key employee incentive and retention plans | creating a motivated management team
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WELCOME to
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KEY EMPLOYEE INCENTIVE AND RETENTION PLANS
Creating a Motivated Management Team
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Construction Industry Overview3rd largest segment of
World economy
2nd largest employer
2nd highest failure rate
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Key Employee Incentive/Retention Plans
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Construction Industry OverviewTop Five Greatest Challenges
Challenge %Shortage of trained field help 60%
Sources of future work 16%
Healthcare insurance costs 10%
Lack of qualified project managers 9%
Financial condition of federal, state or local government 5%
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Key Employee Incentive/Retention Plans
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How many business owners or executives take an extended vacation – more than a month at a time?
Key Employee Incentive/Retention Plans
Why consider?
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How many business owners or executives believe they can throttle back and not be at the office every day?
Key Employee Incentive/Retention Plans
Why consider?
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How many sophisticated buyers will seriously consider acquiring a company that lacks a good management team?
Key Employee Incentive/Retention Plans
Why consider?
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How many business transitions to family members are successful in the absence of Key Employees who will remain with the new ownership?
Key Employee Incentive/Retention Plans
Why consider?
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No matter what language you speak the
answer is NONE
Key Employee Incentive/Retention Plans
NingunaAucunKeiner
Никто
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Each of these scenarios highlights an owner’s need for Key Employees who:
Provide motivation to others
Provide management skills within their departments
Provide leadership to fellow employees
Would stay with the Company after the current owner has departed
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The talent and contributions of Key Employees are often cited as one of the most significant value drivers within a successful Company:
1. Help build profits
2. Help build up the value of the company
3. May increase Company morale
4. May provide a challenging and dynamic work environment
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Contractors that plan to transition ownership:
Internally – Need to entice non-family talent to stay the course.
Externally – Need to have capable, motivated and a loyal group of Key Employees in order to maximize the sale price.
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First Step - Who are your Key Employees?
Key Employee Incentive/Retention Plans
IDENTIFY the Company’s Key Employees and understand what is
IMPORTANT to THEM!
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The majority of a Company’s employees do NOT fit into the “KEY” category….the non-key employees are attracted to the Company and motivated by the usual items:
- A pleasant work environment
- A stimulating job
- Good wages and benefits
- Job security
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KEY Employees act and think more like the owner does:
- They want challenges and opportunities- They want to prosper and grow as the Company
does- They are attuned to industry trends- They want the Company to have competitive
advantages- They appreciate and nurture customer and vendor
relationships- They thrive on productivity- They offer input on how to improve the Company
(whether solicited or not)
Key Employee Incentive/Retention Plans
Basically, they behave like OWNERS!
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You may have “KEY” positions in your organizational chart
You need to make certain the persons filling those slots are “KEY” Employees
Key Employee Incentive/Retention Plans
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Most Key Employees are known within an industry – Making them a focus of recruiting efforts by competitors
Key Employees want tangible recognition and appreciation for their efforts in helping the company succeed
So, how does a Company encourage high-caliber talent to stay the course?
Key Employee Incentive/Retention Plans
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Most common response –
Why don’t we just pay the Key Employees a higher salary?
Key Employee Incentive/Retention Plans
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The most common response is not always the best response:
- Does not stop competitors from offering even higher pay or a better opportunity
- Does not encourage a leadership mentality
- Does not invoke loyalty
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A properly designed key employee incentive/retention plan:
- Allows owners to hand-pick their plan participants
- Plans are subject to minimal IRS intervention
- Carry no minimum or maximum contribution mandates
- Encourage productivity and loyalty
- BEST of All – the plans should pay for themselves in the form of increased productivity
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For both the Company and the Key Employee, a well-designed Key Employee incentive/retention
plan is a
Key Employee Incentive/Retention Plans
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A well-designed plan must include four variables:
1. Substantial financial awards to Key Employees
2. Financial / performance benchmark attainment
3. Deferred benefit payout
4. Communication in writing
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1. Substantial Financial Reward
- The financial reward must be substantial in the eye of the Key Employee to positively impact and motivate behavior
- Substantial could be as much as one month’s salary and up to 25% (or higher) of the Key Employee’s base pay
- Remember – this is an incentive / retention plan NOT a seasonal bonus paid to all employees
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2. Financial / Performance Benchmark Attainment
- Identify at least one financial and/or performance benchmark that must be achieved in order to earn an award
- Benchmarks:- Easily identifiable
- Translate to an increase in bottom-line profit
- The Company’s obligation to fund the award only exists when the Company reaches its profitability targets
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Financial benchmarks:
Easier to identify than performance benchmarks which are usually subjective
Examples of financial benchmarks:• Percentage of profits above a certain threshold• Percentage of increase in net profit or profit
margins• Revenue growth if expenses are below a certain
percentage of gross sales• Percentage of savings from reduced expenses as a
percentage of sales
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Benchmarks may be achieved as a team or individually
Team benchmarks:• Departmental - percentage of growth or sales• Sales/estimating team – number or new or returning
customers• Project Managers – Percentage of profit per job
Individual benchmarks:• Percentage of sales to budget• Individual productivity reward
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3. Deferred Benefit Payout
- A portion of (if not all) of the annual reward must be deferred for future benefit payout – at least 50%
- This where the retention feature is achieved
- Absence of a benefit deferral is the most common mistake when designing a plan
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Deferred Benefit Payout
- The deferred benefit payout and/or years or required participation are determined solely by the owner
- Payout age and/or years of participation can be individualized or consistent among all participants
- Payout can be lump sum or over a period of years
- Vesting prior to payout, is also left to the owner’s discretion
- Stringent vesting = tighter retention attributes
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4. Communication
The plan must be communicated via a written plan summary for each chosen Key Employee
The Key Employee must understand:1. Motivation behind the offer2. Why they were selected to participant3. How the plan is going to operate4. What they might expect in projected benefits once
benchmarks are achieved.
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Types of Incentive / Retention plans
Key Employee Incentive/Retention Plans
CASH OR EQUITY-BASED
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Provides opportunity for stock ownership: One of most powerful motivators One of most powerful employee retention
strategies Stock ties the Key Employee to Company If the Plan requires the Key Employee to pay for the
stock then they are making a personal investment and commitment
Stock ownership provides a strong incentive for increasing company value
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Owners should realize before starting an equity-based plan that even the smallest of ownership carries with it significant rights: Right to access the company books and records Right to be informed about the financial
condition Right to be informed about salary and “perks” of
other stockholders Right to be consulted and even vote on major
corporate decisions
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
If decided that stock is the appropriate incentive for Key Employee, then the timing should be based on: Key employee has been with Company for a
sufficient time (several years) and is a proven commodity
Key employee would be more motivated by stock than cash
Owner is prepared to award the Key Employee a meaningful amount of stock
Willing to bring new stock owner into confidence
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Besides the timing when to award, must also consider: Voting or non-voting stock Amount of stock to be awarded Valuation formula to be used when award or re-
acquire Agreement to buy back stock if employee leaves Performance standard to be attained before Key
Employee has right to receive an award or purchase
If purchase, how will payments be made.
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Issuance of Stock:
Non-qualified stock bonus
Restricted stock bonus plan
Allow Key Employee to purchase
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Non-Qualified Stock Bonus: Key Employee receives
stock at no cost
FMV of stock is determined and taxable to Key Employee as ordinary income – W2 income
Company receives a deduction
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Restricted Stock Bonus Plan A stock bonus is awarded but Key Employee does
not take possession until: Vesting period Performance goal achieved
All basic rights of ownership at time of award Election to be taxed when awarded – 83(b).
Ordinary tax on value when received award Capital gains on any future increases in value
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Key Employee Incentive/Retention Plans
Equity- Based (Stock) Plans
Stock Purchase Cash bonus used to purchase stock
If stock purchased below fmv: The Key Employee is taxed on difference The Company will have offsetting deduction
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Cash based incentive plans are the most prevalent in small- to mid-sized, privately owned companies.
Key Employee Incentive/Retention Plans
Non-qualified deferred compensation plans
Stock Appreciation Rights (SAR) and Phantom Stock Plans
Supplemental Executive Retirement Plan (SERP)
Restricted Executive Bonus Arrangement
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Non-qualified deferred compensation plans If properly designed, this plan is often the simplest,
most effective, and single best method of motivating and retaining Key Employees
Promise to pay benefits in the future based on current or past services of a Key Employee
With the exception of withholding for FICA taxes, in certain situations the benefits awarded to a Key Employee under this plan are not taxable until the date on which such benefits are actually paid to the Key Employee
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Key Employee Incentive/Retention Plans
Non-qualified deferred compensation plans
Liability must be accrued and expense recorded for GAAP purposes in the year earned
Not tax deductible until amounts are paid
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Key Employee Incentive/Retention Plans
Important characteristics of Non-qualified deferred compensation plans
1. A Benefit Formula
Motivates the Key employee to increase the profitability of the Company
Unless the Company meets its profitability objective, the Key Employees can not meet theirs
Company obligation to fund only exists when the Company is profitable
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Key Employee Incentive/Retention Plans
Important characteristics of Non-qualified deferred compensation plans
2. Vesting schedule
“Handcuffs” the Key Employees to the Company for an extended time period, i.e. Retention
Consider a continual or “rolling” vesting schedule applied separately to each year’s contribution
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Key Employee Incentive/Retention Plans
Important characteristics of Non-qualified deferred compensation plans
3. Forfeiture provisions
Allows for the termination of a Key Employee’s vested rights in benefits
A Key Employee loses all deferred comp if he / she leaves the company and violates an agreement not to: compete, take trade secrets, or take vendors, customers, or company employees.
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Key Employee Incentive/Retention Plans
Important characteristics of Non-qualified deferred compensation plans
4. Payment schedules Determine when payments of vested
amounts commence and for how long after a Key Employee leaves
Multiple year payout assists the Key Employee as he/she is taxed on monies received
Multiple year payout assists the Company by deterring the Key Employee from using the deferred comp to compete
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Key Employee Incentive/Retention Plans
Important characteristics of Non-qualified deferred compensation plans
5. Funding devices Ensure the cash is available when needed However, tax restrictions exist which
prevent the Company from formally funding the plan
Proper investment should be guided by income tax considerations
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Key Employee Incentive/Retention Plans
Phantom Stock and Stock Appreciation Rights Plans
Key Employee receives something that: Looks like stock Grows in value like stock Can be turned in to cash just like stock
But is NOT stock
No actual ownership changes
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Key Employee Incentive/Retention Plans
Phantom Stock Plan
Phantom shares corresponding to shares of stock are allocated to the participating Key Employee’s account
As the value of the true stock increases (or decreases), so does the value of the phantom stock
When Key Employee terminates employment, the Company will “buy-back” the phantom stock at the per share value of the true stock
The amount paid is deductible to the Company
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Key Employee Incentive/Retention Plans
Stock Appreciation Rights Plan
Value of benefits is tied to the value of the Company’s stock
Only entitled to receive appreciation on a certain percentage of SAR units valued against the Company’s stock, not the entire principal amount
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Key Employee Incentive/Retention Plans
Supplemental Executive Retirement Plan
Agreement to provide supplemental retirement income to a Key Employee if certain pre-agreed eligibility and vesting conditions are met
100% Company funded with no option for salary deferral At retirement, the Key Employee receives supplemental
income paid out from the cash flow of the Company Company owned life insurance should be in place to cover a
premature death to provide a lump sum benefit to beneficiaries
Benefits are taxable to Key Employee when received and tax deductible when paid
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Key Employee Incentive/Retention Plans
Restricted Executive Bonus Arrangement
Company deposits annual bonuses into a cash-oriented life insurance policy for the benefit of the Key Employee and his/her dependents.
Key Employee owns the policy but has restricted access to the cash values until the terms of the plan have been met
Key Employee owns policy; thus, bonuses are considered taxable to in the year paid
Company receives an immediate tax deduction
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Key Employee Incentive/Retention PlansSUMMARY:
No matter what type of incentive plan you institute, it must meet the following criteria:
As Key employee attains goals, the Company value should increase
The plan “handcuffs” the Key Employee to the Company
Plan objectives are meaningful, realistic, and well-communicated
Benefits are substantial Guidelines on how to achieve the benefit are specific
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Key Employee Incentive/Retention Plans
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QUESTIONS
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Speakers
Please contact Joyce with any questions at:
816.945.5121 or [email protected]
Joyce Farris, CPA, CGMAShareholder, Mayer Hoffman McCannManaging Director, CBIZ MHM, LLC
CBIZ & MHM
Joyce, who has more than 30 years of accounting experience, serves as a CBIZ MHM, LLC Managing Director and Mayer Hoffman McCann P.C. Shareholder in the Kansas City office. Joyce is responsible for managing the entire client relationship as she coordinates the attest work with tax and consulting services. The majority of her clients are entrepreneurial-owned and privately-owned companies in the construction, real estate, and whole-sale distribution industries.
Joyce’s primary responsibility is to manage and direct the firm’s regional Construction Industry Services Group. From the day she started with the Firm, Joyce has been involved with clients in the construction industry from performing audits and preparing tax returns to consulting on mergers and acquisitions and transition planning. Joyce serves a variety of construction clients including general contractors, heavy/civil contractors, specialty contractors, engineering firms, landscape architectural/land planning firms, home builders and real-estate developers. Her clients have local, national, and international operations. During her career, Joyce took a leave from the Firm to pursue an opportunity as a CFO in private industry. This unique experience has provided Joyce with an in-depth knowledge of and respect for the issues affecting her clients and their respective COOs and CFOs.
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