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Business Growth
Apr 21, 2016

Characteristics Of Bonus Incentive Plans

Sponsored Content provided by Dallas Romanowski - Managing Partner, Cornerstone Business Advisors

Too often, owners discover that the compensation plans they've put in place for key employees are sadly inadequate when those key employees leave for greener pastures. The departure of one or more of these key employees not only complicates your daily business life, but it also can slam shut the door on your exit plans. Without experienced management in place, you may find it very difficult (if not impossible) to leave your business in style.
 
Key employees are aptly named because not only are they key to the efficient and profitable operation of your business, they also are key to your departure. No one will want or be able to run your business without you, unless key management remains after you’re gone.
 
How then does an owner manage to keep key employees on board? Rather than tie them to the mast, many owners install employee incentive plans that motivate them to stay. In doing so, owners also work to achieve their goals to exit successfully.
 
We have identified four characteristics common to successful bonus plans. They:

  • Are specific, not arbitrary, and are in writing
  • Are tied to performance standards
  • Make substantial bonuses
  • Handcuff the key employee to the business
Let's look at each briefly.
 
Clear Communication
 
The most basic characteristic of a successful plan is that it is communicated clearly by the employer and is understood thoroughly by the employee. This means that successful plans are put in writing and based on determinable standards. To be successful, employees know that the plan exists and how it works. Plans are explained to employees in face-to-face meetings, often with the owner's advisers present to answer questions.
 
Performance Standards
 
The second characteristic is that the incentive plan’s bonus is tied to performance standards. Owners often work closely with their advisers to determine which performance standards should be used – perhaps net revenues or taxable income above a certain threshold – and for which employees.
 
The standards of performance that the owner chooses must be ones that an employee's activities can influence and that, when attained, increase the value of the company.
 
Let's look at how one owner accomplished exactly that.
 
Duke Manning was struggling to keep his renowned, yet temperamental, chef in line. Henri always wanted more money even though the profits of the restaurant, specifically the kitchen, were uneven. Since Chef Henri controlled both the food costs and the labor costs, Manning and his advisers designed an incentive plan to encourage Henri to keep both items in line, but not too low.
 
Manning’s incentive plan worked as follows: If quarterly food costs were no greater than 26 percent and no lower than 22 percent (a range believed necessary to keep food quality high), Henri would receive incentive compensation equal to 1 percent of the restaurant revenues. Similarly, if quarterly labor costs stayed between 25 percent and 21 percent, Henri would receive another 1 percent or a possible total of 2 percent of the gross revenues. Manning determined that if the kitchen could not stay within these ranges, profitability or the reputation and quality of the restaurant would suffer. If the restaurant prospered, revenues could be in excess of $3 million and Henri could earn as much as $60,000.
 
The result? Henri was motivated to increase revenues, because his bonus would increase while keeping costs and quality in line.
 
Substantial
 
Third, the size of the bonus must be substantial enough to motivate employees to reach their performance standards. As a rule of thumb, a plan should create a potential bonus of at least 30 percent of a key employee's compensation. Anything less may not be sufficiently attractive to motivate employees to modify their behavior to make the company more valuable.
 
Handcuffs
 
Finally, a successful plan handcuffs the key employees to the business. The goal here is 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.
 
Recall Henri’s incentive. Because Manning wanted to keep Henri for the long term, Manning paid half of Henri's bonus to Henri as he earned it and deferred (and subjected it to a vesting schedule) the other half. Of course, if Henri left the restaurant before he was vested he would forfeit half of his bonuses.
 
If you’re interested in learning more about this important topic, we have a host of other tools in our incentive plan arsenals to help you design a successful employee bonus plan that contributes directly to the success of your business exit.
 
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial adviser. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial adviser. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit planning is a discipline that typically requires the collaboration of multiple professional advisers. 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 that you need.

The Cornerstone team includes former C-Level executives, successful entrepreneurs and advisers who offer unmatched experience in delivering advanced, custom-tailored, results-oriented solutions for business leaders. As a member of the Business Enterprise Institute (BEI), Cornerstone is an authorized distributor of BEI’s content and Exit Planning Tools.  We developed the Performance Culture System™ to help clients implement best practices and drive high performance throughout their organization. For more information, visit www.launchgrowexit.com, call (910) 681-1420, or email [email protected].

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