The reward consideration isn’t about a number per se. Rather, it is a decision regarding whether the plan will offer a capped, percent-of-salary award or an uncapped, percent-of-profits award—an option that is unique to private companies. This requires that owners consider their financial obligations as the company steward and their own progress on the path to financial independence (as b-school professor Noam Wasserman put it, the choice to be “rich” or to be “king”). 8
If you haven’t achieved financial independence, you may not be ready to uncap cash rewards. But if you can uncap awards, you can also unleash employee energy—and that can generate a larger payoff for you, the company, and key employees in the long haul.
Too often, the leaders of private companies rely on “muscle memory” when it comes to determining the proper platform for LT Cash awards. As a result, they jump too quickly to accept an often flawed hypothesis that a cascaded bonus or a nonqualified deferred compensation platform, for example, is best for their company.
Instead, Boards and leaders should work through the first four design imperatives of purpose, eligibility, metrics, and sizing. Only then, with the insights and parameters of the previous imperatives in mind, should they turn to the task of choosing the best platform for their LT Cash plans.
Each of the platforms has its own characteristics and works best in certain situations (as follows). And each can and should be customized for your company.
Qualified Plans or qualified profit-sharing plans (QPS) offer advantaged tax treatment to both company and talent—qualified plans are tax deductible upon contribution and tax deferred after separation. These plans can be subject to vesting parameters. However, the size of the annual contribution is generally limited to $58,000 (2021). Thus, they are often adopted as one of the elements of the long-term incentive plans (LTIPs) of high growth companies.
Nonqualified Deferred Compensation (NQDC) is a good fit when there will be a combination of company and individual contributions. This platform supports materially flexible performance pay because the contribution size is practically unlimited, but it is also subject to claims of creditors. Companies with clearly delineated management groups often adopt this platform.
Split Dollar life insurance platforms reward loyalty with steady and stable annual contributions in a relatively flexible structure. They can run for long periods of 10-15+ years and work best for executive teams in their 30s, 40s and early 50s. They are often adopted by family-owned companies who want to retain non-family executives.
162 Bonuses enhance the retirement prospects of executives by allowing them to contribute company bonuses and their own money, having a long-term tax advantage that is potentially significant. They work best when there is a large enough group to qualify for simplified underwriting (typically 10+ execs) and when the executives are mid-50s or younger. They are usually adopted in companies whose owners value simplicity and flexibility.
Cascaded Bonuses offer high levels of visibility and easy administration with their company deferral followed by a “vest & pay” regime. This platform is typically governed by an informal policy document versus a formal plan, and there is no limitation on the number of plan participants. It also offers material flexibility in the size of awards. Often, companies heading towards longer term change in control or having a perpetual partnership structure adopt this model, with participants using their mid-term cascaded bonuses to buy into the company.