Retaining Your Management Team – Think Atop the Box

One-size-fits-all retention packages are usually unsuccessful in persuading a diverse group of key employees to stay put. Instead, companies that tailor retention approaches to the specific interest of each executive, as well as the current corporate position, benefit with higher retention rates.

Studies show the employer cost to replace one executive-level employee ranges between 150 to 400 percent of the employee’s salary. Traditional tools, such as deferred compensation plans, have not been the most effective solution. These plans do not offer employers current tax deductions. What’s more, those executives who remain on board are subject to the claims of the employer’s creditors.


When executives at a fast-growing biotech company looked beyond the standard retention package (deferred stay bonuses) and focused instead on the needs of individual employees, they found a more balanced situation than anticipated.

Among the key people at risk were two senior executives with exceptional industry experience. The biotech company edged near profitability and decided to offer executives a three-year “stay bonus.” They agreed to set cash aside on its books for payment to executives at the end of three years. But this decision did not motivate the executives; they saw considerable risk in being a general creditor of the company. If the company released monies and failed, the executives could lose the bonus payment. For the company’s part, it worried over the liability it faced on its balance sheet, as well as earnings cost to the company.

What’s more, when the executives received the payments at the end of year three, those payments would be ordinary income taxed at 50 percent, factoring in state and federal taxes.


The ideal plan provides the executives with a fully secured payment, not subject to creditors, and with a favorable tax treatment when paid. For the company, it needed to make this arrangement a two-way street. It offers the executives something of value, but what does it cost if the executives depart? The biotech company wanted protection, too, without a hit to the balance sheet.

After studying many alternatives, overlooked by others, BFG helped find a solution that met both company needs and the executives’. Even better, the company can tailor the payout to meet each executive’s needs while protecting itself, too.

In structuring a special arrangement, the company was able to fund it on a tax-deductible basis, with no income tax to the executives until they received payout. These benefits were held off the company balance sheet and fully protected against the company creditors.

Another executive wanted proceeds paid to his children instead of taking the proceeds into personal income to avoid capital gains on the payout in three years, required with ordinary income in traditional deferred compensation.

For the company, it was able to obtain a policy to pay itself if the executive left the company in the first three years, thus, protecting its shareholders.

When you consider the far-reaching application of this special arrangement, one can see how it can benefit small to mid-size companies who also need to attract and retain key employees. They also want current tax deductions for contributions and capital gains treatment on distributions, with full creditor protection. And why not? They deserve it every bit just as the major players.

In the High-Stakes Search for Talent, Can Small to Mid-Size Firms Even the Odds with Fortune 1000 Companies?

Does company size matter when business competes for employee talent?

Yes, if you represent a small, mid-sized business (SMB) because the same opportunities to lure talent that exist for major corporations do not exist for SMBs.

Yes, if you are a talented employee or executive who believes the best opportunity for advancement and the best benefit packages are available in major corporations.

What’s more, the smaller the company, the greater the influence for a key employee to make a difference in business outcomes.

How then can SMBs compensate for disadvantages in size?

The steel-fused backbone of the economy, SMBs keep the nation’s economy upright. I’ve run SMBs for decades so pardon me if I take pride in these facts from the Small Business Administration (SBA):

  • 22.9 million small businesses occupy virtually all neighborhoods across America.
  • Small businesses make up more than 99.7% of all employers.
  • Small businesses create 75% of the net new jobs in our economy.


Private companies, including closely held and family-owned businesses, often find it difficult to attract and retain key management personnel. That’s because publicly held companies lure talent with huge signing bonuses, company stock and creative perks to magnetize total compensation packages.

While equity in a private company may not be marketable in a traditional sense―not tradable on a stock exchange—private companies can provide long-term equity incentives as liquid investments for employees.

Unfortunately, many business owners shy away from using their equity. They don’t want to give up control or account to minority shareholders. But you can create long-term, equity-type incentives for employees without ceding control to them.

Most publicly held companies offer four compensation elements: salary, annual bonus, long-term incentives and equity compensation such as stock options or restricted stock awards. [See Chart I] Many times the long-term incentive is the equity in the company.

But private companies find it difficult to recruit top-level management talent because they typically do not offer equity compensation, the fourth key element in a competitive compensation package.

In lieu of equity, many private companies use nonqualified deferred compensation (NQDCs) plans to fill this void. However, they structure the plan with incentives built around the long-term goals of the company. [Right side of Chart I]. These plans usually provide for employer contribution, based on select indicators set by the company: revenue growth, after-tax profits, and cash flow.

For example, a company can tie its key employee to itself with a vesting plan; the company funds the plan with life insurance or other assets to minimize its cost over time. This approach works far better than phantom stock plans that possess an adverse accounting treatment.

For more information on structuring this approach, download my recent white paper:How Executive Benefits Enhance Executive Compensation Programs—Cost-Effective Benefit Programs Provide Win-Win Outcomes for Executives and Shareholders.

Because most private companies and professional firms use much different corporate tax structures than the Fortune 1000 companies as discussed above, many nonqualified plan strategies just don’t make good economic sense.


As a method to reward performance, deferred compensation aligns the interest of key employees with those of shareholders. These plans are the most benign of all compensation methodologies. In a deferred compensation arrangement, select people are offered the option of deferring “their own compensation.” They don’t receive their “own money” until some future date, often at or near retirement.

In some plan designs, the employer will also set aside a percentage of cash bonuses in the plan. The monies deferred go into the company’s coffers and are subject to the claims of creditors should the company fail. Because they do not receive the money deferred, executives and key employees are not taxed on these amounts until they withdrawn. [Download deferred comp booklet]


Deferred compensation is similar to a 401(k) plan, except that no guarantee exists that, when the money becomes due, it will still be there. What sounds riskier than that? These plans are not formally funded or protected by ERISA like a company’s 401(k). They’re informally funded, which means the assets are subject to the claims of the company’s creditors.

In addition to employee risk, the company does not receive a current tax deduction for any money deferred or any contribution it may make on behalf of the key employee. This restriction is where the problem lies for the closely held business that has a tax pass-through structure.


Before we discuss an alternative for the pass-through tax structure, let’s examine why Fortune 1000 companies use deferred compensation and why they are so popular among highly compensated executives and employees.

Tax leverage is the most important attribute of NQDC plans, most of which are funded with corporate- owned life insurance (COLI), an asset that provides many tax benefits. Fortune 1000 companies generate leverage with the combination of non-taxable insurance proceeds, non-taxable accumulation of the policy’s cash values and, when benefits payout, tax deductibility. This leverage enables the employer to provide substantial benefits to key employees with little or no cost.

Using life insurance as a vehicle to obtain leverage may be a little confusing so let’s address how the leverage works. When cash value life insurance is used by the employer to “informally fund” deferred compensation arrangements, three income tax questions are raised:

  • Does the employer’s tax deduction pay the premiums? No.
  • Are the benefit payments, when paid by the employer to the employee, tax deductible? Yes.
  • Are the life insurance death proceeds paid the employer income tax-free? Yes.

You can see how the leverage emerges. The employee defers tax money and the employer uses the policy to create tax leverage. Fortune 1000 companies take advantage of this concept because they are not as concerned with tax deductions today. That means premiums and amounts deferred are not tax deductible, and the major corporations hold plenty of cash to fund these arrangements, while they wait several years to get the life insurance benefits tax-free.

The closely held business or professional firm cannot wait out the 20, 30 or 40 years required to make all of this leverage work.

Chart II below shows how the leverage builds on a 45-year old employee deferring $100,000 for seven years, and then taking a distribution on retirement benefits beginning at age 65 for 15 years.

We then assumed in this illustration that he or she would die at age 82. (At this point, the tax-free life insurance benefits return to the company.) Notice how the company ties up a sizeable amount of cash for 37 years―assuming he dies at age 82—before it recaptures its cost. For most pass-through entities we’ve work with, this outcome does not work.

So why do Fortune 1000 companies fund their executive benefits with COLI, especially since cash flow isn’t as important to them as earnings per share? Their profit and loss statements shine when using COLI.

Major companies also insure much larger groups than small organizations; it is likely they won’t have to wait 37 years to recapture a portion of their costs. Finally, major companies operate under much higher corporate tax rates, which is why COLI serves as a far better taxable asset than say, mutual funds.


To learn the alternative that works for both the key employee and his employer—one that could be tax deductible to the firm today, and grow tax-deferred to the employee without the risk of general creditor status, please click here for detailed position paper on competition for talent between the minnows and whales.

In the position paper, we look at two executive situations, one where the executive works for a large organization and one where he or she is employed by a private firm. My goal is to uncover a differentiating benefit the private company can offer to compete against the large, publicly traded company. What’s more, I discuss the critical phases of retirement planning: Contribution, Accumulation, Distribution, and the financial imperatives of moving through each. I trust you will find the information useful.