Employers need good employee incentive plans so that the interests of their firms and companies are aligned with the needs and wants of their key people. That’s a reality supported not only by empirical studies but also by plain logic. And it’s true for both public and private concerns.

But at private companies, there’s less room for error when it comes to incentive plans. These businesses must not only compete with public companies for talent but often do so with fewer resources, including cash.

They are also having to assuage workers’ fears. Those seeking work at a private company sometimes worry about its long-term survival and fear they are taking on a greater risk by joining. Those concerns might be based more in perception than reality, but they can make a private company’s competition for talent more difficult.

Short-Term Incentive Plans
Employee incentive plans can generally be divided into short-term and long-term components. While public companies may be inclined to offer short-term incentives, focusing even on periods as brief as three months, a private company is more likely to think of entire fiscal years when structuring a short-term plan.

Regardless of the time horizons, short-term plans that are based on an employee’s objective, measurable performance targets are most effective and the least controversial to participants, management and shareholders. More subjective short-term plans are less likely to be effective, if only because employees are more apt to be focused on what can actually be measured.

An employee’s performance might be tied to the earnings, revenue or growth rates for the entire company or a particular business segment. It can even be tied to their achievement of milestones, such as when the company launches a new product or closes a major transaction. Or a short-term plan can be tied to individual performance metrics such as individual sales or customer ratings.

In some cases, a company may want its short-term plan to consider both an employee’s individual performance and the performance of a group. This approach, when deployed successfully, can mitigate concerns about individualism and foster greater teamwork while also promoting a culture of accountability.

Another common approach in structuring short-term plans is to create performance thresholds and targets. The threshold is the minimum level of performance required to be rewarded, while the target is the level of performance established as optimal by the entire company. For each component, the incentives increase as they exceed the threshold and approach the target, where they are sometimes capped. Some companies adopt a more entrepreneurial philosophy that avoids caps on performance-based compensation.

Short-term incentives are typically paid in cash, though, as we discuss later, they sometimes can be paid with equity. From a tax perspective, short-term plans are typically less helpful for participants, as cash awards are taxable upon receipt as ordinary compensation income. The company, on the other hand, can deduct the amounts paid, subject to various limitations. In some cases, a company can construct tax-deferral mechanisms for its short-term incentive plan participants, but these mechanisms create additional complexity and can even subject participants to the risk of losing their awards if the company runs into financial difficulties.

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