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Ken Gibson
October 21st, 2011 by Ken Gibson

Complexity and Compensation

Let’s face it, business life is accelerating in its complexity.  Denial won’t help us overcome it; we must embrace it and learn to manage it.  As some organizations attempt to “rein it in,” they find themselves making things worse rather than better.  A recent Harvard Business Review article makes the point this way:

“In and of itself, this complexity is not a bad thing—it brings opportunities as well as challenges. The problem is the way companies attempt to respond to it. To reconcile their many conflicting goals, managers redesign the organization’s structure, performance measures, and incentives, trying to align employees’ behavior with shifting external challenges. More layers get added, more procedures imposed. Then, to smooth the implementation of those ‘hard’ changes, companies introduce a variety of ‘soft’ initiatives designed to infuse work with positive emotions and create a workplace where interpersonal relationships and collaboration will flourish.”

Our experience has been similar when we are engaged to help companies design incentive plans.   Value sharing arrangements such as bonus programs, phantom stock, profit pools, performance unit plans, etc.  should bring greater clarity not complexity.  Too often, business leaders want their rewards programs to achieve more than they are designed to and become a substitute for performance management. As a result, they add layers of metrics and measures that are intended to micro manage the results the company wants employees to achieve.

If a value sharing program is going to offer more clarity than complexity, what is that it should make clear?  Here’s our list:

  • It should make clear that the company considers the employee a key partner in the achievement of its growth goals.
  • It should reinforce the company’s business model and the strategy employed to roll it out to the marketplace.
  • It should help clarify the role of a given employee in the business model and strategy.
  • It should make clear the outcomes the employee is responsible for within that role.
  • It should create line of sight between the employee’s personal financial vision and the company’s growth goals and vision.

If a company will use compensation as a clarifier and reinforcer of “what’s important,” it will take a big step towards better managing the complexity that inevitably will continue to grow.

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Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Managing Talent | 1 Comment »

Tom Miller
October 17th, 2011 by Tom Miller

Should Private Companies Let Employees Own Stock? Part 7

Can Sally (our national sales leader) buy phantom stock from the company? Is such a thing possible?

In fact, we can sell Sally phantom shares. Let’s see how it would work.

This is referred to as a Deferred Stock Unit plan—a form of deferred compensation. Sally would be given the opportunity to defer some of her cash compensation (e.g., salary or bonus) into units of phantom stock. Said differently, Sally would “convert” some of her future pay to phantom stock.

An example: Assume Sally makes $200,000 in annual salary. She might defer up to 25% (or more, or less) of her salary into the plan. Assuming she does so she would acquire a deferred compensation interest that would have $50,000 worth of starting value. In other words, she would have 5,000 units of phantom stock (at $10/share) credited to her deferred comp account.

In reality, you’re not selling shares to her. That is, she’s not acquiring an ownership right in exchange for writing you a check. She’s deferring some of her income into an unsecured bookkeeping account that is measured by the growth of the phantom share price. But it has the same essential effect as selling Sally phantom shares. She is voluntarily foregoing wages in order to ‘invest’ in the company! That’s a pretty serious commitment. We’re definitely building an ownership mentality.

Plus, it’s much better for Sally tax-wise than buying actual stock. Why? Because she gets to do it with pre-tax dollars.

Tax-wise for you it’s not perfect, but it’s not so bad. You (or the company) will forego the current tax deduction on the income Sally chooses to defer. However, it’s a delayed deduction, not a lost deduction. Instead, of getting the deduction today of $50,000 (wages) you’ll get the future deduction on $90,000 (assuming our EBITDA growth example given in my previous blog).

This is a pretty flexible and promising arrangement when you have employees who believe in the future of the company and an owner who’s willing to share that growth—for a price.

Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | 2 Comments »

Tom Miller
October 6th, 2011 by Tom Miller

Should Private Companies Let Employees Own Stock? Part 6

So we’ve agreed (haven’t we?) that some form of phantom stock is likely to be better for private businesses. I mentioned that there are
three types of plans that may fit. Here’s the first.

Full value grant. We could give Sally (our senior sales executive) some shares that are valued, in full, at $10 per unit. We’re going to specify some conditions and restrictions (to be discussed later). Nonetheless, we’re committing the full $10 in value times the number of shares we decide to give her. If we give her 5,000 shares she’ll start with a true value of $50,000 (subject to vesting and other restrictions). At some future date she’ll redeem those awards for real cash. Assuming EBITDA grows to $18mm (from $10mm) on her
redemption date, Sally will receive a check for $90,000.

What about Sally’s taxes? Well, remember that with actual stock awards Sally would pay taxes when she received the grant or when the vesting lapsed. With phantom awards, Sally pays no taxes until she actually receives her award value (e.g., the $90k). In this way, she
never has to pay income taxes until she’s in receipt of the actual cash. It’s true that had she received actual stock (and paid the taxes up front) she might have saved some taxes in the long run. However, with phantom stock your tax deduction (i.e., the company’s) is higher than it would have been with actual stock. In the first case (actual stock), your deduction was for $50,000, thus a tax benefit of $20,000 (assuming 40% bracket). With the phantom stock example, you get to deduct the full $90,000, resulting in a tax benefit of $36,000. If
you’re feeling guilty about Sally’s taxes go ahead and give her more shares, enough to result in your “after-tax cost” being the same.

A full-value award of phantom stock may be just right for Sally. But generally, we suggest it only for those special employees who have been involved with the company for some time (i.e., they’ve earned some of the value that exists now). There are better ways for most employees.

Next time: Can we sell phantom shares to employees?

Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | 1 Comment »

Tom Miller
September 28th, 2011 by Tom Miller

Should Private Companies Let Employees Own Stock? Part 5

In my last blog I began the discussion of phantom stock—and why it’s often better for the employer and the employees. Here’s how to go about establishing a plan.

  1. First, you must establish a way to value the phantom shares. In essence, you’re trying to identify the value of the company. You can obtain a formal appraisal or you can establish the value by a formula. The latter will work best in most
    situations. Perhaps the formula will reflect a multiple of EBITDA or Net Income. Any reasonable formula can work. To be safe, use a formula that is going to be less than the actual fair market value you might sell the company for some day. You don’t want the employees’ phantom shares to be valued higher than your own.
  2. The next step is to create some phantom shares. Pick a number—1 million, 10 million—the number doesn’t matter as long as you have enough to make the plan work with the number of eligible participants you anticipate. This part can sometimes seem confusing or cause concern. “Wait,” you might be thinking, “shouldn’t I use the same number of shares we have outstanding in the company? Aren’t I trying to ‘shadow’ the movement of actual stock?” Actually, no. We don’t like the term ‘shadow stock’ because we’re not trying to replicate actual shares. We’re simply trying to provide an attractive award for employees at a future date. As you’ll see, it doesn’t matter whether there are more or fewer shares
    in the plan than in your company. Let’s do an example using EBITDA (earnings before interest, taxes, depreciation and amortization) as our value indictor:

EBITDA    $10,000,000

Multiple selected    5

Formula Value  $50,000,000

Shares selected     5,000,000

Starting share price    $10

    3. Now let’s design our plan. Remember that with actual stock plans we had three choices: (a) give shares, (b) sell shares,  or (c) give options (to buy in the future at today’s price). Guess what? We have the same three options. We can simply award Sally (our national sales leader) some phantom shares. Or we can “sell” her some. Or we can create a phantom option.

Coming up—we’ll look at all three of these options using phantom shares.

Posted in Business Growth & Compensation, Business Growth and Rewards, Incentive Planning, Key Talent Compensation, Phantom Stock | 1 Comment »

Ken Gibson
September 23rd, 2011 by Ken Gibson

“Superstar” Compensation: Solving the “Jobs” Problem and other Benefits

It appears a contributing blogger to Fast Company has been channeling VisionLink while employing an interesting analogy from the sports world.  I like his thinking and it is certainly compatible with what we’ve (Tom Miller and I) been preaching in our blogs and elsewhere for some time.

In his article, Kevin Kruse offers this insight:

“Last month, NFL quarterback Michael Vick signed a new $100 million contract with the Philadelphia Eagles, making him one of the highest paid athletes in football. When the contract amount was announced, it was not immediately apparent (unless you dug a little deeper) that only $40 million is actually guaranteed. This ‘base pay’ is only 40% of the compensation package, leaving 60% at risk, based on performance.  In even simpler terms: for every $1 of base pay Vick can earn an extra $1.50 based on results.

“This ratio provides the proper risk versus reward for both parties. Vick will earn his whopping $100 million only if he stays healthy enough to lead the team for the next six years and only if he achieves certain on-field results. The variable amount in his contract must be ‘re-earned’ each year. This demonstrates that organizations are willing to pay a high premium for great performance.

“This athletic analogy describes the concept of variable compensation (a model where an employee receives a low base and dramatically higher performance bonuses), and how risk-sharing (in this case between athlete and team) can be applied to help encourage more hiring by employers at a time when job creation globally is arguably our biggest economic challenge.”

Kevin goes on to explain how this model is commonly used in commission arrangements for sales people in organizations, but should be more widely embraced throughout a business.  The concept puts ownership in the position of potentially sharing future profits, but the trade off is there is much less up front risk of tying up money in guaranteed compensation.

Many of those that have been unemployed long-term are concerned about taking positions that will set their pay scale at a lower level than they once enjoyed, diminishing their earning capacity when the economy comes back.  The “superstar” model allows a company to commit employees to a potentially lower level of guaranteed pay but with substantially larger upside potential than they earned through pure salary arrangements in previous positions.  It solves everyone’s problem and gives businesses greater flexibility in their hiring commitments.

Kruse closes out by saying:

“Critics of the variable pay revolution will say this is just a sneaky way for companies to pay workers less. But remember the Michael Vick formula: $1.50 of pay-for-results for every $1.00 of fixed pay. Applying this to a $100,000 a year salaried worker, a variable program might pay the worker $60,000 base (plus benefits) with performance bonuses up to $90,000 per year–more than their actual salary! Employees taking part in variable pay programs should be willing to give up $1 of fixed pay in return for at least $2 of additional at-risk pay.

“…Compensating employees like professional athletes can enable individuals to potentially earn more money while their employers reduce short-term risk and gain valuable intellectual and human capital. Done right, both employee and employer can feel good about their contribution toward stimulating job creation efforts.  The end result just might be more players on the field.”

I agree.

Posted in Uncategorized | 1 Comment »

Ken Gibson
September 21st, 2011 by Ken Gibson

“Speaking” of Compensation

I’m departing from my normal “educational” blog today and will be waxing more “informational” this time. Please forgive the slight deviation.

Many who have visited our blog or website have inquired whether we ever speak publicly on any of the topics we blog about.  We do.  In fact, Tom Miller and I have spoken in a number of forums nationally on a range of compensation topics and other themes that relate to driving business growth.  Here is just a partial list of the forums and events at which we’ve spoken:

  • CFO Magazine Convention
  • Inc. 500 Convention
  • Board of Directors Forum
  • SHERM Crossroads Convention
  • Pershing LLC INSITE™ Conference
  • M Financial National Conference
  • American Bar Association Tax Conference
  • Vistage Groups

If you belong to an assocation or other group that needs  speakers on topics that relate to rewards programs or other compensation issues, we are happy to entertain such invitations. Our presentation approach is educational but dynamic.  It is intended to help the audience understand that compensation is one of the largest and most important investments a company makes—and should generate a measurable return for shareholders.

In our presentations, Tom and I help paint a picture of how rewards programs can be used as strategic tools to help fuel growth in a business.  Special emphasis is placed on addressing compensation and business growth issues for business leaders such as the following:

  • The proper role and scope of incentive plans
  • How to measure the return on a company’s compensation investment
  • How to develop an “ownership mentality” within the workforce
  • What alternatives to sharing equity exist for private companies
  • Determining the right amount of compensation and how it should be paid
  • Which type of long-term incentive plan is right for a company

 

In addition to our speaking engagements, VisionLink broadcasts a monthly webinar nationally that any are invited to attend. Our next one will be held next Tuesday, September 27 (8:30 a.m. PDT) and is entitled: Sales vs. Performance vs. Growth Incentives. Feel free to register for that event or view our catalogue of previous broadcasts.

Thank you for indulging me in this departure and soft plug.  I hope knowing this will be useful to many of you.

 

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Posted in Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Managing Talent, Recession Strategies, Uncategorized | No Comments »

Ken Gibson
September 15th, 2011 by Ken Gibson

Innovation and Compensation

I have recently become somewhat a student of innovation; particularly looking at how great companies and individuals manage to get ideas and products implemented while others stop and stall.  Among the things I’ve assimilated in that learning process are the following:

  1. Great innovators associate. Those that are prone to effective innovation are constantly associating one idea or experience with others.  They also systemitize the association process so that it occurs regular and naturally.
  2. Great innovators question everything.  Their curiosity is insatiable and they want to get to the bottom of things.  Why are things the way they are?  Do they need to be like that?
  3. Great innovators network. They want to associate with people that have a broad range of backgrounds and experiences so their life view is expansive and their feedback loop is broad.
  4. Great innovators seek feedback. They want to know what others think before they introduce a product to market.  They want it tested.  It doesn’t have to be perfect, but it has to meet the right need in the right way.
  5. Great innovators have a bias towards action. Innovating is not dreaming or wishing or even just being creative.  It is about getting ideas implemented and working in a way that transforms the end user’s experience.

There’s more I’ve learned, but let’s work with that list for now.  As we examine it in the context of compensation there are some important issues to consider.  A company’s approach to building effective rewards needs to follow a similar process:

  1. Those that develop compensation programs need to be able to view compensation as a dynamic tool and ”associate” each component both with other elements of pay and with the business model of the company.  As the company’s innovation cycle continues and expands, the approach to rewards needs to be able to reflect that new reality.
  2. If individuals are going to create an “innovative” rewards structure, they have to be willing to question everything.  What is the outcome we’re trying to drive?  Why is that important?  How should that outcome be rewarded?  When should it be rewarded?
  3. Innovative companies look beyond the “network” of their own industry in seeking creative ways to properly reward people for value creation.  They don’t think in terms of what the peer companies in their “space” are doing.  They look at what great, innovative companies are doing and then take lessons from their approaches to everything, including pay.
  4. Businesses that are effective at every level have a continuous feedback system in place.  They measure and assess.  They look at data and make decisions based on what that data reveals. Similarly, they seek feedback from their workforce about whether they are succeeeding at creating a sense of partnership, painting a compelling vision and building a sense of unity about the outcomes being pursued.  If they aren’t, they use pay as one of their strategic tools to target a better result.
  5. Companies that get compensation right usually get a lot of other things right because they are prone to act.  They don’t let the pursuit of the perfect paralyze them from taking action.  They get close enough, they stay focused, they get it done, roll it out and then make adjustments as they need to.

As you approach bettering the compensation strategies you wish to adopt, hopefully you will likewise become a student of innovation.  If you do, the horizon of possibilities will expand and your ability to drive results will be magnified.

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Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Key Talent Compensation | No Comments »

Ken Gibson
September 9th, 2011 by Ken Gibson

What Your Employees Would say about their Compensation…if they Thought they Could

You have smart people working for you.  For the most part, they believe in the company and where it’s headed.  Because they are thoughtful and intelligent, they are willing to learn about the role you want them to play in creating value for the business.  The better ones had options when they chose to work for your company.  The best ones have other options now.

So, if  what I describe above is familiar to you–if you have one or more person like this working for you right now–what would they say to you about compensation if they were honest about their expectations?

In the course of our work with clients, we have interviewed hundreds of just such individuals within successful businesses.  In composite terms, I’d now like to share what we’ve heard.  I’ll categorize the responses in three groups and then lay out the expectations of those we’ve spoken to in the first person; speaking as if I were that smart, thoughtful employee who did and does have options.

  • Sustainable Cash Flow–”I recognize that my experience and skill level merit a certain level of pay.  I’m not stupid; I’ve done some research, asked around and I know what most people in my position earn. I’ve built a certain lifestyle around that expectation.  Now I just want to know that as long as I perform–and the company continues to do well–I’ll have enough guaranteed and incentive income to keep me and my family in our ‘world’ and still be able to plan for the future.  As a result, it would be helpful to know what philosophy the company has going forward for how much of my earnings will be guaranteed and how much upside potential there will be through “value sharing” if I help the company meet its growth targets.  To the extent some of my compensation  will be ‘at risk,’ I’d like to be clear on the measures being used to determine payouts and know that those metrics are based on something I have control over.  I would also favor something that isn’t ‘all or nothing’; if we achieve a superior result, it would be nice to know even more would be available.  That would be meaningful to me–and seem fair.”
  • Security– “There are certain risks that could change my world pretty quickly.  If a member of my family becomes seriously sick or injured, or if I die or become disabled, I need some means of protection.  Likewise, I need to be able to plan properly for retirement, education for my kids and so on.  I certainly don’t expect the company to foot the bill for every type of risk I’m trying to plan for or protect against.  At the same time, I recognize the business is in a unique position to use the size of its workforce as leverage to obtain certain benefits and that’s it’s also in the company’s best interest that its key people not be too vulnerable. So, I hope I can have some flexibility in my benefit options that will allow me to address my circumstances in as customized a manner as possible.  I’m willing to share in the cost of doing so–I just want to make sure consideration is being given to the range of issues that could impact both me and the company if proper planning isn’t done.  Here are some of the things the ideal arrangement would include:
    • Medical Insurance—options for PPO, HMO, catastrophic coverage (dental, vision, long-term care options are a plus and having some options even at my cost would be helpful in this regard)
    • Life Insurance—options for additional coverage at a group rate are ideal; some kind of permanent coverage the company pays for while I’m employed is better (I’ve heard of things such as ‘split dollar’ arrangements where the company gets its money back when I leave)
    • Disability Coverage—this one worries me the most; so it would be great if there was either a group plan or individual coverage that replaces my income if I’m not able to work; again, I’m willing to share in the cost of this but I also recognize it takes the company off the hook for having to decide what to do if I am out with some kind of long-term condition
    • Retirement Plan—a 401(k) is great, I’d just like to make sure you’re looking out for me in the investment options I’m given and that you are making sure  hidden costs are being squeezed out so I can maximize my benefit.  If the company makes a contribution to the plan, it tells me they value a long-term relationship with me and want to help me plan for my future
    • Supplemental Retirement Plan—it’s a bummer that the government restricts my contributions to the 401(k) plan; what I put in is based on what people earning less than me put in.  As a result, having a supplemental plan to allow me to set aside more for the future and on a tax favored basis would be ideal.  I know many companies provide this through some kind of deferred compensation arrangement”
  • Wealth Accumulation—“It’s nice having a retirement plan, but it’s not what I mean by having a wealth accumulation opportunity.  I’m talking about having the means to share in the ‘wealth’ I help create in the business.  If my commitment of time and talent means the company achieves something it wouldn’t have achieved without that contribution, is it not fair to want to participate in the value I help generate?  It seems like a win/win to me if it’s set up properly.  I don’t care whether I get equity or not—I just want to know that there is a long-term mechanism in place that makes the achievement of the owners’ vision a financially meaningful event for me.  I’d be motivated by that and it would seem like more of a partnership arrangement if I can  participate in something like that.”

So, there you have it.  That’s what your best employees are thinking and what they’d like to say if given the chance.  Now you know.  You’re welcome.

For more information on this topic, view our webinar entitled: “What Your Employees are not Telling  You about your Current Rewards Programs.”

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Posted in Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Managing Talent | 1 Comment »

Tom Miller
September 9th, 2011 by Tom Miller

Should Private Companies Let Employees Own Stock? Part 4

In my last three blogs I discussed why stock ownership for employees may not be such a good idea. So what’s better?

Phantom Stock—A Better Approach

Each of the ideas for Sally (our Sales VP) had merit. Granting stock is simple and clear-cut. It provides instant recognition and value. It’s great, particularly, for someone who’s been with you for awhile and has made a contribution to your past success. But, the concept carries the baggage we described.

Having Sally buy stock also is intriguing. It deepens her commitment and aligns her with both short-term and long-term goals of the company. But again, baggage.

Stock options are attractive because they’re win-win. Sally only wins if shareholders see their stock value go up. Sally is tied to future growth of the company. But…complexity, cash flow problems (i.e., baggage)

What if we could replicate any or all of these approaches without making Sally an actual owner? Is it possible to generate the ownership value and mentality without the baggage? In a word, yes. We can do it with phantom stock.

Phantom Stock Defined

A phantom stock plan is a contractual agreement wherein a company promises to make cash payments to employees upon the achievement of certain conditions. What’s the purpose? Just as with stock awards, the purpose of a phantom stock plan is to generate an ownership mentality and reward key employees for helping to grow the business value.

However, phantom stock has one big advantage—no sharing of actual equity with the employees. No requirement to open the books. No ownership rights. No need to pay dividends (although some plans do). The existing owners stay in control of 100% of the stock or interest in the company.

At the same time, phantom stock can create comparable or even identical value as actual stock. Next time I’ll outline some of the positive things that happen when you create a plan on behalf of employees–and the ways to do it right.

 

Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation, Phantom Stock | No Comments »

Tom Miller
August 31st, 2011 by Tom Miller

Sharing Stock–Approach #3

We’ve looked at restricted stock and stock purchase plans. There’s an even more common way to get stock in the hands of employees.

Of course:  stock options. Public companies use them commonly. Why shouldn’t you? This would enable Sally (your national sales director) to get some stock at a fair price and help her get capital gain taxation if you sell the company some day.

Maybe. Maybe not.

First of all we still have a cash-flow concern. Sally will need to come up with enough cash to exercise her option after the vesting period has passed. Let’s say the stock is worth $10 today and you give her 5,000 options to buy the stock at that price. Her three year vesting period passes and Sally scrapes together the $50,000 to exercise her options. Let’s assume the company share price has grown to $18 in the meantime. She now has $40,000 of new equity value (($18-$10) X 5,000). How do the taxes work?

There are two different types of options—nonqualified and qualified (or incentive). This isn’t the place to cover the differences in taxes—except to say that incentive options, generally, produce a better tax result for Sally and a worse tax result for you. Meanwhile, Sally may now be in a position to benefit from a future transaction (i.e., sale of the company or IPO) assuming the event occurs at least a year from the date of the exercise of the options.

However, what if neither event ever occurs? You’re back to our original problems of redemptions, dividends, etc. In my “30 plus” years experience coaching companies on these plans I’ve seen many more situations where the “future transaction” doesn’t happen, than it does happen. As a result the majority owner and the owner-employee face the grind of negotiating a “fair” price for the stock at the time of a future separation of service. How well do you think you’ll enjoy that future conversation with Sally’s attorney?

The bottom line: the financial results of stock or stock option awards can appear to justify the effort—under the perfect circumstances. But reality is never as simple as you expect it to be. The majority of private company owners will regret the move to stock awards for employees. The perceived value of employee ownership is, nine times out of ten, not nearly worth the price.[1]

So what should we do instead. Stay tuned.

[1] The author acknowledges the primary exception to the rule: if your company is on a clearly lit IPO track, stock options offer an excellent and efficient way to reward employees.

 

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Posted in Business Growth & Compensation, Business Growth and Rewards, Compensation Planning, Current Pay Trends and Topics, Incentive Planning, Key Talent Compensation | No Comments »

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