I routinely advocate incentives in nearly every type of business because I know what a powerful motivator they are. But there is one type of business where incentives are especially useful -- an ESOP company. If you are reading this, you probably already know what an ESOP is. But just in case you don't, an ESOP is a way for a business owner to use benefits in the tax code to sell her/his company to the employees. The owner can use pre-tax money to fund the sale, and the employees can use pre-tax money to fund their own retirement.
Once an ESOP has been completed and the employees own the business, their ability to fund their future retirement is largely determined by their ability to increase the value of the business over time. Without this, there are no savings and therefore no payouts.
ESOP companies are required by law to conduct annual valuations and these valuations are performed by accredited valuation professionals. This valuation is used to determine the share price and this share price is multiplied by each employee's total number of shares to determine the amount of their retirement payout.
Because there is so much riding on the valuation, everyone in an ESOP company needs to be focused on increasing it. This provides an ideal environment for incentives. And company valuation is an ideal incentive plan measure because it is quantifiable, reliable, and objective. So why don't more companies use it? Because formal valuations can be time consuming and expensive to produce. But since an ESOP company is already paying for it, valuation makes an ideal measure to include on incentive plans. And when you add it to other specific measures designed to encourage individuals to find ways to increase this value, you have a very powerful motivational tool.
Incorporating company valuation into an incentive plan is simple -- you merely estimate the desired year-over-year increase and add it to the prior year's valuation to create the target for the new year. It might look something like this -- 2008 Valuation plus $1 million.
This measure is suitable for any employee in an ESOP company, but it should be weighted most highly for executives (i.e., 40 to 60%). It is also useful for lower-level employees, but since they have little influence over the final valuation, it should not be highly weighted (i.e., 10%).
If you manage an ESOP business, you should seriously consider an incentive plan for every one of your employees. Well designed incentives can really help keep everyone focused on increasing the value of the business.