Reward in Family Businesses
2nd February 2018
One of the perennial challenges with family businesses that have decided to bring in an outside top management team is incentivising the team when the typical situation is that they can’t own shares in business itself. Understandably the family don’t want to dilute their control and ownership which has been passed down generations. However, the management are keen to have a stake in the business and receive reward, and recognition, for their contribution. With family NED’s often sitting on Remuneration Committees reward and pay in general are highly relevant topics for families to address.
Long-Term Incentive Plans
An LTIP is a key tool in attracting and retaining the best management. A programme is required that makes management feel, act and think like an owner thereby delivering the best results on a sustainable long-term basis. LTIPs now form part of most top management pay packages and, therefore, will be a requirement of most candidates for a new senior position.
This needs to be done in a “win-win” way for both family owners and management. The most common LTIP vehicle with family firms is a cash-based performance incentive, where rewards are earned based on the incremental increase in actual (or notional) share price, which contributes to a deferred cash payment. Alternatively, a simple cash LTIP based off profits growth can be operated. However a model is required that gets the balance right between incentivisation and retention. LTIPs can be granted annually, with payouts based on rolling (say) three year performance, or take an “end to end” approach with only one award made in each three year cycle. One more topical consideration is to be mindful of avoiding accusations of “fat cat” pay and the equally topical theme of the relationship between CEO pay and that on the shop floor.
Start with the Premise that the Programme Should Pay Out Only When Value is Created
The architecture of the LTIP should be based on sharing in the value that the CEO helps create. Frequently, the way to measure that value is EBITDA (earnings before interest, taxes, depreciation, and amortisation), starting with a reference value before the new CEO joins and allocating a percentage of the value created to a pool that is shared by the top few members of the management team. This incentivises the CEO and provides some tools to attract and retain top talent. In some programmes, a professional third party assesses the company’s value each year, providing an independent view of the payout, but this method has a yearly expense attached to it. One recent client simply assigned a percentage of the EBITDA growth over time to a pool.
Work with Experts
Creating an LTIP is not something that should be handled in-house. It takes a professional compensation consultant to translate the family’s value system and objectives into an appropriate LTIP architecture, and then to fit the programme to the requirements of the finalist candidate. There is always a bit of negotiating that goes on, first within the board and family, then with the final candidate. The process usually requires several steps/iterations over a couple of months and needs to be documented, with the legals containing the finer points of detail regarding matters such as what happens (i) if the CEO resigns/is sacked, (ii) if the family decides to sell the business etc.
Because the process can take some time, we strongly encourage clients to start developing the LTIP at the beginning of a CEO, COO or CFO search. It is too late to start the process once the final candidate has been identified. If there is an LTIP already in place, it may need to be refreshed to match the current marketplace. Again, this process should be started early, since even relatively minor modifications can take a couple of months to get everyone in agreement.
While a recruiter can provide a sense of whether a programme is comparable with others in the market, it takes a compensation consultant who deals with private companies to “turn the dials” and match a programme to a specific situation. Recruiters familiar with family-owned businesses are accustomed to collaborating in this way and working with various other consultancies supporting the family-owned business community.
Whilst it is rare, a plan where a small amount of shares - say 5-10% - are made available to be owned by the employees during the tenure of their of employment is an inspired way of securing additional commitment and retention. However, this needs to be an easy process to administer and is subject to an annual valuation of shares. Some companies might be doing this anyway within the context of an internal share market for the family shareholders. Also the company law and tax implications of offering shares to employees – as well as also providing employees with a mechanism to sell them to other shareholders – can be complex and should not be underestimated.
Benefits of Benchmarking
Furthermore, there are benefits of comparing your organisation’s shape and pay structures within your sector to ensure you have the right size, shape and structure to provide optimum pay levels – Korn Ferry Pay Solutions being a leader in the market in enabling this.
Andrew Notcutt is a Family Business Consultant at Korn Ferry’s global Centre of Excellence for family business. He supports family businesses across a spectrum of advisory services; culture and behaviours, employee engagement, reward, leadership, next generation development, succession planning, governance and board practice. He works with senior teams to provide tailored solutions aligned with strategy. He is a fourth generation member of his own family business.
Korn Ferry is the preeminent global people and organizational advisory firm. We help leaders, organizations and societies succeed by releasing the full power and potential of people. We can deliver a comprehensive and integrated service across all areas of executive reward advice, including governance, design, analytics, data and modelling. We hold remuneration data for 25,000 organisations and 20 million incumbents across all levels, sectors and geographies and are therefore able to offer unrivalled expertise in this area to family firms.