How a preferred compensation plan can give employees a stake

Question

I recall reading a column you wrote a few years ago about putting a structure in place so that younger employees can buy shares in a company. I foolishly did not cut it out, so forgive me for asking a similar question again.

I’m getting to the stage where I want to become less involved in my company. I want to enable a few trusted employees to get a share in my business. My thinking is that, if the business is well run, I will receive a sustainable income from the business when I retire. My employees will become shareholders and have a vested interest in making the business succeed over the long term. How do I go about doing this?

Answer

The structure you are talking about is called a preferred compensation plan. It is a contract between the company and employees that is linked to an investment plan.

The way it works is that you identify a key employee (or employees) who you would like to retain and become a shareholder.

You draw up an agreement with the employee in which you agree to increase their salary by an agreed amount. This would be invested for a period. At the end of the period, if certain agreed milestones are met, the employee would receive the proceeds on the agreed basis. This could be in cash or in funds to buy a shareholding in the business, or a combination of cash and shares.

You would increase your employee’s salary by the premium plus any tax that the addition of the premium would add to their salary. The employee has to remain in a cash-flow-neutral situation.

The employee would take out the investment policy and cede it to the employer as a security cession to fulfil his or her obligations to work at a satisfactory level for a particular period, for example five years.

At the end of the period, the employer cancels the security cession and the employee will have the proceeds to buy a shareholding in the business.

For example, if you would like a key employee to have R1-million in five years’ time to buy a share in your business, you would increase their salary so that they have an after-tax amount of R12,000 a month to invest. This should increase by 10% a year. If the investment returned 8% a year, it would be worth R1-million after five years.

This is a great way for a business owner to extract capital from the business, attract and retain competent staff, improve BEE scores and structure the business to continue once they retire. By the way, if you ever wish to read my old articles you can find them on the Daily Maverick site at www.dailymaverick.co.za/ author/kenny-meiring.

At the end of the period, if certain agreed milestones are met, the employee would receive the proceeds