Posts Tagged ‘Compensation’

The most recent post discussed the structure of a Stock Appreciation Rights Program as part of your ongoing effort to retain and motivate key employees, and as alternative to issuing equity.  The principal advantages of the SAR program are:

  1. It provides a clear connection between financial reward and the success of the company.
  2. It encourages cooperation among individuals and groups, because everyone will benefit financially if the company prospers.
  3. The vesting schedule encourages and directly rewards longevity.
  4. The company repurchases non-vested shares for zero dollars.
  5. When the company repurchases vested shares, 100% of the repurchase price is tax deductible.

As we indicated in the last post, an SAR program provides little in the way of immediate reward.  For some individuals, such as “hunter” salespeople, the lack of short-term feedback can be a demotivator.  This shortcoming can be remedied by an effective cash bonus program.

There is one cardinal rule for designing any cash compensation program; namely, reward the employee for success in areas in which s/he has a significant amount of control or, at least, considerable influence.  Financial accountability is critical, and that means the capacity to carve out in numbers the results of your employee’s efforts.

Let’s say, for example, that your company manufactures a number of products which carry a wide range of Gross Margin as a percent of sales.  Among those product lines that generate comparable unit volume, your sales force should emphasize sales of the high Gross Margin products, and you should reward those who are successful in this effort.  Specifically, the bonus plan must reward both Gross Margin dollars and Gross Margin percentages.

We have designed a number of sales compensation programs over the past 40 years, with particular emphasis on this very principle.  The beauty of this idea is that, if the salesperson increases the proportion of high Gross Margin business, while maintaining constant sales volume, s/he will benefit twice. First, Gross Margin dollars will increase because the Gross Margin percentage is higher on constant sales.  Second, s/he will get a bigger slice of those Gross Margin dollars.   So, the salesperson will get a bigger slice of a bigger pie.  Now, that’s motivation!

Stock Appreciation Rights programs and cash bonus programs are not mutually exclusive.  Quite the contrary, they can be companions that address the need to motivate the employee in the short run and encourage both strategic thinking and longevity.

Good luck!


PhotoPopell This article has been contributed by Steven D. Popell. Steve has been a general management consultant since 1970. Steve is a Certified Management Consultant, business valuation expert, and inventor of ExiTrak®– a process designed to assist the privately-held company owner/manager to build an attractive strategic acquisition candidate

It is the ROI, not the ROC, Stupid!

by Himanshu Jhamb on September 30, 2009

ROI ROCIn my earlier post on June 10, 2009 I shared an example of what ROI looks like. In this post, I am writing about if ROI is not seen as ROI, how your possibilities get killed even before you start to act on them. This happens when customers confuse the ROI (Return on Investment) with the ROC (Return on Cost).

ROI is a constitutive component of how we measure Value; so needless to say, it is a critical part of how we choose to transact (or not), in any situation. Then there is the Investment which is a critical part of the ROI. The biggest pitfall is how this shows up for your customers. Consider this example:

You are at the crossroads of your career. You work very hard at your job, day in day out… day in day out… day in day out… you get the picture. The more hard work you put in, the more of the same results are being produced (e.g. getting only a 2-5% raise year after year after year… ). There is no certainty of the promotion you’d hoped you’d get in your upcoming review. You met your goals, you fulfilled your promises and all that happens at the time of review cycle is you’re told the company did not meet its numbers so you’ll just get a 2% raise or worse, nothing at all.

At this point, you say “This is not working”. I need to go learn some new things. I need to look for where I can get more education… different education and with that you set out looking for it. Then you come across two choices; one education costs $20,000/year and the other $2,000/year. This is the crossroads at which you make a choice and the importance of this choice is huge because it will have an impact on perhaps your entire life.

The choice is made in how you think about this. Before I go further lets clearly distinguish that the “I=Investment” IS NOT “C=Cost”. Cost is usually thought of as something you have to pay in order to get something else RIGHT NOW. Investment is thought in the context of something you have to pay in order to get something bigger (than what you paid) in the future .

Most people look at the ROI as the ROC and that conversation closes the opportunity there and then. So, when you are talking to your customers about the value of what you are offering, make sure you CLEARLY bring forth that the price tag associated with your offer, is not a COST to them, it is, in fact an INVESTMENT, that they are making into a future possibility that will MORE THAN cover the investment they are making at that point.

If they still insist on looking at the “I” as the “C” ask them a simple question: “It is clear that you have considered the Cost of doing this. Have you considered the cost of NOT DOING IT!”

Try this in your next conversation. It works in bringing forth the ROI very clearly… and the results will show for themselves.

compensation_reward_strategy_pictureThe most frequent approach to valuing a sole practitioner’s private practice is the “Excess Earnings” Method.  In this method, excess earnings represent Total Practice Earnings (salary + bonus + company profit) in excess of the sum of “reasonable compensation” and a reasonable return on the practice’s Net Worth (Assets minus Liabilities.)  When the estimated value of excess earnings is multiplied by a factor (the multiple) reflecting the relative risk of the earnings stream, the result is goodwill.  Goodwill plus Net Worth equals the total value of the practice.

While the excess earnings method itself is quite straightforward, determining what constitutes reasonable compensation is anything but.  Even “experts” can draw vastly different conclusions on this topic.  Clearly, if there is no agreement on what level of compensation is reasonable, there can be no agreement on what is excess.  This post will seek to demystify this question and clarify the process.

The Excess Earnings Method is based on the principle that the vast majority of the value of a sole practitioner’s private practice is the capacity of the practice (the practitioner) to generate net income after all expenses.  This principle is common to virtually all types of businesses. The difference here is that this method requires that the earnings of the practice be compared to those of “comparable” practices.  The following scenario will help to illustrate the fundamental issue in this comparison.

You, the sole practitioner, have decided to take a year off and sail around the world on your boat.  {To simplify this example, we will assume that Net Worth = $0}  Your task as CEO is to hire a person with identical skills and experience to manage your business, and to provide all the services your clients require.  This individual would be neither an owner nor a partner in your firm.  What would you have to pay this person?

Let’s assume that you could hire an equally competent replacement for yourself for $150,000 per year.  If your Total Practice Earnings = $400,000, Excess Earnings = $250,000.  The difference between the non-owner’s compensation and your Total Practice Earnings reflects the benefits of ownership.  In other words, you compensate yourself at the $400,000 level not because that reflects market rates, but simply because you own the company, and you can.

While the concept and the basic calculation are easy to grasp and implement, the problem arises in determining precisely what constitutes market rates.  There are two ways to do so.

  1. Find at least one economically similar practice that employs a practitioner of comparable skills and experience to you.  Where such arms-length financial arrangements exist, they represent best evidence.  Unfortunately, such direct comparisons are typically few and far between.
  2. Much more common is to rely on the estimates of other sole practitioners in your field as to what such a non-owner employee would earn in their practices.

The lynchpin of both avenues of inquiry is the identification of one or more economically comparable practices.  By what standards does one determine comparability?

First, the practitioners must be practicing in the same or closely related specialty, however unusual or thinly populated.  To compare a transplant specialist with a cross section of general surgeons would be of little help.

Second, the backgrounds and credentials of the practitioners must be quite similar.  This does not mean that they went to the same medical school or had virtually identical residencies.  However, one cannot very well compare someone who is board certified in a specialty with one who is not.  Nor is one likely to find a helpful comparison between individuals whose time in practice varies by 15-20 years.

Third, economically comparable practitioners must function at about the same skill level, and be so recognized by their peers.  Fortunately, the narrower the specialty, the better known are the few leading practitioners and, therefore, the easier it is to obtain such judgments from colleagues.

It is important to keep in mind that we are not comparing the Total Practice Earnings of similar practice owners.  That would defeat the basic objective, which is to determine the incremental increase in Total Practice Earnings resulting from self-employment.  Only by making that determination can we determine the value of ownership in the private practice and, as a result, the value of the practice itself.

PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state.