“What is strategic remuneration, and what does it have to do with selling a business?” Few organisations apply anywhere near as much scrutiny to remuneration programmes as they do to even relatively minor capital expenditure proposals. In this episode we’ll drill into the importance of strategic remuneration. We give our listeners real examples on when this strategy could be beneficial in a business sale context.
- Why are we talking about this?
- What is strategic remuneration?
- How to make incentive schemes work for your business
- Action items to consider
Joanna: It’s Joanna Oakey here on Welcome back to The Deal Room Podcast. A podcast proudly brought to you by our commercial legal practice Aspect Legal. Now today we have on the show Simon Clatworthy from Start Your Earn Out Now. He is going to talk to us all about the concept of remuneration of your staff and what on earth that has to do with selling your business.
So Simon, thank you so much for coming on board to chat to us today.
Simon: You’re welcome.
Why are we talking about this?
Joanna: Great. Okay. Let’s start off with why are we talking about this topic.? What on earth does remuneration of staff have to do with selling a business. I think it’s probably fair to say it’s not the first thing that business owners think of when they’re looking at selling their business.
Simon: No and I think that’s fair I think the first thing that a business owner will think of when they’re looking to sell their business is – What’s my profit or my EBIT – my earnings before interest and tax because that what most people think of when they are looking to do business taking that value and multiplying it by some deemed market multiple to the right price. But if we then take a step back from there and say what is the driver of that profitability if you like. And invariably your team and your staff are one of your core assets and you need to ensure that they are being appropriately remunerated prior to sale and post sale to ensure that your key staff remain with the business after you sell it. My experience has obviously always been the case those purchasers say what and how are you going to ensure that your team that I’m going to acquire are going to stay with me after you’ve gone and you’ve sold the business.
Joanna: Yeah, it’s a really good point.
It’s interesting that you say this because I have a for sale matter sitting on my desk right now that just came in this morning where one of the key terms I can see the buyer is after is a warranty from the seller in relation to the period of time that the staff will stay and it’s a little bit scary for a seller at that point to then realize that they are exposed to the extent that their staff may not stay on board. So the buyer’s issue also becomes the seller’s issue in that sense. So I think it’s really topical and certainly I’ve seen many transactions suffer problems where staffing hasn’t been considered early enough and staff are viewed to be an important function of the value in the business.
What is strategic remuneration?
Simon: I agree with that and I think it even goes right back to actually the building blocks of what makes up an employee’s remuneration and that’s why I talk about this concept of strategic remuneration whether you’re buying or selling a business.Strategic remuneration to me just very simply in so far as the depth on it is the alignment of employee remuneration with the goals and aspirations of the business. I think traditionally family owned businesses in particular go to market and say well they might go to a H.R. consultant so what’s the median or the middle price band that I need to pay to get someone in this role. And they’ll just go and pay that person a fixed salary and then the person comes on board. There’s no flexibility in and around good performance bad performance other than performance management with regards to the way in which you reward or not an employee where to me a strategic remuneration component then comes in when we break the constituent parts of remuneration up between fixed remuneration being the base salary, benefits, superannuation and the likes and the variable piece. The variable piece traditionally would be called an incentive or a bonus. I mean family businesses are very good at giving Christmas bonuses and discretionary bonuses. To me that’s not strategic at all. That’s just to give someone something. There’s no correlation to that figure to a specific objective for a set of criteria that has been achieved.
How to make incentive schemes work for your business
Joanna: Yeah. I think one of the objections that I hear sometimes in relation to using incentives or whatever you want to call them as part of a package is number one the staff concern over how that’s going to be calculated and how much they can rely on that because I guess it’s really important if you want to incentivize staffing the right way that they feel that there are parameters that are within their control and that they are actually going to get the incentives at the end of the day I think there’s a real feeling around in terms of staff as a whole that incentives aren’t actually part of the remuneration they’re just a bonus that they hope they get in many instances. So how do you deal with that component.
Simon: You Then come back to this whole concept of the alignment between the variable remuneration component and what the company is trying to achieve as a whole you would normally create what I would call the alignment between the profitability of the organization or me as a driver in it as well. So what I’m trying to do when I develop these remuneration schemes is to ensure that the employees get rewarded for the value that gets created within the organization such that they get rewarded if the value of the business goes up or the profitability goes up. There’s a co sharing environment.
Joanna: Can you give me an example of where you’ve seen this work really well?
Simon: I’ve seen it work very well and the majority of the clients that I’d design for I can think of an engineering company which we put an incentive scheme in place. We replaced a discretionary bonus and financial model which we said if we have a certain operating profit definitive value and an operating profit to revenue number there would be a certain a calculation which was overt and everyone on the team were able to see what the calculation was and we illustrated to them to say for each incremental dollar of EBIT or operating profit that was an employee pull whether you were deemed to be great, good or average as former based on a predetermined set of measurable performance criteria you got a different rating which then gave you varying levels of pro-rata allocation into that profit pull. We did that and we saw the company improve it’s performance in the first year by 20 percent. Was that as a direct result of the incentive scheme? I don’t think you can say that it was silver bullet but certainly it did result in the employees becoming far more aware of what actions they could take which resulted in the profitability of the business being improved and revenue growing. The real driver or the real key to successful incentive schemes is making sure the employees understand what they need to do what buttons to push, what levers to pull to get that improved performance which gives an increase of payable to the employees or participants if you like.
Joanna: And I guess implicit in all of this appears to be that the employees then are aware of the objective of the owner in selling the business and brought along on that journey and participating in that journey is that right?
Simon: I think what we’ve spoken about before doesn’t necessarily have to correlate to a business being sold but obviously if you’ve got a well functioning business with a nicely aligned remuneration plan for the employees it goes hand in hand to suggest that we should have a more more valuable business and we’ve got to a system and a scheme in place such that when the business does get sold there’s a scheme that’s already in place that through law an employee can’t get reemployed on terms and conditions any less favorable. So the scheme has to have either longevity to go into a new owners environment or another scheme needs to be created such that they know they are no worse off financially.
Joanna: Right. I see. So you’re talking about this in terms of you’re not necessarily linking it to an actual sale that’s achieved you’re just linking it to the value of the business or the growth in the value of the business at the time.
Simon: Correct. Obviously if we’re then readying the business for sale we can relay an additional component to the variable remuneration component which says if we do sell a business we can give a percentage of the business back to a number of or a poll of employees such that the value that’s been added to during that period and upon the realization event occurring there’s a pool of money which get made available to them and the other part that I think really dovetails beautifully in this business sale component is if you like the retention bonus which says I do sell the business and there’s a requirement for you to start a minimum of 12 to 18 24 months and by being the owner of the business even though sold it will ensure that the end of that period there is an additional amount of money that is available to you. And I’d have two transactions in the last year where the buyer has demanded as a condition of sale and one transaction was 8 percent and the other transaction was 10 percent of the sale value was made available as a retention payment to the key people that needed to stay within the business. Obviously they opt to stay for a period of time anyway so of that five and 10 percent. Half of that was going to the owners. The other half was going to a number of key executives.
Joanna: That’s really interesting we’ve seen this operate successfully quite a few times as well. One of the examples that comes to mind where I saw it work particularly successfully for when we were acting for a buyer. So coming from a buyer’s perspective in this particular instance we’re acting for an offshore by who is looking to enter into a market in Australia and so to do that they did that via acquisition and because they were offshore it was incredibly important to them that there was a continuity of the team here in the Australian firm that they acquiring particularly for at least that first 12 month period. And so what the seller had done he had set up this remuneration strategy for the key staff that incentivized them throughout the sale in relation to a successful transaction and staying on post transaction for I can’t recall but now I think about it was around about 12 months but the benefit of that was our client’s clients sitting in the position as buyers really help them.
I could see how it impacted them throughout the transaction because it really gave them a lot of comfort and when a roadblock occurred you know as it happens that bumps occur in all deals to some degree or another and when bumps occurred this assurance that they had in relation to staff attention because of the way the incentives were built was really something that worked well for them and so therefore it worked really well for the seller as well because it saved the deal at times when there were issues that had appeared.
I’ve seen other organisations tried as well and sometimes that don’t work so well so I do think to some degree it depends on how well you set it up. I think the other interesting component of it is this – this component as to whether or not it’s linked to business performance as a whole or whether the seller is being really clear with the team about what their objectives are in building to a sale and then transition post sale. Because in this environment that I’m talking about there was a lot of clarity for the whole team about what the owner was doing in terms of selling and I felt that that really helped the transition occur really well in that instance.
Simon: And I think the whole purpose of transparency openness honesty plays a big part in all forms of remuneration because what the owner of the business is saying I’m happy to share some of the proceeds from sale with you and recognise that you’re an integral part of the transaction and not only did you get a piece of the transaction on sale in the event and this is where it comes in nicely into this horrible territory of earn outs. I’ll give you a piece of the earn out as well. So the more I get out of the earn out the more you get as well. So the employees then become very much aligned to ensuring that the business continues to perform as best as possible during that post sale period and such any need to stay. Secondly if there is a performance matrix put in place in and around the post sale consideration i.e. earn out being paid. The Employees that are staying there are incentivised on top of what they normally would be to ensure that the owner becomes payable.
Joanna: Yeah that’s a really great point and I guess the one thing that we should mention in doing this is there might also be taxation elements to consider. So of course you have to be clear about who has the obligations for payment and if that is the seller themselves to the extent that it’s connected to them getting the earn out then you just have to be careful how that works because the seller may not want to be in the position where they’re paying tax and then you gifting the fund. So there’s all of those sorts of things to get your head around as well.
Simon: Yes taxes is a very important consideration in any transaction. But what I have tended to do in the past which works quite well with these sort of earn out aligned incentives is to put into the agreement what percentage of the earn out is available to the remaining employees such that the purchaser then pays it. So rather than going the seller of the business and then having to pay when they no longer his employees. The buyer is paying by deducting what otherwise would have gone to the employees. So the vendor of the business gets let’s say 80 percent of the earn out and then 20 percent obviously gets paid by the buyer.
He would have been paying that amount anyway but rather than going to the seller it goes to the remaining employees.
Joanna: And I guess from a legal perspective the sorts of things that we’d look at there is who are we actually sometimes this is set up better as than something from the employing entity directly with a staff to the bit of degree it can be to reduce the number of parties that we have to include the direct contractual relationship with.
So there’s all sorts of considerations here I guess we’re saying Simon.
Simon: Absolutely. Indeed it has. I think why I like the sort of wholesale incentives is it gives the buyer greater comfort.
That he or she is going to retain the services of those employees executives moving forward because they’re incentivized to stay.
Joanna: And as per my example, I think that that has a lot of cut through for many buyers in terms of them having something that they can rely on in terms of key staff retention over that critical transition period and initial operation period post completion.
Joanna: All Right. Well look I think we have covered some really useful topics here today, Simon. Is there anything that you would like to leave our listeners to think about. I mean been sort of a short discussion about what is quite a complex area but what are the action items that you would be suggesting and how soon before sale should businesses be thinking about it? Although, I guess you’d say even if you’re not looking at sampling maybe this should be a consideration.
Action items to consider
Simon: I think very much along those lines I think every business owner should pause and think about the way in which they remunerate their staff and the remuneration structure that they currently have, that they have in place delivering the results that they want. Can they design it better? And I think the key takeaway is don’t borrow someone else’s scheme. Make sure whatever you put in is appropriate for you. Every organization is unique so don’t think that what worked in one environment will work in another. You need to stop. And reflect and most importantly make sure that the way in which you pay your staff is going to give you every possible chance of achieving your organisational goals whether it be short medium or long term.
Joanna: Yeah I think absolutely right and I really like your comment about being careful about replicating entirely someone else’s scheme or another thing that you’ve seen.
I think one of the issues with that is in this particular type of area there is so much tailoring I think that probably is required in terms of how to make sure you’re aligning the staff with the actual business in the way that it operates. Because businesses operate differently and have different levers and of course each staff member within an organisation has different levers that they’re able to control and be going to I guess be motivated by an incentive in relation to. So I guess they’re all the reasons why it’s important to look at your particular situation in a separate way to perhaps how you’ve seen the templet do it.
Simon: Correct and in that vein take your time don’t rush it.
I would say more companies get it wrong and get it right but that’s not an excuse to not do it at all and I think it’s really important that you do look to do it for the right reasons and I suppose one of the other aspects of having a level of variable pay in someone’s remuneration package are like from a business owners viewpoint means that if you’re having a tough year you don’t actually have to necessarily retrench people to cut your remuneration costs because of you took a view that 80 percent of someone’s remuneration was fixed 20 percent was based on individual and company performance and if companies not performing, you may save 10 percent of the total remuneration that may have been available to the employee. So it means that your fixed cost is therefore lower and as a result of that you may not need to let go of good staff in tough times. And that’s one of my key selling points that I put across to organisations because the last thing you want to do is lose good staff.
Joanna: It’s interesting as well to think about the industries that this is applicable to I mean for some industries, this type of approach is actually quite standard. I guess the real challenge here is for businesses where this is not quite as standard in the industry or perhaps for the types of positions that we’re talking about for key staff it’s not quite as standard perhaps the message is don’t just discount this because you don’t know many other people doing it and you don’t know how to achieve it look at it in the context of what the impact could be in relation to your business.
Simon: Well I think the other aspect is when you’re looking at trying to pull it together look at the total remuneration that you potentially are looking to pay someone and don’t be afraid to have a high threshold and that of all the stars align and everything goes absolutely perfectly well that person can earn an amount of money which may fall out of a traditional band for a particular role but it would only be under amazing circumstances that would occur. You obviously need to make sure that you come back and do your analysis to ensure that the way in which you’re structured and designed the scheme doesn’t result in you paying out more money to your employees than you as the business owner have actually gained through the process.
Joanna: But that’s a really good point Simon.
Simon: I’ve seen unfortunately it happen a lot not with schemes I’ve developed but I have seen people put schemes in place and they haven’t done the correct analysis. And the employees end up earning substantial amounts of money and then when they actually look at the way in which it all flowed down to the bottom line of the organisation they actually ended up paying out more money to the employees as incentives than the company actually made from it.
Joanna: I guess that’s a good point so becareful about what you created. Well look fabulous Simon, thank you so much for coming in to talk to us today about this concept of strategic remuneration and how it actually works in not just preparing a business for sale and transition and not just how it can work both from the buy side and the sell side perspective but also how it might be applicable to businesses more generally. Simon thank you so much for coming in. I hope we can have you back one day again soon to maybe talk about some of these issues in a little bit more detail or maybe share some more knowledge you have in this area.
Simon: Thank you very much the opportunity. That would Be great.
Joanna: Excellent okay thank you so much for coming on to the program today. If you listeners would want more information about this topic just head over to our website at thedealroompodcast.com where you will be able download a transcript of this podcast episode if you would like to read it in more detail and of course you will also find details of how to contact Simon Clatworthy at Start Your Earn Out Now if you would like to get in contact with him.
There you will also find details on how to contact our lawyers at Aspect Legal if you or your clients would like to discuss any legal aspects of sales or acquisitions. We also have a number of great services that help businesses both prepare for a sale or acquisition and also help guide them the sale and acquisition process. We work with clients both big and small and have different type of services depending on size and complexity. So don’t hesitate on booking an appointment if you would like to find out how we might be able to assist.
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