The executive/leadership team’s value
Part 2 of 2 – How should you pay your executives to help you get there?
In last week’s blog, we covered the variety of exit plan options landscape business owners have depending on their goals and preparedness. The senior leadership team’s value to owners as they prepare their businesses for sale and as they transition to the future is clear. In this Part 2, we review the most effective types of executive compensation plans for you to consider as you plan your team’s plan.
In general, the total executive compensation plan will be between 30 to 50 percent tied to annual and long-term incentive rewards. In the public market, the long-term rewards will be based on stock appreciation and stock options. In the private market, the long-term rewards may be based on stock or, more often, a long-term incentive plan that tracks the performance of the company in a similar fashion.
First things first, though. Are your executive team members receiving a competitive base salary? Are your base salary comparables drawn from your region/city, based on position responsibilities and the size of the company? Are you overpaying some and underpaying others for no reason other than their tenure with the company? Is there a consistency with the level of responsibility and rewards in the group? Do high base salaries limit your ability to set meaningful bonus goals tied to achieving company results every year?
Are the target bonus awards set before the year begins and quantifiable so that individuals can track results on a regular basis? Does the leadership team review the progress to date and make corrections as needed throughout the year? Do the targets for annual bonuses cascade through the company so that all employees are working toward the same goals? Are your cash bonus award opportunities within the recommended guidelines for that position?
Should this improved compensation package include higher bonuses tied to short-term goals (like revenue growth and gross margin targets)? Probably not. Cash compensation doesn’t focus the employee on the long-term and, when you are thinking of selling to a third party, several of those leaders will need to be in place to assure the future cash flow. If you can’t deliver a senior person who has the customer/employee/sales/etc. level capabilities, it will probably make buying your company riskier for the buyer, therefore reducing your most likely price.
Even companies that are rebuilding from a setback and wanting to conserve cash can design a program for the senior people that will create a shared reward for their sacrificing compensation in the short term. Plans can be designed that tie the payment schedule for incentives to the company’s cash flow dynamics.
The owner will establish a total compensation plan for executives set appropriately for his market. In many cases when the owner is putting the executive compensation plan together, he will also offer Employment Agreements that outline present terms of employment and provide assurances about post-closing compensation in general. For example, if this individual is terminated by a buyer in the first 12 months (varies) after the closing, a payment would be made by the seller (or the buyer) that is intended to compensate him for his contribution to that point and compensate him for an interim period while he searches for new employment. If the executive wants to leave before the end of his term, he will forfeit certain benefits that were put in place to incent him to stay.
Long-Term Incentive Plans
Should an incentive that is based upon a long-term goal be equity in the company? Not always. In fact, in family-owned businesses, owners may not want to “give away” equity that they spent years building, even if they want to generously reward employees who helped them achieve their success.
As the executive team takes on more independence to run the company on the owner’s behalf the owner will become more committed to these new incentive programs. It may be that the company designs a plan that does not offer actual equity, but instead, offers a long-term plan that pays benefits that mirror company stock payouts over a period. Incentives may be paid based on long-term EBITDA targets. In these cases, the company can provide a significant benefit without diluting the current owner’s shares.
Most privately-held businesses are going to manage their cash flows to minimize taxes, so it is important to have an independently verified source of information for measuring success. The goals should be “owned” by the executive team with the owner gradually “letting go of the reins”.
And in the case of executives purchasing stock, think about it from the executive’s perspective. Is this a person who can afford to have significant amounts of their long-term incentive tied up in illiquid company stock? Many employees of a small (in our industry, up to $20mil annual revenue private company) think they already have enough risk with the company with salary and bonuses tied to the company’s fortunes. A long-term incentive plan that provides a retirement payout may be more appropriate.
If the owner plans to transition the company to an internal group (family, management, or ESOP) AND if the executives are interested in owning equity in the company, it might make sense to establish an equity-based compensation plan. The owner may grant restricted stock that has a vesting period of five years from the date of the grant. There may be an opportunity for those who received this stock to receive options to purchase additional stock based on achieving financial goals. Once the company reaches a certain level, for example, the executives would receive long-term incentive awards (which might be a blend of cash and stock.)
Special incentives for the team that is liquidating typically consist of an incentive bonus paid upon the successful conclusion of the business measured by objective facts established in writing. For example, the sale of the trucks and equipment of the business by x date for a total amount of at least 80% of resale value. I’ve even seen a CFO of a company being sold offered a contract that called for the company to pay for his job search counseling and medical benefits for a period of not less than x months on top of a bonus at the closing of the business.
Total executive compensation plans are important both before and after the ownership transition in keeping that team in place and focused. When the total compensation plan including the right mix of both cash and long-term incentives tied to the future performance of the company, these team members will become even more focused on achieving results that improve the company’s value.
The goal is to reward the executives with opportunities that would be competitive with larger companies as an incentive for them to stay with your operation. The benefit to the company is the executive’s focus on the desired goals, an energized employee who has a feeling of ownership and the retention through vesting) of this key person through the plan.
If you’d like to further discuss your thinking about these matters or buying, selling, or exiting your business, let’s have a conversation. In addition, we can help you determine your readiness for sale, selling, or buying a company, or helping with an existing acquisition.
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