A major challenge that maturing family-controlled companies face is recruiting, retaining, and engaging outside executive talent. These families have watched their companies grow and succeed, but in order to maintain a profitable trajectory for future generations, they may have to look outside of the family for future executive leadership. How do they start?
On one hand, family and private businesses have distinct advantages when it comes to recruiting externally, but they also face challenges, especially as it relates to executive compensation. However, by leveraging those advantages, and taking the right approach to executive compensation, they can recruit external talent to the existing leadership team for the next generation.
The Advantages of a Privately-Held Company
There are several advantages inherent in family companies which help them to attract, engage, and retain the best executive talent for their business. Unlike public companies, private companies don’t face the same scrutiny of short time horizons and pressure from shareholder advisory firms. Private companies also have the freedom to structure executive compensation in a way that’s appropriate to the culture and business, while public companies—under external pressure—are too often forced to offer one-size-fits-all executive pay packages that tick all of the boxes to satisfy the demands of shareholder advisors.
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Free from the constraints imposed on public companies, some privately-controlled companies have developed unique pay programs that have become a heritage component of the company culture. This freedom enables the private company to create and produce far more nuanced compensation programs that can include long-term incentive plans tied to economic drivers, deferred compensation plans and private company stock. Unique pay programs like these can be a competitive advantage, especially compared to the plain-vanilla programs at public companies.
Family-controlled companies also often offer an attractive company culture, a key reason many family businesses top the lists of “best places to work.” That attractive culture—a refreshing contrast to the bureaucracy and politics that can often exist in public companies—can foster tremendous loyalty. The result is that many executives choose to join and stay with family firms for reasons well beyond compensation.
Long Term Versus Short Term
As noted above, private companies also have naturally long-term business perspectives, contrasted with public companies which face significant pressure to meet quarterly earnings-per-share targets. This offers private company leaders the opportunity and flexibility to develop and execute long-term business strategies.
Private companies also don’t experience the volatility of public equity markets. Therefore, long-term incentives tied to a private valuation offer a more stable basis for long-term compensation.
Challenges of a Family-Owned Business
While privately-owned firms have competitive advantages as discussed above, they often face common compensation challenges. Chief among those challenges is a more informal approach to compensation governance. Executive compensation at a private firm is not subject to the same transparency as a public company where listing rules dictate the existence of an independent compensation committee and a Compensation Disclosure and Analysis (CD&A) in annual proxy statements.
Compensation committees at private firms are often comprised of family shareholders and insiders, which can make executive pay discussions potentially contentious. Private companies typically offer long-term incentives that are well below market, compared to what pubic companies offer. And, since it’s highly unlikely that a private, family company can match the level of long-term incentive compensation at a public company, it’s imperative that the total compensation strategy consider this shortfall.
Family companies then need to develop a cohesive compensation strategy that covers all elements of executive pay: base salary, annual incentive, long-term incentives, and benefits/ perquisites. It is imperative that private company leaders understand how all of the pay elements fit together, as well as have a nuanced understanding of the trade-offs between various elements.
Balancing Culture and Compensation
While family culture can be a significant competitive advantage, there can be a downside and they should not lean too heavily on that culture and the goodwill of their executives. Presuming that loyal, long-tenured executives are less concerned about compensation and that company culture can offset all competitive shortfalls in compensation is a serious misstep. It’s the right balance that encourages executives to come on, and then stay.
Because family companies usually place less emphasis on the external labor market, there can be a lack of understanding of current market practices and norms. Private companies may reward loyalty and promote from within, but without an up-to-date understanding of executive compensation trends, they can be hindered when competing for top talent. Family businesses don’t ignore their competitors’ business practices; they shouldn’t ignore market practices when it comes to executive compensation either.
Pay Governance and Communication
The family company needs to refine the executive pay governance process and customize the governance process to fit its board structure and culture. Best practices for private companies include:
- Clarifying the committee’s purview
- Defining decision rights
- Establishing a calendar of events and a predictable annual agenda
- Monitoring market practices, including trends in executive pay levels, plan design, and technical issues (e.g., tax, accounting, and the SEC).
The compensation committee should recognize how the company’s practices differ from market practices and what makes the compensation value proposition unique.
Finally, family-controlled companies must do a good job communicating the executive compensation “deal.” It’s imperative that their unique—but often opaque—compensation programs become more transparent so that both executives and compensation committees understand total compensation programs and the behaviors and goals they are driving.
Win the War for Talent
With careful planning and structure, family-controlled companies can manage executive compensation so that it addresses the most common challenges and maximizes the competitive advantages inherent to a private company. After all, the goal is to build the right executive team and advance the long-term growth strategy of the business.