The new paradigm in key employee retention plans

The pandemic provided business owners with a unique opportunity for strategic contemplation, allowing them to consider how to emerge stronger and how to prepare the company for their ultimate departure. 

Both scenarios require a focus on operational efficiencies, value enhancement and the training and recruitment of key talent. The last is particularly crucial, as key talent plays a vital role in driving improvements, efficiencies and growth initiatives. 

Given the critical role of key talent, owners must carefully consider how to best compensate them. Salary, bonuses and benefits are obviously important. They must be competitive. More than that, key talent’s compensation package must be compelling and elicit an owner “mentality” to achieve desired results. 

No longer paid for a job title, key talent is often looking to participate financially in results achieved. As such, owners looking to retain, motivate and recruit key talent need to focus on innovative long-term incentive plans (LTPL). 

A new paradigm

The new approach to long-term incentive plan design requires a shift in perspective and focus. 

1. Focus on value-creation
      Instead of hiring key talent to fill a position, they are now being recruited to perform a role, such as an “integrator.” As such, they are not being paid for their behavior (time spent, duties fulfilled, actions accomplished), rather they are being paid for achieving a desired result—for producing a targeted outcome. This has led to a shift away from the idea of “incentivizing” toward a philosophy of “value-sharing.”
       Value-sharing is directly linked to value creation. Once key performers understand how value creation is defined for the business and what their role is in creating and sustaining it, they understand how reward is earned. And the more they help create, the more they share in what they produce. They become “growth-partners.”
       They develop a sense of stewardship about protecting shareholder interests and apply an ownership mindset towards decision making. A mindset shift that creates a unified financial vision for growing the company. Thereby negating the familiar “entitlement” mentality that often accompanies il-designed incentive plans.
2. Simplicity is a must
      The incentive plan must be easy to understand first and foremost. For long-term plans, which are paid based on annual performance, rewards should be primarily tied to profit. This is the measurement that not only aligns everyone’s efforts toward the only variable that fuels growth, but also has a direct link to enterprise value.
      There are nine different incentive plan types that owners can employ to reward long-term value creation. Three of them are ways to share equity, three are different types of phantom stock plans and three are reward approaches that are tied to other financial measures (which impact business value).
      Many organizations need help determining which type of plan is suitable for their companies. This is the role of an independent consultant hired to direct the process and see it through implementation. And to keep plan construction simple. 
3. Meaningful and deferred payout
      Incentive awards must be meaningful and compelling. When it comes to value-sharing opportunities, owners need to adjust their thinking if they expect to attract/retain great talent and treat them like partners.
      Today’s marketplace indicates that incentive award potential must reach at least 25 percent of a key performers’ salary, with 50 percent-plus being commonplace, after a fair return on shareholders capital. Less than these thresholds are more consistent with discretionary or periodic cash bonuses, which eludes the “growth partner” mentality necessary to influence behavior and/or recruit key performers.
      Mentality where owner and key performers are working in sync toward a shared financial vision. And as partners, apply an ownership mindset toward all their decision-making.
      Ideally, your key performers compensation package is made up of both short-term and long-term incentive-based pay. Both are tied to the attainment of predetermined financial benchmarks that reflect metrics an owner wants to focus on. Those benchmarks may even be identical, with a portion of the annual award paid in cash (short-term) and the balance (a majority in this author’s opinion) at some point in the future, determined by the owner.
      Time for a reality check. If given the choice, most key performers would prefer cash to a future promise of compensation. Here is where an owner must share a compelling vision for the company’s future. As a retention tool, long-term incentive plans looking out four-plus years  are critical. This element often overlooked. 
4. Communication
      As important as previous design elements are, this one is even more so. How an owner communicates both the purpose of their incentive plan as well as the mechanics cannot be underestimated. If plan benchmarks and performance expectations are not clear or believable, the plan will fail. All the modeling in the world will not make any difference if key performers do not believe the results can be achieved, including their financial participation in that journey. 

Final thoughts

As owners (and their advisory teams) contemplate the challenges and opportunities in today’s quest for key talent, they are reevaluating business strategy and their own value proposition. Owners are recognizing the importance of shifting operational responsibility away from themselves to increase enterprise value in order to increase the likelihood of a successful ownership transition. At the same time, they are being cognizant of the need for prudent cost-containment measures that do not hinder their ability to move forward with confidence. 

Long-term incentive plans, rooted in value-creation, offer a “self- financed” solution. They benefit shareholders by creating a unified financial vision, reinforce roles, outcomes, strategic priorities and ultimately value creation. They benefit key performers by putting them in control of their earnings while simultaneously sharing in the value that they help create. 

During a time when competition for top talent is at a zenith, creative pay structure must not only be compelling, it must be irresistible. Therefore, shifting from traditional incentives to value-sharing models is not only logical but also strategically imperative in the current competitive landscape.