Dyanne Ross-Hanson - Key Employee Incentive Plans - Why You Need Them and Critical Design Elements (I1817)

Hey friend, I know how this feels. Waking up exhausted after multiple trips to the bathroom and feeling embarrassed by sudden leaks. I used to be constantly on edge, searching for a restroom whenever I was out. Then I discovered better woman. I was skeptical at first, but two months in, everything changed. I experienced improved bladder control. No more heart-stopping moments when I laugh or sneeze. Less urged to go, deeper and more restful sleep. I finally felt like myself again, confident and in control. Better Woman is natural, effective, clinically tested, and trusted by women for over 25 years. Ready to take back your control? Head over to Bebetternow.com to order your supply today. That's Bebetternow.com. These statements have not been evaluated by the FDA. This product is not intended to diagnose, treat, cure, or prevent any disease. Uses directed individual results may vary. Welcome to the Exit Coach Radio show, the show for baby boomer business owners who are looking for cutting edge information as they plan their 3 to 10 year business succession and exit. Every week we interview top professional advisors for. Their best tips, strategies, and precautions so you can be well planned. And don't miss our one minute exit coach tip of the day on exitcoachradio.com. And now here's your host, the exit coach, Bill Black. Welcome everyone. Thanks for joining us today. Very excited to have you with us. We have a great action-packed show and we're gonna get right into it because we know you don't like to wait. Neither do I. Uh, my first guest is Diane Ross Hansen, and she's joining us from Exit Planning Strategies LLC from Oakdale, Minnesota, and we're gonna talk about what Exit Planning strategies LLC does. They work with owners of privately held businesses to develop intentional ownership transition plans. And their expertise includes internal transitions and key employee incentive plans, among others that help meet the owner's transition objectives. So today we're going to talk about key employee incentive plans, why you need them, and critical design elements. So Diane, welcome to the show and thanks for joining us. Thank you very much, Phil. Pleasure to be here. Thank you very much for joining us. We're always intrigued by this topic, Diane. It's, it's one that is so important for these business owners who are thinking about transitioning out and they're going to have to leave somebody behind in charge who can take care of the business. So we're going to talk about that in just a second, but first, if you would just tell us a little bit about you and your background and what exit planning strategies does. Sure, thank you. um, pleasure to be with you today as mentioned, uh, in the form of a little bit of background information, mine is about 30+ years, uh, primarily in the financial service industry. I started exit planning strategies about 10 years ago. With the goals of, uh, really 3 things I think bringing focus to my area of expertise and passion, which as you had mentioned is working with business owners with the development of intentional ownership transition plans, uh, offering objective fee-based consulting, independent of any predetermined outcome or product. And then finally to address what I think all of us see as a tremendous need for exit planning expertise based upon the demographics and the statistics on the pervasive absence of any sort of exit planning. So again, those of us that specialize in exit planning know the statistics. 75% to 85% of owners' net worth tied up in their business and real estate. Less than 1 in 4 have any sort of a thoughtful, mindful plan, only 9% with any type of documented plan. And let's address a couple words that you used that I really liked. Number one was creating an intentional plan. What happens to most of these business owners that don't have a plan? Why is it so important to have one? Well, for most owners, they've spent a great deal of time and effort in building a successful enterprise and without taking the time to create. an intentional plan, they leave that transaction up to fate, not within their control. One of the things that we stress with owners is that transitioning their business, paying the least amount of taxes, and doing it on their terms is probably the most significant financial event of their life. Well said and and if they don't do anything, I mean, do a lot of business owners still think I'm just gonna worry about that when it's time to sell my business I'll sell it it'll be just like selling a house. OK, so that that's the problem is that they're not cognizant of all that goes into the sale of the business because it is gonna, I mean for a lot of them it's gonna be a one time event. Exactly. And yet it's, it's, it's the, the process of exit planning, as you and I both know, is not an event. It's rather a process and even on internal transitions, 3 to 5 years, well, no, 5 to 10 years for internal transitions, 3 to 5 for what we refer to as a third party or an outside transition. I don't know but I, I agree. I don't know about you, but when somebody asked me when's the best time to plan your exit, I say the best time was was 5 years ago. The second best time is now. If you haven't done anything about it yet, you've got a rude awakening because and the reason is, as you and I both know, but maybe some of our listeners. is because some of these strategies take a long time to to really uh to create value and to lock in key people. It takes time to develop all this kind of stuff and you don't, it's not like you're going to stop everything and just focus on building your exit plan and implementing these strategies. So and it's a team effort too, isn't it? Oh, without a doubt it's interdisciplinary. I tell clients that I can't do my work without an advisory team at minimum their CPA who is verse with valuation and at minimum their attorney. Yeah, and so the second word that you said early on was independent, and that is that as an exit planner you, you're not, you're not managing towards a document or a financial product or a tax strategy you're managing the the owner's expectations and. that that management they will have to implement tax, legal, operational and financial strategies. So you're coming at it and saying let's create it's kind of like the architect of the the the construction project we're going to have to do bring in a lot of people, but we need to bring them in at the right time and for the right project, right? Correct, absolutely, um, great, yeah, so let's talk, let's talk about that and let's talk about what you guys do and one of the most important topics is dealing with your people because. A lot of business owners I talked to, the owner does way too much in the business. They're way too important, and if they sell the business, there's no way they can walk away without the business really falling apart. So tying in and finding and locking in those key people is important. So how do people, how do business owners work with you to develop exemployee incentive and retention plans that are important to the exit plan? OK, well, first of all, uh, when, when owners ask me the question and we talk a lot about building value, um, and, and, and what can we do to do to build value in the company which in turn is going to increase the amount of capital hopefully that that owner will take when they transition out and of course there are a number of different things available to build value but I always say that in my opinion. The greatest single value driver is. Developing, motivating, and retaining a key management bench. And when I say bench, I don't necessarily mean a team. I mean, I do mean a team. I don't mean multiple. It can be one key employee, it can be 5, it can be 10, depending upon the unique characteristics of the business. But the reality is is that key employees, their productivity. Their results are probably the single greatest driver because whether or not the owner is going to be transitioning to an insider, which often are those key employees, or transitioning to an outside buyer, having that stable, motivated, loyal key employee management group is going to increase value, going to allow them to negotiate from a position of strength. I always say that key employees are an indispensable component of any sustainable successful business, and they're a critical ingredient to whatever strategy the owner ultimately designs. So no matter what if they're gonna go to sell to an outsider sell to an insider or just kind of go part time no matter what a key ingredient of their planning is going to be this particular topic. No doubt about it. In fact, even and, and more, more so even in family transitions where perhaps the, the stock is going to be limited to just those family members. Key employee retention motivation, productivity is even as critical there as well. But again, that's a, that's an internal. And an outside buyer as you and I know places significant importance on two primary issues the company's earnings. And secondly, the quality of its management team. They want to know if the management team is going to stay beyond the sale and beyond the closing. I, I hear that over over and over and over again from M&A people that one of the top things that we put the greatest weight on is who is your management team who, who are we getting with this? Good point. OK, so, so what you know, so what are some of the ingredients that, uh, I mean there's, you know, stock and there's, uh, things that mimic stock and there's bonuses and all these kind of things what are some of the the key ingredients um to a plan? Yeah, absolutely, um, you know, the first thing that comes about is that the owner has to identify who are your key people. Now that may seem like a very simplistic question. But the reality is, is that, you know, most often the owner does know who are those key people. They're not the, the, the normal that are just looking for job security, looking for a pleasant work environment. Key employees tend to think like the owner, not only think and act like the owner, but they also often will share an interest in participating. In the growth of the company that they believe that they're responsible in some great part to, to contributing. So, um, identifying those key people and one of the things I already always tell owners that key employees, the importance is to differentiate between key employees and employees in key positions because sometimes those can differ. But when it comes to designing the incentive plans, there are 4 key design variables that I share with owners. The first is having a benchmark financial or performance based that indicates how an annual award will be earned. Without that benchmark, two things happen either the key employees. Suffer from an entitlement mentality. If they get a bonus one year, they want it the next by identifying a benchmark, uh, having to attain it, it takes the owner oftentimes out of the hotspot in feeling obligated to make an award each year. So establishing a benchmark is the first. The second, believe it or not, sounds simplistic, but it's communicating the plan. Communication is key to manage the expectation, as well as illustrate the potential benefit that the key employee is gonna receive. It also offers uh a unique opportunity to Oh, acknowledge the key employees' contribution to the company. So communication is #2. The the third design is is that the, the plan has to be provide for what is considered substantial. award. What does that mean in today's marketplace variable compensation should amount to at least 20-25% of salary on up. Less than that, you're not going to get the owner off and is not going to get the type of behavior. A change that they may be looking for, so it has to be substantial. The last, probably the most overlooked design variable that I find in my experience in working with owners is that some percentage of that annual award has to be deferred rather than outright. The problem with a 100% outright award is that that the, the key employee, you know, is very appreciative, but that, that wanes after a month or two. By having some percentage of that award deferred, therein lies the retention. Feature which is so critical for most owners. So when designing the plan, it's having a formula, communicating it, having it be substantial, and absolutely deferral and or not and or but also vesting. Mhm. Very important, very important to retain that key. By the way, the term key employee I have heard comes from the fact that most shopkeepers back in the early days had one employee that they trusted the key to the shop to. That's that's good that's that yeah that's the key employee and you can picture, you know, that's the person that opens and closes and all that kind of stuff back in the day so so now we have, we have key employees we've got we benchmark it we communicate it because uh a lot of it and it's important to communicate because a lot of them are wondering this topic what's in this for me, you know, if I, if I put in another 10 years or you know what what's my stake in any outcome down the road, uh, the substantial award and deferral, so those are great design. Uh, headings and headings for for designing a plan. Uh, let me ask you a question. When you get into now the the actual design of the plan, a lot of times owners make mistakes along the way. What are some of the big mistakes that you see owners make when they're looking at all this before they even get into this design it component? Mhm. Great question. Two things that immediately come to my mind. The first mistake that most owners make when we talk about key employee incentive plans. is confusing that with an arbitrary or a seasonal bonus plan that they give all employees. OK, oftentimes when I ask an owner, do you have an incentive plan? Do you have a key employee incentive plan? The answer will be yes, we do. OK, describe it. Well, at the end of the year, depending upon how we've done, we kind of hand out year end bonuses. I call that Christmas bonus. That's not an incentive plan that's gonna motivate and impact behavior of a few key individuals so that's the first mistake. Thinking that owners have a plan when in reality they don't, because unless they follow those four key design variables, what they have is a bonus plan, which is great, but it's not going to influence behavior. The second biggest mistake that I see in this arena is where owners choose to build an incentive plan based on stock in their companies versus cash. And the reason that I say that that's a mistake is that while both cash and stock are foundations for key employee incentives, there's a good reason not to utilize stock in a privately held company prematurely. It's what makes litigation attorneys rich. So when we develop these plans we're very cautious about the owner going the route of a stock based incentive plan unless it's a part of an overall transition strategy versus utilizing a cash base. What are cash based? well. A deferred compensation is commonly used. Phantom stock is what I refer to as synthetic equity. It looks like stock. It values like stock, but it's not actual minority interest. Stock appreciation is another form of a cash-based key employee incentive plan. Um, that would be probably the two biggest things is believing they have a bona fide key employee incentive plan when in fact it lacks, it lacks design features, requirements, and second, using stock versus cash when it's not part of an overall internal strategy. Yeah, that stock is easy to give, but it can create real big complications on the back end if something goes wrong or at the time. Of a sale and or time of termination of employment. So, uh, OK, so and you mentioned a couple of things there fandom stock and stock appreciation rights and a lot of people go, well, aren't those stock, but they're, they're actually contractual arrangements that mimic the, the, uh, the the workings of stock. So, so they mimic the growth. And values of the company but they have very important characteristics and let's not get too much into that but let's talk about um one other question I had which was how can key employee incentive plans be integrated when somebody's thinking internal transfer, internal transfer to key employees or to employee groups. Excellent question thank you. um, it's interesting because when when we work with clients and we take a look at the statistics of owners that are actually looking to transition to internal buyers it's growing and a lot of it depends upon the industry, the size of the company, etc. but I'll ask a client and and you can probably respond to this when you, when you talk about internal transitions, what's the number one problem or challenge? With most internal transitions, would you like to take a stab, Bill? The employees have no money of their own. Exactly, exactly. They don't have, they, they very rarely will bring new capital to the table. So the way that these key employee incentive plans are often structured is that that deferral piece that goes in and is held back. It is oftentimes what owners will utilize to allow your key people at least a down payment for a partial stock purchase once the two agree that that's the direction that they're going that they're going to pursue. So the deferral piece on the key employee incentive plan is an excellent foundation for your internal, your internal buyers to accumulate at least the down payment, and that's where some of the modeling of projected benefits comes into play. That's an excellent point and, and because you know it's been said many times that when you're selling a business or transitioning to key employees, you're really there is no new money you're you're just repositioning. So here you're incentivizing employees to work harder and build the business value and then you're saying now we'll release that money and you can use that to purchase equity within the business as a down payment. I love that concept. Exactly, exactly. I, I, you know, I could talk you know I could talk about this all day, right? I mean, and I'm sure I think you could too well we should we should schedule an hour interview for this because 20 minutes isn't nearly enough, but we're almost out of time today. I, but I do want our listeners to be able to follow up now and get back and and find out more about you and your company. So tell us how can they reach you and find out more about these excellent strategies that we've been discussing. My website is the best place to reach me. It's www.exitplanstrategies.com. On there you'll find all kinds of information. You can request white papers on any of the information you see on the website, and of course I am always open to a free exploratory complimentary consultation for anyone who's interested. Now listeners, you can tell when someone knows what they're talking about, you know, and Diane Ross Hansen knows what she's talking about with all of this kind of stuff. Every point that she brought up. Uh right on the money. So get in touch with Diane and find out more about their company at exitlanstrategies.com. And Diane, we're going to have to do another interview to get deeper into this sometime, but I really enjoyed having you on, and it was fantastic, great information you've shared with our listeners. Thank you very much. Thank you, Bill. I've appreciated the opportunity. We're going to take a short break and we're gonna be right back after this. So please stay tuned. You're listening to Exit Coachradio.com, the information station for age 50 plus business owners, where we're interviewing top advisors for their best tips, ideas, and precautions so you can be well planned. We upload new one minute tips every day. Exitcoachradio.com. Come listen for a minute. Thank you for listening to Exit Coach Radio. Hey friend, I know how this feels. Waking up exhausted after multiple trips to the bathroom and feeling embarrassed by sudden leaks. I used to be constantly on edge, searching for a restroom whenever I was out. Then I discovered better woman. I was skeptical at first, but two months in, everything changed. I experienced improved bladder control. No more heart-stopping moments when I laugh or sneeze. Less urged to go, deeper and more restful sleep. I finally felt like myself again, confident and in control. Better Woman is natural, effective, clinically tested, and trusted by women for over 25 years. Ready to take back your control? Head over to Bebetternow.com to order your supply today. That's Bebetternow.com. These statements have not been evaluated by the FDA. This product is not intended to diagnose, treat, cure, or prevent any disease. Users directed individual results may vary.