HOW TO PLAN FOR BUSINESS OWNERSHIP AND COMPENSATION (PART 3)
Alternatives to Equity Incentives
There are other ways to compensate key managers that do not require the founder to give up equity in the company. The following are a few of these alternatives .In choosing among them, consider the advice of an accountant, who can recommend the most appropriate structure for the business.
Deferred Compensation Plan
In a deferred compensation plan, the entrepreneur can specify that the awards and bonuses be linked to profits and performance of both the individual and the company, with the lion’s share depending on the individual’s performance. The employee does not pay taxes on this award until it is actually paid out at some specified date.
With a bonus plan, a series of goals are set by the company with input from the employee, and as the employee reaches each goal, the bonus is given. This method is often used with sales personnel and others who have a direct impact on the profitability of the company. The key to success with bonus plan is to specify measurable objectives.
Capital Appreciation Rights
Capital appreciation rights give employees the right to participate in the profits of the company at a specified percentage, even though they are not full shareholders with voting rights. Capital appreciation rights, or “phantom stock,” provide long-term compensation incentives whose value is based on the increase in the value of the business. The phantom stock will look, act, and reward like real stock, but it will have no voting rights and will limit the employee’s obligations should the business fail.
Typically, the employee has to be with the company for a period of three to five years to be considered vested in capital appreciation rights, but otherwise employees do not have to pay for these rights.
Profit-sharing plans are quite distinct from other compensation plans. These plans must include all employees, without regard to individual contribution to profit or performance. They are different from pensions in that owners are not required to contribute in any year and employees are not “entitled” to them.
Organizing business processes, location, and people is an important and difficult task that requires thought and planning. Decisions made in the earliest stages of a new venture can seriously – and often negatively – affect the new firm’s ability to grow and be successful in the future.