If your company employs more than 75 people you likely have thought about compensation design for the key people in your company. For most compensation has four components:
- Pay your key employees receive.
- Benefits they get.
- Variable cash compensation.
- Compensation they might receive at retirement.
Compensation they might receive at retirement and variable cash compensation can and often should be combined into one program. The goal with this type of compensation plan is to reward your key people when they get great results and to keep them around with a form of golden handcuffs.
The program I’ve come to like when trying to solve both a bonus plan and one that rewards a manager on retirement is called a Stock Appreciation Right Program (SARS). It’s a form of phantom stock where the manager is rewarded when the company appreciates in value and a hurdle rate for financial performance has been achieved.
Why have two programs tied into one?
When a company adopts a SARS program they are saying to their key people that if they’re able to grow the value of the company they’ll get a piece of the action.
I’ve seen that when clients we work with concentrate on both variable compensation and retirement compensation their employees will look at both short term and long-term activities in the company. This helps build a more rounded view of the company.
How would the two programs work?
The retirement portion of the program is quite simple. You would take the following steps:
- Decide what percentage of the increased company value goes to your employees.
- Establish a vesting schedule for your key employees.
- Put together a way for valuing your company that you can do internally on an annual basis.
- Evaluate annually if the company has increased in value.
- Put money aside for your executive to use at retirement. You will want to use what is known as a Rabbi Trust for this.
The variable compensation part of the program is more complicated. You will want your manager to think as if they are an owner. The bonus should be based as if they were an owner. This means you will often want your manager’s variable compensation to be paid last, just like you are.
Being paid last means that after all company expenses are paid and all financial contingencies are accounted for you will have money that is available for distribution. This money will be split between you as the owner and your key executives.
I often believe that this split should be done on the same basis as the retirement program. If you have allocated 5% of increased value to your key manager, then you might want to also allocate 5% of distributions be allocated on an annual basis.
An example for your bonus plan might be as follows:
- Company profits $1,000,000
- Required contingency and bank loan funding $400,000
- Amount available for distribution $600,000
- Amount paid as bonus at 5% to manager $30,000
These plans are complicated. I find that when our clients look at introducing phantom stock SARS plans it often takes several months for everyone to understand and be comfortable with the program. If you find the idea of combining your key people variable compensation plans with one that helps tie them to your company attractive, then investigating this type of plan might the right thing for you to do.
A related issue is getting your key people to stay with your company if you either sell it or have a problem with your health or your life. We call this process a stay bonus. We’ve written a case study on this topic and invite you to click on the button below to download your report.