Written by: Elizabeth J Mower
When we talk about Exit Planning, a term that we often use is key employee. We say that key employees are critical to a successful exit, owners must do everything they can to retain them, and that key employees can either facilitate or destroy an owner’s Exit Plan, depending on how owners approach them. The importance of a key employee naturally raises the question: “What is a key employee, and how do I know how to find one?”
This article will define what a key employee is, explain how business owners and advisors can identify them, and provides ideas for how owners can best retain them.
What Is a Key Employee?
The meaning of key employee might seem subjective, but it isn’t. A key employee is an employee who tangibly contributes to the success of the business above and beyond expectations. Key employees not only do their jobs well but also do jobs beyond their purview exceptionally well. For example, a sales rep who always meets his goals and occasionally exceeds them is a good employee but not a key employee. A sales rep who always exceeds her goals, creates a sales script that improves the performance of other reps by 20%, and is the primary driver of company referrals is likely a key employee.
How Can I Identify Key Employees?
Key employees have the following three qualities:
- Key employees directly, significantly, and positively contribute to the company’s value. They exceed expectations in fulfilling their responsibilities and making important decisions, which improves sales, profitability, product development, and other critical business drivers.
- Key employees participate in the company’s strategic future meaningfully. They have a vision for the company’s future that is evident in the ideas they provide and the creativity they use to solve problems.
- The loss of key employees damages the business’s performance in the short and long term and can lead to the loss of clients, vendors, and cash flow.
The most common error that business owners make when identifying key employees is mistaking employees they like for key employees. Exit Planning Advisors report that business owners tend to include office managers, bookkeeping personal, and CFOs on their lists of key employees. However, for the purposes of Exit Planning, these types of employees are rarely considered key.
Because business owners often equate likeability and loyalty to being key, it’s a good idea for them to obtain objective help in identifying key employees. Exit Planning Advisors have the resources to identity key employees and often work with business consultants to allay any doubts. Once owners and advisors have identified key employees, they can work to retain them throughout the Exit Planning Process.
How Can I Retain Key Employees?
Key employees are crucial to the company’s outstanding daily operations and, vicariously, the owner’s successful business exit. Without strong, experienced management in place, no one will want or be able to run the business after the owner leaves. Thus, many successfully exiting owners implement employee incentive plans to ensure a successful exit. We have identified four characteristics common to successful incentive plans:
- They are tied to performance standards.
- They are clear, consistent, specific, and in writing.
- They create substantial bonuses.
- They handcuff key employees to the business.
Let’s look at each of these characteristics in detail to show how owners can implement them.
Performance standards are the most important aspect of properly designed key-employee incentive plans. Performance standards vary among employees. Thus, owners must work with their advisors to create effective and achievable goals that will compensate key employees’ exemplary performances sufficiently while, more importantly, increasing the value of the business.
When establishing performance standards, owners must assure that the incentives motivate employees to adjust their behavior to increase business value. They must encourage key employees to act a certain way without harming product/service quality or employee output. For example, owners cannot use money reserved to ensure quality to pay performance-standards-based bonuses. The goal of establishing performance standards is to build the business’ value, which converts into cash upon the owner’s exit. Thus, owners must pay careful attention to the performance standards’ designs and consequences.
The types of performance criteria owners can use are boundless. Additionally, there are countless formulas that owners can use for equity- or cash-based incentive plans. Because of the importance of performance standards in establishing incentives for key employees, owners should consult with an Exit Planning Advisor, who can begin determining the best kinds of incentive plans to install.
Clear, Consistent, Specific Communication
Arbitrary incentive plans are frustrating to key employees. Key employees know their importance and are diligent in their work. Thus, they expect the same sense of importance and diligence in their incentive plans. Creating an incentive plan that is clear, consistent, specific, and in writing will ensure key employees’ success and allow them to reach their incentive goals, which leads to greater business value. Owners should present the plan to key employees during a face-to-face meeting and include their Exit Planning Advisor and Advisor Team to answer any questions the key employees might have.
Bonus structures must encourage key employees to meet the clearly stated incentive plan’s standards: An inadequate bonus can discourage key employees, damaging everyday business processes in the short term and the owner’s Exit Plan in the long term. Today, the minimum standard for potential incentives (whether in cash or stock options) rests between 25% and 30% of a key employee’s annual compensation. Anything less might not motivate the key employee to increase the company’s value. However, because this bonus potential is substantial, potential incentives are paid only when the key employee reaches set goals, thus increasing the business’ value and the key employee’s performance.
Handcuffing means motivating key employees to stay with the business to achieve the substantial bonuses offered by meeting the incentive plan’s goals. One effective method of handcuffing involves awarding bonuses on a vesting schedule. For instance, an owner might agree to pay half of the key employees’ bonuses as they achieve it—allowing key employees to enjoy the fruits of their labor—while deferring the other half to a vesting schedule, which causes key employees to forfeit the other half of their bonus if they leave the company before they are vested. Exit Planning Advisors have the tools and strategiesto find quality advisors to create tailor-made handcuffing strategies for owners’ key employees.
In short, losing a key employee will result in financial losses for the business, thus delaying an owner’s exit. Fortunately, key employees are usually aware of their importance and only need owners to create an incentive plan to compensate them adequately for their performance. Finding and retaining key employees can seem overwhelming, but knowing how is half the battle. Exit Planning Advisors can help owners convert this knowledge into action and ensure a smooth business exit, regardless of when it might occur.
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