I recently worked with a mid-sized company to design a profit sharing and retention plan for a key employee. The project was a great example of how a well- intentioned owner can unwittingly not just miss the mark but create problems with a poorly designed plan.

The company has just under $10 million in revenue and the owners don’t plan on growing the business much beyond its current size. But they want to be a good employer and recognize the value of sharing profits with the employees.

The original retention plan for the key employee drafted by the owners was generous. The owners knew they were paying him well and TPO did a market study and confirmed that the key employee’s base salary was above his peers. While his peers were eligible for 34% of their base salary in a bonus, the key employee here would increase his profit sharing with the owners to a 50/50 split within three years. The owners hadn’t thought carefully about their reason for implementing the plan nor had they considered the return on their investment in the key employee. In fact, their plan didn’t appear to be sustainable in the event of a change in executive structure.

Here are a few questions that helped drive revisions to the plan:

How long do the owners intend to stay in the business and how do they plan on leaving it?

If the key employee were to leave, how easy or difficult would it be to replace him? (In this case, the strong opinion of the owner is that if the employee left, it would be moderately easy to replace him.)

Is the current organization structure likely to remain? (Will the company need to add a second executive in the near future? Will one of the owners relinquish a key role?)

Are there other uses for the company’s profits such as long-term assets or other items that ultimately maximize the company’s value?

What does the key employee want? (Does he or she want ownership? Is money a motivator? Remember, the best incentives are meaningful to the recipient.)

What is the basis for the amount of the profit sharing? (It seems generous to give an increasing part of the profits to someone that has no financial risk for the company)

Once the owners had a better idea of why they wanted in an incentive plan, we were able to redesign it to recognize the key employee’s contributions, demonstrate how valuable he is to the company, and retain him in the short run. But at the same time, the owners tied incentives to mutually agreed-upon objectives and retained access to profits for the company’s benefit. They also added a key statement for their protection reserving the right to amend, modify or terminate the plan at any time.