By Stephen D. Kirkland, CPA, CMC, CFF
You know that your clients may be extremely astute when it comes to manufacturing widgets. But managing business operations is a different challenge. The boards and officers of closely held businesses (and nonprofits) often lack the knowledge needed to appropriately set compensation amounts. Yet this is a vitally important part of running a successful operation. The total dollar amounts deployed for compensation are often one of a business’ largest expenses. And pay may be one of the most sensitive issues from the perspective of their employees.
Providing comparability data and guidance to these clients can help them in many ways. For example, as odd as it may seem, they may not know how to properly reward their employees. Many businesses simply put their compensation system on autopilot and rely on across-the-board cost-of-living increases once per year. They may not understand how incentive compensation plans can increase productivity and reduce turnover. They also may not be aware of the complex tax issues that arise when various forms of compensation are used.
Your services in this area may also help clients prevent the devastating consequences of litigation. When I began providing litigation support services in the compensation area many years ago, the cases almost always involved disputes between corporations and the tax authorities. However, that has changed dramatically over the years. Now most of my expert witness work is in shareholder disputes that do not involve the tax authorities. This trend seems to have come about partly as a result of businesses being passed down from the founders to the second and third generations of their families. It is now common for well-established, successful businesses to be owned by a combination of both individuals who work at the company and others who do not. Unfortunately, they do not all see eye-to-eye when it comes to how much should be paid to those who run the businesses.
In addition to old economy companies, compensation issues also arise in new economy businesses. The founders of startups involving e-commerce or intellectual property may be brilliant, but they need help in figuring out the complexities of compensation options available to them.
In addition, compensation issues seem to be increasingly common at professional service firms, including law firms, medical practices, and CPA firms.
The likelihood of an ugly dispute increases when compensation terms are not clarified in advance, not put in writing, or not approved by a governing body.
In many cases, outside shareholders are not aware of the compensation terms between their companies and the inside shareholders. Since compensation terms are often kept confidential, this can lead to surprises. Confidentiality in this area may be a good idea, however all shareholders may have certain rights to the company’s books and records. And when outside shareholders find out how much the officers were paid, they may be compelled to quickly bring legal action against the officers, even if those officers are their siblings or cousins. One of my professors used to say that there are no friends when it comes to money, and I have learned to understand what he meant.
This type of litigation quickly consumes considerable resources, including time and money. Customers and employees who are not directly involved in the disputes can also be affected.
There does not seem to be any foolproof way to avoid these disputes. But by analyzing the officers’ qualifications, duties, and responsibilities, you may be able to help reach consensus on fair and reasonable compensation terms for the officers. An annual review with an independent consultant may go a long way toward avoiding a conflict down the road. And relying on industry data and competitive compensation practices can help.
Consider offering to help outline the duties and expectations of each officer, much the same way companies often do with non-owner employees. Each officer could be given goals with the potential for performance bonuses when the goals have been reached. The idea is to create a win-win for all shareholders and be prepared to explain that to outside shareholders if the need arises. Yet compensation arrangements are often not thought out, or agreed upon, in advance. And when they are not, the business may become a “disruptor”…and not in a good way.
Stephen D. Kirkland, CPA, CMC, CFF is a compensation consultant with Atlantic Executive Consulting, LLC. He serves as an expert witness in cases involving potentially unreasonable compensation. He can be reached at (803) 724-1414 or through ReasonableComp.biz.