The Salary Sage

MEASURE OF THE MONTH -- Appointments

DEFINITION

Scheduling, preparing for, attending, and following-up on sales calls.

CALCULATION

This measure involves some or all of the following elements:

1. Identifying the lead.
2. Scheduling the appointment.
3. Preparing for the appointment.
4. Conducting the appointment
5. Following up after the appointment
6. Closing the business

WHEN TO USE THIS MEASURE

Certain types of sales processes lend themselves very well to this measure. These are processes where it has been determined in advance that the sale is a "numbers game;" that is, where a certain number of phone calls generates a certain number of appointments, which leads to a certain number of meetings, which results in a certain number of proposals, which ultimately produces a certain volume of sales. In these situations, it is essential that sales people "make their numbers."

That said, many people, including me, shy away from measures like these, favoring instead measure that focus on the desired outcome (i.e., the sale itself) rather than the steps along the way. In addition, experienced sales people don't appreciate being "micro-managed" and may perceive such measures as demeaning. It is important to recognize that not every sales person approaches the sales process the same way.

That said, there are certain situation where measuring and paying for key sales milestones works well:

1. When you have an inexperienced sales force
2. When you are certain that following a certain process will maximize sales
3. When you have a large and/or geographically diverse sales force making consistency important.

HOW TO USE THIS MEASURE

When you use this measure, remember to:

1. Specify in detail what constitutes a "qualified lead" and only give credit for these leads.
2. Couple process measures (like appointments) with results measures (like closed business) on the incentive plan.
3. Weight the results measure (the sale) higher than the appointment since that is what you are really after.

WHO IS MEASURE BEST SUITED FOR?

This measure is best suited to new or inexperienced sales and/or marketing people as a way to motivate them to follow a particular sales process and to reward them when they successfully achieve certain milestones.

CAN THIS MEASURE BE GAMED?

If you pay for appointments, you will get appointments. But you may not get the type of appointments you really want. We have all heard stories of sales people padding their calendars with friends, neighbors and relatives just to show activity, even though it is not likely to produce business. When using this measure, be certain to define in detail what constitutes a "qualified lead" and only give credit for those leads.

It is also important to make sure that sales people document their appointments and that the sales manager follows up to make sure that not only did the neeting happen, but they happened the way the sales person said they did. You don't want to give credit for an appointment that lasted 5 minutes because the prospect had to leave or one that didn't happen at all because the prospect called to cancel.

I may sound cynical, but these are the kind of issues that come up when you decide to measure the process rather than the outcome. If you use these types of measures, you should be fully aware of the behavior they can create.

EXIT STRATEGIES

In the final of three entries in the recent series on ESOPs, I discussed the merits of one particular type of ESOP, Employee Stock Ownerships plans. This type of ESOP is designed for business owners to sell all or part of their business to their employees. This can be a very effective exit strategy for owners who wish to detach themselves from the business.

This got me thinking about exit strategies in general, so I decided to include additional information. 

What Is An Exit Strategy?

Business owners have dreams. Successfully growing the company is one of them. Building and running a successful business has it’s own rewards; but the real payoff comes when the company has material value in the market place. That’s where an exit strategy comes in. An exit strategy is more than a last minute way to detach oneself from a changing business -- It is a comprehensive plan designed to ensure that the business grows and develops in ways that will help owners achieve their personal, professional, and financial goals.

When Should I Create One?

Most people think an exit strategy is the last thing they do before leaving the company. In truth, by that time, it’s way to late. The savvy CEO develops an exit strategy long before that ‑ perhaps as early as the initial business planning process!

Where to Begin?

A good place to start is with an Owner’ Profile. This involves extensive goal-setting around both the lifestyle the owner hopes to lead, and the type of business s/he wishes to build (and sell) in order to achieve it. Such a profile encourages owners to reflect deeply on their values, beliefs, motivations, and goals regarding current and future wealth. The goal is to examine and identify the elements of the lifestyle owners wish to lead, and the people, organizations, and causes they hold in highest esteem. This will lead to early decisions about how owners spend their time and money, how much money will be required to accomplish their goals, and how they will distribute their wealth to heirs and benefactors. It is true that business plans and exit strategies must change due to economic and technological circumstances, but it is easier to edit than it is to create.

What Comes Next?

Armed with a clear and compelling understanding of where the owner hopes the business will take them, they are equipped to take the steps necessary to make it happen. When it comes to that, I think in terms of the following steps:

1. Market Analysis ‑ This involves studying industry trends, evaluating the economic outlook, and reviewing recent M & A activity.

2. Company Valuation‑ This entails establishing the company’s true value using key variables such as EBITDA. It might also involve paying a professional for an independent valuation.

3. Acquisition Strategy ‑ Key elements of this plan include determining when the company is ready to sell, deciding how and when to contact prospective buyers, and developing the preferred transaction structure.

4. Acquisition Team ‑ This includes gathering all the specialized support necessary to do the deal including accounting, finance, legal, tax, financial planning, and brokerage.

5. Marketing the Company ‑ This involves more than just selling the bottom line: It involves packaging the company in a way that evokes excitement and enthusiasm from prospective buyers.

6. Pre-Qualifying Buyers ‑ Preparing the company for sale is half the battle; the other half is finding the right buyer.

7. Preparing Employees ‑ Preparing employees for change is one of the most frequently mishandled aspects of the sales process. Done right, employees are energized to face the challenges ahead. Mishandled, the company stands to lose its key talent.

8. Negotiating the Sale ‑ When you get to this point, you’re almost there. But this is no place for amateurs. Get good help!

9. Due Diligence ‑ More promising deals fail at this time than at any other. Again, plan well and get good help.

10. Motivating Employees ‑ In most situations, maximizing value depends on keeping employees focused and motivated before, during, and after the sale.

11. After the Sale ‑ Even after the deal is done, there’s still work to do. This is the time for earn-outs, transition strategies, and integrating diverse cultures.

In the end, my message is simple. Don’t wait until the end to develop an exit strategy. Create one early and update it as you go along. This way, you will increase the likelihood that the business will help you fulfill your lifelong dreams.

The Right Leverage Can Move Mountains

In the last entry I addressed how much stretch to build into goals. In this one I take a look at another key element of incentive design, how large should the incentive earning opportunity actually be? Incentive opportunity is also referred to as leverage (because it is normally calculated as a percentage of base salary or salary range midpoint), or dollars at risk (because incentive dollars are not guaranteed. Whichever term you use to refer to it, the table below gives you a rough idea of what would be considered typical leverage for a variety of positions:

(1) Sales positions at this level may have a Target greater than that shown depending on the nature of the sale. Some sales and sales management positions may even have targets as great as 100% of base salary. Click here for more information on setting sales targets.

Check out Incentive Plan Builder for more information on payout targets.

Goal Setting & Probability of Achievement

When designing incentive plans, the question often arises "how hard should it be to reach target?" There are many theories about this, but in general I follow this approach:

I like to set Threshold (i.e., the minimum level of performance below which there is not payout) so that there is 1 in 5 (20%) chance they WON’T be met. This is important. Thresholds should never be set so low that they are virtually guaranteed. When that happens, the company very well might be making payments and getting nothing of value for them. On the other hand, if Thresholds are too difficult to achieve, too many people will fail to reach them and the incentive plan will be perceived as unrealistic resulting in many participants not even trying.

I like to set Targets (i.e., the desired or expected level of performance) so that incentive plan participants have a slightly better than 50/50 chance of hitting them. Am I a “softy?” Maybe, but I prefer to look at it this way – Success breeds success. And I would much rather have people hitting targets more often than not for the confidence that provides. Yes, you may say, but aren’t you giving away money? No, because I always make sure that the company’s return on performance is greater than that of the employee. That way, I can always be sure that the Company is better off having the results than not having them. Yes, you might add, but what if the company would have had the results anyway? To this I would answer, you might get away with that for a while, but eventually employees are going to feel used and undervalued and either leave, or worse yet, their body will keep coming to work but they’ll leave their brain at home.

As for Outstanding, that should be a real stretch. I like 10% because that suggests that one year in 10 someone could reach or exceed them. Said another way, if 10 people are given the same goal one might reach the Outstanding level of achievement. Going beyond Outstanding can be a very good thing for both the employee and the company (provided the goals are set right). This is the stuff myths are made of. When someone goes beyond outstanding, the word gets out and, if you play your cards right, everyone will be imagining it might happen to them. And good things happen when people dream!

In summary, when goals are calibrated correctly, in any given year (or on any given measure), you would have 80% of employees "in the money" by being above Threshold (20% would be below Threshold and earn no payout), 50% to 60% at or above Target, and 10% at or above Outstanding.

Establishing the right probabilities of achievement when setting goals is something of an art form and it can take am few years to get it right. If you keep the probabilities mentioned above in mind and check actual results against them each year, you can fine tune your performance predictions until you reach the right overall levels of achievement.

Check out Incentive Plan Builder for more information on goal setting.

The ESOP I Love and the ESOP I Hate (Part 3)

And now, for something completely different. . .

The last two blog entries have dealt exclusively with one type of ESOP, the Employee Stock Option Plan. If you have read those entries, you know that I am not a big fan of such plans. In this third and last installment of the three-part series on ESOPs, we are going to look at an entirely different type of ESOP, the Employee Stock Ownership Plan. What a difference a word can make. This type of ESOP, while not appropriate for every company, can be an enormous benefit when all the right pieces fall into place.

A TRUE WIN/WIN

The term win/win is thrown around rather blithely, but in the case of an ESOP it is really quite accurate. An ESOP simultaneously does all of the following:

1. It provides an exit strategy to owners of privately held businesses by using company profits to fund the sale of the business to the employees.
2. It enables employees to acquire ownership in their company without having to invest their own money.
3. It creates a beneficial relationship between the company and federal and state governments by allowing the Company to use pretax profits to fund the buy-out of the owners.
4. It provides significant tax and retirement benefits to the employees after they become owners.
5. It provides continuing tax advantages for the company after the original owners have sold the business to the employees.

That is the essence of an ESOP. Of course, the devil is in the details and ESOPs are usually highly complex to set up and administer. But beyond the near term financial benefits already mentioned, there are a host of other benefits:

1. Because ESOPs are wholly or partially employee-owned, they tend to have a very unique corporate culture that is built around openness, fairness, and egalitarianism.
2. ESOP companies tend to enjoy unusually high productivity that stems from high levels of employee involvement.
3. ESOP companies tend to place high importance on employee education, participatory decision-making, and open communication.

In general, this makes them a lot of fun to work for.

THERE ARE SOME DISADVANTAGES

As I mentioned earlier, ESOPs are not for everyone, and it is important to consider the downside before taking the plunge. Here are a few things to keep in mind:

1. Availability of Financing -- Fortunate are those companies that are able to finance the sale of the company to employees through cash-flow and associated tax benefits. But most often some form of financing is required. If the transaction is financed with a bank loan, the company must have the ability to qualify for this loan. Otherwise the seller may have to give a personal guarantee and/or self-finance the sale.
2. Disclosure -- ESOPs are required by law to produce a considerable amount of paperwork for the government and the employees.
3. Valuation -- ESOPs must secure an independent valuation each year to establish the value of the stock.
4. Liquidity -- In order to fund transactions as employees leave and/or retire, an appropriate amount of cash must be kept on hand to repurchase their stock. This is not normally a problem for the first few years, but it must be carefully managed after that.
5. Fiduciary Liability -- The plan committee members who administer the plan are deemed to be fiduciaries and can be held liable if they knowingly participate in improper transactions.
6. Stock Performance -- If the value of the business does not increase over time, the employees may feel that they would rather have a cash incentive rather than the deferred benefit provided by an ESOP. In the extreme case, if the company goes out of business, employees stand to lose everything in their ESOP account.

THE BOTTOM LINE

Clearly, the brief and simple description of both types of ESOPs reveals the complex nature of these types of pay plans. To sum it up, I would steer clear of Employee Stock Option Plans in favor of annual cash incentives (provided the cash incentives are self funding and the company can afford them). I encourage owners of privately held businesses who seek an exit strategy to look into Employee Stock Ownership Plans as they provide intriguing possibilities

MORE INFORMATION

Check these links for more information on Employee Stock Ownership Plans:

Menke & Associates -- Consulting firm specializing in setting up and administering ESOPs

National Center for Employee Ownership -- National association made up primarily of ESOP organizations

Great Game of Business -- Organization dedicated to disseminating the principles of employee ownership

The ESOP I Love and the ESOP I Hate (Part 2)

In Part 1 of this three-part series on ESOPS, I expressed concern that the combination of economic uncertainty, cost-cutting measures, and unwarranted vilification of cash incentives might result in an upsurge in Employee Stock Option Plans (ESOPS). In that posting, I described my concern in terms of the following objections:

• The volatility of share price
• Minimal employee impact or control over this price
• The artificial illusion of extreme value fostered by granting large numbers of low-value shares
• Managers creating unrealistic expectation of the future value of options
• Excessive complexity and administrative expense
• The huge distraction (even obsession) caused by such programs
• The tendency for options to create more selfishness (and jealousy) than teamwork

But this is only the tip of the ice-berg. The effectiveness of any compensation program is directly related to how well employees understand it. Since stock options are among the most complex compensation vehicles around, a major communication and education effort is essential in order to avoid confusion and dissatisfaction. This is particularly important with options because unlike other forms of compensation, there is a long list of gotchas than can creep up to bite employees in the backside and shatter their expectations. Below is a list of some of these things:

VESTING SCHEDULES

Stock options are rarely owned by employees when they are granted. Instead, the employee "vests" or qualifies for their options over time based on some schedule. These schedules often require employees to wait 4 or 5 years before they actually own the options granted to them when they join the company.

DILUTION

Dilution occurs when investors put money into the company and receive stock in return. This has the immediate effect of reducing the value (not the number) of everyone else's shares.

REVERSE SPLITS

When companies go public, it is not uncommon for them to declare a reverse split. This is an instantaneous reduction in the number of shares owned by all employees. One of my clients had been telling employees for months that their stock would be valued around $12 per share when it went public. They neglected, however, to mention that this was after a 10:1 reverse split (they argued that such information would demotivate the employees so they conveniently suppressed it). So while it is true that the stock did come out around $12 per share, every employee lost 90% of their shares, effectively making their stock worth $1.20 per share, not the $12 they were promised.

BUY-OUT CLAUSES

Some stock plans involve buy-out clauses that enable management to buy-back employee shares at any time at the fair market value that exists when the buy-back occurs. I once owned a 5% share in a Company that was rapidly increasing in value. When management saw that the company would be worth a fortune in a few years, they activated the buy-out clause, paying me a small amount for shares that three years later were worth a fortune.

PREFERRED STOCK

Stock options are granted as common stock. But some companies also issue preferred stock (usually to investors) with considerably greater privileges and hence value. Since preferred stock gets paid out first, there are many instances where the holders of common stock (i.e., the employees) end up with nothing.

EXPIRATION

Stock options normally have expiration dates. It is possible for employees to wait 5 years for shares to fully vest then have them expire before they are worth anything.

LITIGATION

Not surprisingly, with such complexity, uncertainty, confusion, and greed, stock options are ripe for litigation. This is a great boon to lawyers, but a source of enormous frustration, delays and ultimately disappointment for employees.

VALUATION

Before a company is publicly-traded, the value of stock options must be determined through an independent valuation. This amounts to a complex financial analysis followed by a judgment call on the part of a valuation professional. Such professionals value companies based on a number of different variables, but the most important one is profitability. Unfortunately, profitability can be easily manipulated by those with a controlling interest. I have one client whose company profit is severely impacted by the owner's lifestyle, much of which is charged to the business (corporate jet, country retreat, expensive meetings in exotic places). By the time all this is over, there isn't much profit and the value of the business is adversely impacted.

THE BOTTOM LINE

Whenever I am advising business owners about whether or not to create a stock option plan, I usually suggest they keep their equity and find other ways to motivate employees. Whenever I am advising employees about whether or not to accept a job involving a significant cut in pay in return for stock options, I usually suggest that they negotiate for more cash or look for another job. At the end of the day, stock options don't do the company or its employees any favors. Both are better off making effective use of incentives which are far better at driving results. They also pay employees in something they can count on, cash.

In the next entry of this three part series, I will take a look at the type of ESOP I really like, the Employee Stock Ownership Plan.