Ladder to equity explains why cash bonuses and discretionary bonuses don’t always work well and can create negative behaviour.
Profit share plans can work, and the only (main) criticism is that they focus on short-term behaviour and performance over one quarter or one year.
Using a profit share style program to fund (or help fund) an equity plan may be the best solution for many businesses.
When we design the equity plan mechanisms, we need to create a system that combines funding and allocation models that encourage the behaviour we need to promote to build long-term equity value in the business.
Funds to acquire shares (6 methods):
- Tax-exempt (gifting) to each employee – limit of $1,000 per person per annum.
- Salary sacrificing (pre-tax dollars deducted from employee salary to buy shares) – limit of $5,000 per person per annum.
- Buy shares at market value (or less than a 15% discount).
- Borrow to buy shares ( typically in professional services firms through lenders like Macquarie Bank).
- Profit share plan – a percentage of profits above a benchmark (target) profit level is contributed to the plan on behalf of employees.
- Company contribution to the share plan based on a KPI, bonus scheme or discretionary basis.
Allocation of shares once acquired:
Methods 1, 2, 3 and 4 are simple to allocate as they are funded by or for the employee, and the dollar amount can only be used to acquire shares.
Methods 5 & 6 require a method to allocate the dollar amount received amongst the invited employees. The most common method is to apply a simple formula to calculate the % of the total each employee is entitled to – so, for example:
Salary * performance score.
Salary * years of service.
Team-based performance score * individual performance score.
Sales $ above annual sales target * net promoter score.
Value of client book managed * peer review score.
Example using salary & performance score with 3 employees:
John Smith – salary of $100,000 and performance score of 90% = 90,000 – equal to 34%
Fred Jones – salary of $150,000 and performance score of 70% = 105,000 – equal to 40%
Irene Chen – salary of $70,000 and performance score of 98% =68,600 – equal to 26%
Total – 263,600
These (and any other) KPIs can be combined, and other formulas constructed/combined – focusing on behavioural change. The only caution is to keep the overall model fairly simple and easy to understand (by employees).
Feel free to reach out via info@successionplus.com.au if you want to know more about this topic.
