Compensation is a vital part of human resource management, which helps in encouraging the employees and improving organizational effectiveness. The compensation methods offered to a company’s employees is essential not only because it costs money, but because it is likely to be the primary reason the employees work for the company
A company’s compensation methods also informs a great deal about the company’s/their values and culture. Employees often look at what a company pays rather than what it says. In many aspects, people behave as they are rewarded.
Traditional Compensation Methods:
Characterized by the following:
- Company with no profit.
- Vesting into profit or equity over time.
- An economic interest in the performance of the whole but business not just parts of it.
Stock Options: Companies can grant them to employees, contractors, consultants and investors. These options, which are contracts, give an employee the right to buy or exercise a set number of shares of the company stock at a pre-set price, also known as the grant price. This offer doesn’t last forever, though. You have a set amount of time to exercise your options before they expire. Team members can vest into equity ownership rights, or stock purchase rights, with performance or time served. Typically a total sum vested over a 4 year period, often with credit for past service, and vesting in some combination of time and performance.
Profit Interest Units: A profit interest represents an actual current ownership interest in the LLC. A profit interest, when structured to be in compliance with applicable Internal Revenue Service “safe harbors,” is tax free to the recipient. This can operate like Stock Options, but does not amount to ownership of stock or voting rights. It can be granted shares of profit or a preferential return, etc. It can also have an exit-event kicker to act like equity.
Non-Traditional Compensation Methods
Characterized by the following:
- Immediate participation in profit of a specific economic interest or event.
- A group of team members that can participate only while they work for the business.
- A potentially non-fixed dynamic economic interest.
- An economic interest that is not based in law/contract.
Profit Pools: Profit pools are a strategy model that can be used to help managers or companies focus on profits, rather than on revenue growth. This can create a present-day pool of profits that are intended to be shared with a fixed or dynamic group of people. You can customize participation rules, amount, and be specific, or general about the rules of how the decisions get made by participant.
Event-Based Profit: This works like a profit pool, only the rules only apply to a specific economic event or input. For example; This could apply to a new class of team members (or same team but different proportion) in, for example, a launch of a new class, offering, or tied to a specific service line (like a particular membership class, etc)
Commission/Revenue Sharing Pools: This is like revenue sharing or commission, only it operates as a pool to allocate to a group or team. This makes sense when top-line performance is more important than bottom line, or where the relationship between top and bottom line are fixed. Team would therefore not need to wait as long to determine what profit really is (more instant gratification) however, it does not train people to think/act like owners. This could also create more of a sales culture or cause team to value more direct contributions to the top line over total company values, priorities, etc.
The Bottom Line:
Clearly, managing a firm’s compensation policy is a complex task as it facilitates systematically administered and equitable salaries, reconciles employees’ career aspirations with respect to earnings, aligns employees’ personal objectives with those of the organization, and keeps the firm’s costs under control.
In general, the non-traditional tools are used to implement sharing now or soon, where the traditional tools are designed for team retention, incentives, long-term upside creation. There are always some trade-offs. It’s possible to use a form of both, but can get complicated to administer and create conflict later.
Exemplar Companies Can Help Startups Explore Compensation Options
Exemplar Companies small business and startup experts can help small business owners devise a compensation plan that works for their unique business. For more information, please contact our team today.
CEO, Exemplar Companies, Pbc.
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