By Maurie Cashman
Golden handcuffs are one of four characteristics of an Employee Incentive Plan. Such plans should:
- Be specific, not arbitrary, and in writing;
- Be tied to performance standards and pay for themselves;
- Pay substantial bonuses; and
- Handcuff the key employee to the business.
This week, we focus on handcuffing key employees to the business. The goal of the handcuff is to keep the employee with the company after the bonus is awarded. To help accomplish this, we can incorporate several techniques into a stock purchase or non-qualified deferred compensation plan. There are several different ways to structure employee incentive plans. Some are done with stock options, which create a specific benefit and can have unintended consequences. Today weâ€™ll focus on a cash bonus plan that may be better suited to most non-public companies.
A vesting schedule handcuffs key employees to the company for a time period necessary to become entitled to the bonus awarded. A continual or rolling vesting schedule in which a single vesting schedule is applied separately to each year’s contribution is an excellent technique to consider. Using a vesting schedule, an employee is handcuffed to the company for a long period of time because the key employee is never fully vested in the most recent contribution.
Let’s assume that a $40,000 award is assigned to a key employee: ten thousand of which is given immediately and the other thirty thousand subject to a five-year vesting schedule. If the award is earned in 2015, the effect of vesting in the non-distributed funds is demonstrated in the following graph:
As you can see, only in the year 2020 is the employee fully vested in the award earned in 2015. Should the employee leave the company prior to that time, he/she is only entitled to a percentage of the total award amount. Your key employees are thus “handcuffed” to your business because they receive the full award only by staying with your business.
The longer they stay, the more they receive.
- Each year they stay, a new award is made;
- Each year, additional vesting is attributed to the prior four or five years’ deferred account; and
- Each year the entire deferred amount may grow in value if interest is credited to the deferred accounts.
Vesting handcuffs key people – financially – to your business.
Payment Schedules and Forfeiture Provisions
Owners use payment schedules to determine when payments of vested amounts begin and how long they are continued after an employee leaves.
A forfeiture provision can be used to reclaim some or all of an employee’s vested benefits if he leaves your business and violates his employment agreement. This is an incentive for your employee to honor a covenant not to compete or trade secret provision contained in his employment agreement.
Combining payment schedules with forfeiture considerations can deter recently departed employees from using funds from the deferred compensation plan to compete with the former employer.
Money to pay the deferred bonus must be available when needed for handcuffing your key employees to your company to be effective. Your key employees must be confident that funding is in place to pay the deferred award. The type of funding vehicle can influence the timing and amount of income taxes at the company level.
Consider making these handcuffing techniques a part of the design of your employee incentive plan. Remember, a successful bonus plan for your employees ultimately helps you to create your ownership transition plan.