Sal DiFonzo and Myrna Hellerman
For Family-Run Businesses, Here’s The Key to Competitive Recruiting
Family businesses have unique characteristics that certain candidates appreciate: a close-knit culture, nimble business processes and liberation from SEC and investor scrutiny that often introduce inefficiencies into public-company operations. Some candidates are also attracted by respect for the family members and the business success they have achieved. And family businesses often have interesting challenges that appeal to the right executives.
Yet those inducements may not be a sufficient “lure” for top talent. Savvy family businesses use creative approaches to compensation to help non-family executives decide to join — and to stay long enough to be effective. The wealth-accumulation opportunity provided by a competitive long-term incentive plan (LTIP) can be the extra incentive required to seal the deal. A long-term wealth accumulation opportunity delivered through a well-designed LTIP has proven to be a powerful magnet to attract and retain non-family members to family-run businesses.
Often referred to as non-qualified deferred compensation plans, LTIPs differ from qualified plans, like 401(k)s and employee stock ownership plans (ESOPs) because the company can select who is eligible for the plan. An LTIP generally is subject to the Employee Retirement Income Security Act of 1974 (ERISA). However, non-qualified plans like LTIPs typically satisfy what’s known as the “top-hat” exemption and, therefore, are not subject to many of ERISA’s more onerous requirements. A top-hat plan is limited to certain highly compensated employees typically in management, and they are exempt from certain ERISA requirements such as the participation, vesting, and fiduciary responsibility provisions. Despite those attractive characteristics, there are distinct downsides to non-qualified plans: participant awards are subject to creditors of the employer in the event of a bankruptcy. In contrast, assets in qualified plans are protected from both employer and participant creditors.
Hurdles When Recruiting
On the surface, many family businesses appear to offer a non-family executive an unattractive option: • No Ownership Stake. There may never be an opportunity for a non-family executive to have a real ownership stake in the success of the business. • Fixed-Cost Aversion. Family-run enterprises frequently have an aversion to high fixed-cost pay structures. That tends to mean non-family executives earn base salaries on the low side of market value combined with a variable pay opportunity tied to aggressive performance achievements. • Uncertain Future. The family-run business may have only a very vague succession plan in place. Consequently, when there is a change in the family’s leadership, the non-family executive’s future employment at the company can become uncertain and often is subject to the whim of the family member who serves as the new leader. • Impact. The non-family executive’s decision-making autonomy and ability to have an impact on the businesses success can become limited when caught in the cross hairs of family dynamics and disagreements. • No Room at the Top. The evidence suggests another challenge for non-family executives who hope to advance in a family-run business. According to The Wall Street Journal, the average tenure of a CEO at a family business is 25 to 28 years vs. four to six years at a publicly traded company. Advancement to the top for a non-family executive may never be possible. By the time the CEO reaches the end of that long tenure, the next generation of family members may be ready to assume the top leadership roles. Some combination of these hurdles is either apparent to or assumed by candidates. The right LTIP can often help candidates see past the hurdles, addressing the financial aspects of “Why should I join?” and “What will motivate me, as a non-family executive, to stay?”What is an LTIP?
An LTIP typically allows selected executives to participate in the financial rewards associated with the business’ long-term success. Such plans offer a significant financial award, payable in the future. The award is contingent on completion of a specified extended period of service, and the size of the final payout may be modified up or down by the company’s financial performance.
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Often referred to as non-qualified deferred compensation plans, LTIPs differ from qualified plans, like 401(k)s and employee stock ownership plans (ESOPs) because the company can select who is eligible for the plan. An LTIP generally is subject to the Employee Retirement Income Security Act of 1974 (ERISA). However, non-qualified plans like LTIPs typically satisfy what’s known as the “top-hat” exemption and, therefore, are not subject to many of ERISA’s more onerous requirements. A top-hat plan is limited to certain highly compensated employees typically in management, and they are exempt from certain ERISA requirements such as the participation, vesting, and fiduciary responsibility provisions. Despite those attractive characteristics, there are distinct downsides to non-qualified plans: participant awards are subject to creditors of the employer in the event of a bankruptcy. In contrast, assets in qualified plans are protected from both employer and participant creditors.
What Types of LTIPs Are Available?
Long-term incentives can be delivered through a variety of vehicles.Cash
This is the simplest option both to administer and to understand. A participant is granted a cash award and then receives a cash payout at a designated point in the future. For instance, the executive is granted an award worth 100% of base salary that will vest and be paid out five years in the future. The award amount is modified (up or down) depending on the achievement of a specified financial metric over the five-year period.- Pro: Cash is the simplest concept and is typically related to performance.
- Con: Inflation and time value of money erode cash value over time. Companies may compensate by paying interest on unpaid awards or allowing participants to use deferred compensation accounts where they can invest the cash similar to 401(k) style investments.