Having outlined some of the most common incentive plan mistakes that privately-held companies make, let’s look at what works well.
Different owners have different objectives for their business and for the incentive plans that they offer to their managers. But in my 18 years advising in this area, some common themes have arisen:
- Owners want an incentive plan that will encourage managers to do the things that grow the long term value of the business. This means sometimes making decisions that will lower near term financial performance for the sake of the business’ long term value. It also means putting safety and regulatory compliance above short term financial factors.
- They want to share a fair portion of the success of the business with managers but they also want managers to have some real ‘skin in the game’ on the downside.
- They want to encourage a collaborative culture, as much between owners and managers as within the ranks of management.
- They want to encourage managers to reach for the stars and share the owner’s ambitions for the business.
In short they want an incentive plan to make their managers think and act like good owners without the complexity of actually selling them a piece of the business.
An incentive plan to achieve that aim might look like this.
- Just like an owner, the majority of the financial rewards would come from building the business – achieving sustained, multi-year improvements in profitability.
- Just like an owner, every dollar of profit would be worth the same to managers, as if they owned a flat 10% of the business.
- Just like an owner, actual results would be paramount, with the budget playing no part in determining the size of rewards.
- Just like an owner, some portion of rewards would be enjoyed annually but the majority would be deferred and subject to loss if performance was not sustained.
- Just like an owner, rewards on offer would be meaningful.
In the next five articles we’ll explore how each of these aspects can be built into a powerful and effective incentive plan for a privately held business, before looking at a case study of its application.