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The people that work with you can be compensated in two very different methods. The first method is when employees are paid to exist through hourly or salary payments. The second method of employee compensation is when payment is based on performance. This is known as incentive compensation. It is paid as commissions, profit sharing or bonus incentive pay. Setting up a bonus system has been discussed in previous newsletters. Now we’d like to talk about why deferring a portion of incentive pay creates “golden handcuffs” and can have a very positive effect on retaining the key people in your company.
A key executive working for a major corporation and who is a senior employee will often be granted stock options. These stock options typically have a vesting period before they can be exercised. My belief is the main reason for the vesting period is to make it very expensive for a competitor to hire the executive away from the company they are presently working for.
A vesting schedule might include being granted options on a yearly basis. The options that are granted can’t be exercised for a five year period. If the executive leaves for any reason, the options are not exercisable and the executive would leave a significant amount of money on the table. The effect of this is that a competing company needs to make the executive whole before the executive will leave their present employer.
A deferred bonus program for key managers could have the same effect. If you were to take fifty percent of managers’ bonus and defer it, you have put together a type of “golden handcuffs” for your key people. If a manager earns a $10,000 bonus, you could pay half in cash and half as a deferred bonus if they are still with you five years later.
Using our example above, a manager might earn a $10,000 bonus per year for five years. By deferring half of the bonus, after a five year period, they would have $25,000 at risk. If they were to leave your company and take another job, they would also forfeit the $25,000 in accrued bonuses as they left.
The “golden handcuffs” won’t always guarantee that you keep all your key people. What it will do is force your managers to think twice before they leave. It’s not very likely that their new employer would pay them a $25,000 bonus to join their company.
Remember, managers must still be paid well and their salaries must be competitive. If you’re underpaying your managers by $10,000, then losing $25,000 isn’t very hard to take. On the other hand, if you’re paying your managers market salary for their base and they can earn above market salaries through a performance bonus, it’s not likely you will lose a key person because of compensation issues.
We would be glad to have a conversation with you about your compensation strategies. We have several methods of helping you defer income for your key people in ways they would appreciate.
If you would like more information on the ideas above please give us a call. If you would like more information on our firm, please visit us online or e-mail us and a Stage 2 associate will get back to you.
With Warm Regards,
Stage 2 Planning Partners
Josh Patrick © 2006
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