The key to successful management incentive plans is they must be easily understood, drive desired behavior and be reasonable and obtainable with stretch targets. Typically, companies with an exit strategy will want to reward the management teams to increase Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) as the ultimate transaction valuation is usually based on a multiple of EBITDA. Therefore, the following is an example of a management incentive plan that has been implemented successfully with portfolio companies of Private Equity firms to reward management by increasing both EBITDA and Revenue.
The Plan Outline:
CEO Incentive Compensation Plan (the “Annual Plan” or “Plan”)
Eligibility to participate in the Plan shall be limited the President and CEO with final approval of the Board of Directors. Any participant that is hired or selected to participate after the start of the calendar year shall participate on a pro-rata basis. This is determined by multiplying the maximum bonus opportunity by a fraction, the numerator of which shall be the number of weeks of his/her participation in the Plan Year and the denominator of which shall be 52.
Target Incentive Opportunity:
Participants in this Plan will be eligible for an annual incentive opportunity (the “Target Bonus”) that will be the amount earned for meeting the Plan's annual performance measurements. The Target Bonus will be expressed as a percentage of annual base salary as in effect as of the first day of the Plan Year. The Target Bonus will be determined and communicated annually.
20XX Plan Year Target Bonus: _____% of base salary as of __DATE___________.
Awards from the plan are financially driven. Each participant's Target Bonus is based on specific company financial goal(s) established during the annual operating plan approval process and approved by the Board of Directors. The actual incentive or bonus earned (“Bonus Award” or “Award”) is determined by performance against these established financial goals.
For the 20XX Plan Year, the principal financial goal is attainment of the annual EBITDA budget (weighted 70%) and the second financial goal is attainment of the annual Revenue budget (weighted 30%). The minimum threshold of performance (the percent attainment below which no incentive bonus is earned) is 80% of the annual budget.
Calculation and Payment of Earned Incentive Award
The Bonus Award is determined and paid annually based on the performance against the financial goals. For 20XX, the Award is earned when the performance against the revenue sales goal and the EBITDA goal is 80% or greater. The table below includes the 2008 annual sales and annual EBITDA targets and the percentage of base salary earned for each level of performance against target at 80% of target or above, in 5% increments. The Bonus Award represents the percent of base salary earned for performance against each financial goal at each level of performance. For example at 100% achievement of the Sales revenue and EBITDA targets, 100% of the Target Bonus (as a percent of base salary) is earned.
* For achievement between the 5% increments, the Award will be pro-rated. For example, if the %age of budget achieved for both factors is 92.5%, the Award will be 22.5% of base salary.
The Bonus Award is determined and paid after the end of the fiscal year following the release of the audited financials, no more than 45 days after the end of the Plan Year. Awards will be subject to all applicable withholdings and deductions.
Employees on Leave of Absence
Bonus Awards for employees on approved leave will be prorated to exclude the time away from work. A description of approved leaves of absence is available from human resources.
Termination, Death or Disability
Bonus Awards will be paid to participants who are actually employed and on the payroll on the last day of the Plan Year. A participant whose employment terminates prior to the end of the plan year shall forfeit any and all rights to a bonus from the Annual Plan except for approved special circumstances. Specifically those participants who terminate employment due to death, disability, normal retirement, or who are displaced as a result of a reduction in force or position elimination will be paid a pro rata portion of any incentive bonus earned based on the amount of time worked during the Plan Year (through the date of termination). Such prorated payments will be made at the time and in the form received by all Participants.
Other Plan Design Considerations
The Annual Plan will be managed by the Chief Financial Officer and Human Resources Manager and administered by the Board of Directors. All reported financial results will be confirmed by the Chief Financial Officer upon completion of the annual report of independent accountants. Bonus Awards will be approved by the Board of Directors. Communication of all awards will be provided only upon written confirmation of all required approvals.
No participant shall have the right to anticipate, alienate, sell, transfer, assign, pledge or encumber his or her right to receive any Award made under the Annual Plan. No participant shall have any lien on any assets of the Company by reason of any Award made under the Plan
The adoption of the Plan or any modification or amendment hereof does not imply any commitment to continue or adopt the same plan, or any modification thereof, or any other plan for incentive compensation for any succeeding year, provided that no such modification or amendment shall adversely affect rights to receive any amount to which any Participant has become entitled prior to such modifications and amendments. The Company specifically reserves the right to amend, modify, or terminate the Plan at any time for any reason. Neither the Annual Plan nor any Award made under the Plan shall create any employment contract or imply any relationship between the Company and the participant, other than employment terminable by either party at will.
No one may participate in the Plan or have any components of it changed after initial notification of participation, without the expressed written notice of approval by the Board of Directors as appropriate. Every participant and proposed additional participant are reviewed for eligibility on an annual basis. No one participating in another incentive plan may participate concurrently in the Annual Plan, except where approved in writing by the Board of Directors. Eligible participants must have a “successful” performance rating throughout the year to be eligible for payment of an award regardless of the Company's performance against the financial measures.
The Board of Directors reserve the right to increase, decrease or eliminate any and all Annual Plan awards, at the sole and complete discretion.
The management incentive plans are critical to drive behavior and should be developed with Human Resources, the Senior Management Team and the Private Equity Ownership. If the plan is conceive properly and implemented so the entire team is aware of the goals and objectives, then they will modify their behavior to attain the financial goals for personal gain, while increasing overall enterprise value.