that idea, because it’s a crucial function of maintaining a successful business. No matter when, how, or to whom business owners leave their businesses—and even if owners intend to die at their desks—they must assure that they are giving their best employees incentive to stay with the business throughout.
Why Business Owners Need Incentive Plans
Recently, businesses have begun to refer to employees—whether they are key employees or not—as “their most important assets.” They talk about employees in terms of “human capital,” which implies that they are something to be exploited. This cynical view of employees as chattel can lead to one of the most terrifying aspects of business ownership for owners: constant turnover.
Employees, regardless of whether they are high ranking or rank and file, understand when plaudits are empty. Without tangible, and often spendable, proof that the company recognizes their contributions to the company’s success, most employees will eventually leave. Typically, the first ones to leave are the ones that matter most. While no companies can ever claim a 100% employee retention rate over the years, many small businesses struggle to maintain even an average 90% employee retention rate.
This inability or disinterest in motivating employees to stay—despite the constant refrain that “our employees are our greatest assets”—equates to outright business sabotage, ironically approved by the very last person who wants to sabotage the business: the owner. Key employees are crucial to business success—now, in the future, and especially when the owner prepares to exit the business—and owners simply cannot afford to lose them. This is why formal incentive plans are so important for owners to have.
But how do owners implement a successful incentive plan? What does a strong incentive plan look like?
How Business Owners Can Implement Incentive Plans
Business owners have many inborn talents, but typically, creating and implementing a strong incentive plan isn’t one of them. Incentive planning is usually too complex and broad to tackle alone. Thus, owners leverage the combined expertise of an Advisor Teamto help them fill in the gaps in their own expertise.
In implementing a proven incentive plan, advisors and owners must work together to determine what will best incentivize their best employees to stay with the company. This is especially important when owners are considering their business exits because it’s their best employees who will likely run the business as and after they exit, which inherently affects the business’ value. While there are numerous types of plans owners and advisors can use (Phantom Stock Plans, Stock Appreciation Rights Plans, Cash Bonus Plans, or Profit Sharing Plans, just to name a few), all incentive plans must do four things.
- Be tied to performance standards.
- Be clear, consistent, specific, and in writing.
- Create substantial bonuses.
- Handcuff the employee to the business.
Why Tied to Performance Standards?
Much like a business has yearly goals and an owner has specific exit goals, employees need goals to aim for to invest themselves in an incentive plan. Without basing incentive plans on performance standards, owners can back themselves in a corner for two reasons. First, without a performance standard, everyone is left to guess at what they’re supposed to be doing. An employee’s view of a good performance might not match with an owner’s, and what an employee considers an important performance might not be of value to an owner at all (or vice versa). Second, without a performance standard, any awards given can be misconstrued as favoritism, because again, there’s nothing that determines who gets an award or how. Both can lead to bitterness and cratering morale.
Specific performance standards vary by business and industry, and advisors must use their skills and planning tools to determine standards that are both realistic and based on historical performance. They shouldn’t be so easy to achieve so as to cost the company net money but also shouldn’t be so difficult as to make them impossible to achieve at all.
Why Clear, Consistent, Specific, and in Writing?
Unless employees know what they must do to receive their incentive, there’s no way for them to pursue it. Likewise, incentive plans cannot exist solely in the owner’s brain, because if something were to happen to the owner (death at worst, a bad day at best), the incentive plan is meaningless. Putting the plan in writing and assuring that it’s clear, consistent, and specific makes it more likely that employees will successfully achieve their goals, which will positively affect the business’ growth. Advisors can help owners write clear and concise incentive plans, and explain them to employees in face-to-face meetings to assure that everyone understands what’s expected.
Why Create Substantial Bonuses?
For owners, the goal of an incentive plan is to motivate employees to achieve goals that will grow the business to new heights. This implies that employees will need to vastly exceed what they’ve been doing historically, which further implies more work. For employees, if they are asked to do more work, they will expect ample compensation. An owner who offers a 5–10% bonus for 100% more work should not be surprised when their targeted employee declines the opportunity or leaves the company altogether. Generally, a “substantial” bonus is defined as no less than 30% of the employee’s base compensation. With the right tools and ideas, advisors can determine a bonus that is substantial enough to motivate employees to achieve their set performance standards.
The entire point of an incentive plan is to keep the employee invested with the company over a set range of time. In offering an incentive plan to an employee, owners are saying that the company will be better off with the employee than without the employee. To keep that employee around for the long haul, advisors can recommend that the incentive plan be vested over time, which gives employees a piece of the pie now on the condition that they stay with the company and continue to achieve performance standards for the remainder of the pie later.
If owners are the heart of the business, key employees are the circulatory system that keeps the business running smoothly. To neglect them by not providing incentive for them to stay is a huge risk owners take with the success of their businesses—both now and later—and the success of their eventual business exits.