- The transitional period. When small-to-medium companies move from founder or family leadership to the next step of hiring a new, external CEO, proper planning strategy is paramount.
- Focus on CEO pay package. There should be a focus on creating a competitive CEO pay package including salary, annual performance bonuses, and a clear way to link performance to the long-term success of the company.
- Work closely with the board. Working closely with the board of directors is a strong governance practice, while communicating “thoughtfully, early and often” throughout the organization with all parties is critical.
The transition from founder or family leadership to the next step of hiring a new, external CEO can be daunting for small and medium private companies.
A recent research report from accounting and advisory firm BDO reveals, among other key considerations, that in small-to-medium family-owned private companies ($25-$50 million in revenue):
- CEO tenure averages 18 years; more than double the average tenure of a CEO at a public company.
- 41% of CEOs are founders, compared to the overall average of 29%.
- 79% of CEOs have an ownership stake compared to an overall average of 61%.
- The average percentage ownership is 61%, compared to the overall average of 33%.
Judy Canavan, managing director, global employer services at BDO USA, said that because founders and CEOs of family-owned companies usually have a high level of company ownership and “sweat equity,” they typically are more intensely focused on growing the company and increasing its value.
“When the CEO of a private company [retires] and it is time to hire their replacement, the compensation package needs to take the value of that high level of ownership into account to entice a successor who will not have the same high level of ownership,” she said.
Thus, those entities need to focus on creating a competitive CEO pay package including salary, annual performance bonuses, and a clear way to link performance to the long-term success of the company.
Building the Right Compensation Package
In addition to the standard salary and performance bonuses, Canavan said the building blocks should be: retention incentives, which organizations can address through real or “phantom equity” (a type of compensation award that references equity, but does not entitle the recipient to actual ownership in a company); a long-term cash bonus plan; or split-dollar life plan, which allows the sharing of the cost of a premium for a permanent life insurance policy.
Canavan said that when companies are transitioning from being a family or founder-owned company to hiring their first external CEO, they first need to put a long-term strategic plan in place. Also, if family members own a large component of the company, they should work together to align on future plans for the company. For example, they should consider if an employee stock ownership plan (ESOP), some form of a liquidity event (such as selling or merging with another company) or going from private to public status aligns with the long-term goals for the business.
“It is important to do this early in the process rather than at the time of writing the offer letter, to attract the right level of talent,” she said.
For instance, the BDO survey of 751 companies found that for a company between $25 million to $50 million in revenue:
- Total cash compensation — salary and annual bonus/incentive — averages 17% higher for non-founder CEOs.
- Total direct compensation (total cash compensation and the estimated value of any long-term incentive) is 13% higher for non-founder CEOs.
- The average percent of a CEO pay package comprised of long-term incentives/equity is 23% for private companies, whereas for a CEO of a private equity-backed firm it is 51%.
Canavan said in addition to a competitive compensation package, the organization should implement a fiduciary board and, ideally, an advisory board that includes independent directors who are not members of the family nor management.
“Assuming that the board(s) are in place, it is important to develop consensus among the board members regarding the strategic plan, planned transition, approach and timing,” she said, adding that they should address any family member concerns as relevant and ensure that there is a communication plan in place for the employees as well as external stakeholders.
Different Structures
When it comes to differentiating CEO pay between private and public companies, compensation is typically structured differently for the latter.
The most fundamental differentiator, Canavan said, is the availability of stock that can be traded on an exchange. This is important for two reasons:
- Private companies that reach about $100 million may find themselves competing against public companies when recruiting a CEO or other senior team members.
- If a smaller company’s growth trajectory forecasts achieving that size range soon, they may find that competition for talent becomes more challenging as they grow.
More differences in compensation and governance concerns come into play when family firms are acquired by either venture capital (VC) or private equity (PE) companies, said Stephen Charlebois, managing director at Semler Brossy, a consulting firm focused on executive compensation.
“Family-owned companies that are bought by either VC firms or PE companies will often see their compensation plans evolve to be more directly aligned with their investor’s experience and timeline to liquidation via either sale or IPO,” he said.
Another stark difference is that private companies that are bought by PE companies tend to limit the amount of equity used for employees. Depending on the size of the company, this is generally limited to the top 100 or so individuals versus a VC firm that will be more open to sharing equity broadly.
“For a family-owned company that believes in broad employee ownership, being bought by PE can be a huge cultural shock,” he said.
“Many aspects of a private company’s ownership profile and resulting governance model will affect pay and human capital-related decisions,” Charlebois added. “Understanding the nuances of these different models and the various stakeholders involved — enduring family owned vs. VC vs. PE — provides a good starting point when deciding the optimal path forward on CEO/ CFO pay and employees more broadly.”
In the end, BDO’s Canavan says keys to a successful transition to a new, non-family CEO include working closely with the board and considering hiring a third party to help provide guidance.
“In addition to this being a governance best practice, it can also help allay concerns among key stakeholders,” she said. “Finally, communicate thoughtfully, early and often.”
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