One of the biggest challenges that a business owner may face is attracting and retaining top talent to help drive value and build their company. There are a variety of employee incentive compensation tools that can be used to attract and retain talent. Business owners need to consider: Which type of employee incentive tools will work best for that particular business owner’s company?

To answer that question, a business owner needs to drill down on what goal is to be achieved or which problem needs to be solved. And, regardless of the goal or problem, there are a few macro-level guiding principles that need to be considered:

1. Strike a proper balance between “carrots” (rewards to the employee) and “sticks” (provisions to protect the company’s downside if the employee fails to deliver value);
2. There is no one-size-fits-all solution but, instead, the more effective incentive compensation strategies provide short-, mid-, and long-term value and payout opportunities; and
3. When properly crafted, incentive compensation strategies allow small- and medium-sized business to compete for talent with ‘value’ when they cannot compete straight up on cash compensation.

Take, for example, the following scenario:

• The owner of a Woman-Owned Small Business (“WOSB”) government contracting firm has successfully built her company to $15 million in revenue;
• Her business is too concentrated within two agencies, has contracts within each agency; and the WOSB owner wants to expand or diversify client base and/or contracts and grow the company to $30 million in revenue and then think about an exit event ($30 million is the revenue level at which small businesses typically start to become an attractive target for purchase by the mid- to large size government contracting firms);
• The WOSB owner would like to bring on a strong second-in-command with C-suite experience and strong business development skills;
• The WOSB owner must be the most highly-compensated person; and
• The second-in-command that the WOSB owner has identified is paid an annual salary of $250,000 at his current employer and in departing would leave a $30,000 year-end bonus on the table, and the WOSB owner cannot afford to offer a $250,000 annual salary.

So, what type of employee incentive compensation tools could the WOSB owner use to put together a competitive compensation package? The company could put together an incentive compensation strategy as follows:

• A solid base salary (set below the WOSB owner) at $215,000;
• An opportunity for an annual bonus in an amount up to 30% of employee’s base salary, provided certain financial and non-financial performance targets are achieved;
  • Note: the annual salary and bonus=short-term value.
• A supplemental executive retirement plan that would operatively be a 401(k)-like shadow account, into which:
  • The company would make an immediate $30,000 contribution to compensate the employee for money that he or she has to leave on the table at their prior employer, to which the employee would vest over time; and
  • The company, based on its profitability, would need to, on an annual basis, contribute an amount equal to x% of the company’s profits, to which the employee would vest over time.
  • Note: there are certain tax considerations that the company would need to consider, which go beyond the scope of this article, to retain a title to this asset (so, not compensation to employee, but no deduction to company for paying it until actually received by employee).
  • Note: the supplemental executive retirement plan = mid-term value.
• A Stock Appreciation Rights (“SARs”) award to motivate and reward the employee to help build the company to the $30 million revenue level and participate, financially, in the success of such revenue building upon a sale of the company event.  This, however, does not allow the employee to participate in the pre-existing $15 million in revenue and value.
  • Note: this SARs = long-term value.

In sum, a business owner can strategically use incentive compensation tools to compete for top talent with value when cash in the moment is not an option.