Don’t Leave Compensation Out of the Ownership Transition Process

The right compensation plan can help E&C firms retain key people, prepare future owners and reinforce the behaviors the business needs during ownership transition.

Ownership transition forces E&C firms to make decisions that go well beyond who buys shares and when. Current owners have to decide who gets invited into ownership, who doesn’t, what the next generation can afford and what the business requires from key people who may never hold equity. Those decisions affect compensation, status, loyalty and future control, which means firms can’t afford to leave these conversations out of succession planning.

Here’s why: Experienced project leaders, executives and operators know they can simply take their skills somewhere else or even start their own company. Some may also find ownership opportunities at other closely held firms. When ownership isn’t available inside their own companies, the compensation plan has to provide a real reason to stay invested in the business they’re helping build.

“As people grow as leaders and prove they can perform in key management roles, they may recognize they could do it on their own or seek ownership opportunities elsewhere,” says Priya Kapila, partner with FMI Corp. and head of the company’s compensation and rewards team. “Owners have to understand that reality. If an ownership stake won’t be offered, there must be attractive alternatives that keep key people engaged and committed to the business. In many cases, compensation programs are the most natural substitute.”

Using Compensation to Support Succession

Ownership and compensation are very distinct from one another, but they can intersect during a transition. Equity transfer generally leads to the conveyance of decision-making rights and a share of the company’s worth, while compensation plans give firms a more flexible way to keep important people engaged, reward strong performance and, when applicable, prepare future owners.

When a business undergoes succession planning, whether in terms of leadership changes, ownership changes, or both, there are essential issues which impact leaders’ compensation packages that must be addressed. Are there current, high-performing employees with the potential to become future owners, and do they have the funds to buy in? Are there other key employees who will never be owners? And are there other key employees who are not yet ready for ownership, for whom retention and continued professional development must be made top priorities? The answers to these questions matter because not every compensation tool solves the same problem.

The reality is that not every strong performer will become an owner, and not every person who desires ownership will be ready for it. Kapila says firms need criteria for who belongs on the ownership path, what is expected for future owners to demonstrate readiness and how the company will recognize key people who may never hold equity, but still matter to the business.

As a company defines its path for succession, compensation conversations should become more focused. Objectives for compensation programs to support succession can be clarified (e.g., retain key people, encourage and reward their performance or financially prepare future owners for equity purchases). Questions to ask to ensure compensation programs meet the intended objectives include:

1. What role should cash play in the transition? Companies have long used retention bonuses, special awards and other cash payments to secure the permanence of vital individuals during a transition period. Those payments can work, but they only go so far. A check may keep someone from leaving, but it doesn’t make that person think like an owner or compel them to make better decisions for the company.
2. What results should be rewarded? A stronger option ties cash to performance. Instead of paying people just to stay, the company rewards individuals for their efforts to advance business success. Company performance goals may include profitability, company value, project results or other measures the person can influence. “By attaching performance metrics — aligned with corporate strategies and owner expectations - to incentive compensation plans,” Kapila says, “you can create a stronger connection between non-owner leaders and existing owners.”
3. How far ahead should incentives reach? Long-term incentives usually support ownership transition better than an annual bonus because they reward people over the course of several years. These programs can also give non-owners a way to share in company-value growth without receiving equity. “An ownership mentality is something you want to sustain over time,” Kapila says. “Long-term incentive plans are often designed to establish mutual benefit for owners and non-owner leaders when a company performs well. Furthermore, if performance targets are missed, non-owner leaders may also experience a reduction in compensation as owners experience a loss in equity value.”
4. Can incentives encourage the development of future owners? In some cases, long-term incentives can help current owners evaluate prospective future partners before the company opens the ownership door. Leaders can see whether potential owners think beyond their own roles, contribute to firmwide performance and stay committed over time. With the right feedback and transparency, key employees can also get a better sense of what ownership requires before purchasing equity and locking arms with other owners.
5. Will the plan help futures owners fund a buy-in? “When leaders are identified for future ownership, the likelihood that they will have independent wealth available for equity purchase is low,” Kapila says. “In these instances, a long-term incentive plan may be structured to payout cash on a schedule linked to anticipated ownership transitions.” This way, an employee may be able to use the long-term incentive proceeds to buy into the company. Financial implications for the company and prospective future owners must be assessed. “Long-term incentive awards have to be substantial enough to allow leaders to eventually make a significant purchase down the road,” Kapila says, “but not so much money that you’re creating cash flow constraints.”

Pressure-Test the Plan First

A strong leadership compensation approach must start with an expansive view of the full picture. Salary, annual bonuses and long-term incentives should work collectively, and should not strain cash flow, bonding capacity or banking or surety relationships.

Before implementing new leadership compensation plans, identify who may become an owner, who likely won’t and how best to ensure all leaders are recognized for the value they bring to the business moving forward. When identifying prospective owners, be sure to ask the right initial questions: Do they want ownership? Do they understand the capital commitment, personal risk and accountability that come with it? Can they think beyond project-level execution and make decisions for the broader company?

Clear communication among existing owners, as well as among all leaders, can help build or refine compensation plans around real people, real expectations and what the business can afford. From there, review the full pay package, define company performance expectations and test the plan against the business. Because these decisions affect people, ownership and company control, an outside perspective can help pressure-test the plan before the company puts it into action.