One of the challenges a business association faces in the early stages of its creation and development is how to attract and retain high-potential employees, known as “key people,” in today’s strikingly competitive labor market. This is particularly difficult for those recently-launched endeavors on a tight budget.
Moreover, since start-ups operate in a highly-specialized market in which the quick pace of technology development can render certain projects unfeasible almost overnight, there is a high turnover of personnel in these companies.
In this scenario, compensation tools that tie employees’ pay to the business’ success (or lack thereof) have become a vital part of the start-up design, either by making employees invested in achieving the company’s top objectives or by linking compensation to successful expansion of the business model, allowing new investors to come in.
This is a new solution to the old agency problem, aligning the interests of business managers with those of shareholders.
Among the different employee compensation schemes out there, medium- and long-term incentive systems are an optimal instrument for: (i) tying performance of certain employees to the company’s medium-term success, measured in terms of long-term value creation, and (ii) ensuring that both employees and founding shareholders have a shared goal, aligning all of their interests.
The following systems are most often used by start-ups:
Incentives tied to a company’s stock market gains are generally the most appropriate for newly-created companies and those striving for exponential growth over the short and mid-horizon.
Along with the ever-popular employee stock option plan, we frequently see models under which employees become invested in increasing a company’s value but founding shareholders’ stakes are not diluted. This is the case with stock appreciation rights, where gains are paid out in cash.
Alternatively, employees can actually become shareholders of the start-up, holding a direct stake in the company’s capital in the same conditions as the founding shareholders. These co-investment schemes, which are commonly seen in certain growing businesses requiring shareholder investment, nevertheless raise a set of legal and tax issues that must be carefully analyzed for each particular situation. Informed application will allow employees to gain from the company’s business success but will not hamper the founding shareholders’ ability to manage the enterprise.
Other compensation tools that can be equally beneficial for employees and companies include salary sacrifice models, where employees give up part of their salary and, in return, employers give them non-cash benefits adapted to their personal needs, or the simple application of allowable tax exemptions in certain situations, such as work abroad.
No matter what tool is used, companies are challenged to design the most appropriate compensation systems for their business. A successful outcome will depend on the characteristics of the business carried out and on the interests and needs of the founding shareholders.