How do you fill in the numbers on your own paycheck? Do company needs overwhelm personal financial goals? Who helps you figure out what would constitute a 'fair and reasonable' -- or maybe just practical -- CEO compensation package? Here's what a handful of company builders revealed about this trickiest of managerial questions
People who start their own companies say they do it because they love the challenge of building a business. Less often do they admit they want to get rich. But let's face it, you don't put yourself through hell just to feed the soul. Moreover, it's well documented that the time-tested way to lasting wealth in America is to start your own company. Do it right and you get the lion's share of what your company earns. Do it really right and you build up some impressive equity that could one day turn into a goodly chunk of cash.
But even if your company takes off, the issue of how much you should pay yourself will not go away. What is "fair" or "reasonable" when you sign your own paycheck? Money often becomes a charged issue within capital-hungry fast-growing companies, in which cash can seem so scarce to founders -- and so abundant to their hardworking employees. To further cloud the issue, there seem to be few norms or guidelines when it comes to how much money an entrepreneur should be making. That was made clear by a recent poll of CEOs of companies that have made the Inc. 500 list of the fastest-growing private companies in the past five years. Of the 496 companies that responded, 85% were profitable, 46% considered themselves "professionally managed," and one-third foresaw a public offering. And yet 50% of the CEOs queried consulted no one in determining their compensation.
Although CEO compensation in many small companies may be a freelance affair, Inc.'s survey does not imply that those at the helm operate without a plan -- however fluid it might be. The heart of that plan typically involves growing the company, not cutting as fat a paycheck as possible. Eighty percent of respondents said that the company's needs were a major factor in determining their level of compensation, and 39% deemed their compensation below what the market would pay. (Another 37% saw their compensation as "about right.")
Another finding of our survey was the close link between compensation and company performance, with 71% of CEOs noting a pay-for-performance link. That mirrors a strong national trend. Sixty-six percent of the CEOs said that a bonus made up some part of their compensation last year; one-third said that a bonus constituted at least 25% of their pay. That finding is perhaps not surprising, since with this group, growing the company often is the prime motivation, which, in effect, means growing the value of the company. And that is where most CEOs see the ultimate payoff. Forty percent of the respondents owned at least 80% of the equity in their companies. Sixty-nine percent owned at least 50% of the equity.
Although CEO compensation cannot be considered in a vacuum, there is no "right" answer when it comes to what is fair pay. Still, the owner must sign his or her own paycheck, an act that presents specific practical challenges as well as emotional concerns. Following, then, are portraits of nine company builders, glimpsed through the prism of compensation. We asked these CEOs what they paid themselves in 1994 -- and why. Most have developed their own systems and rationales rather than looking to highly regarded texts or highly paid consultants. But reasonable compensation is more than just common sense. It inevitably becomes a piece of the larger puzzle of running and growing a business.* * *
Rocky Mountain Motorworks Inc., Woodland Park, Colo.
1994 financials: $5 million in revenues; profitable
Equity ownership: 100%
Number of employees: 45
Business founded: 1986
Challenge: To hire top managers at going rates
For years Chris Nowak, the founder of Rocky Mountain Motorworks Inc., a distributor of Volkswagen parts and accessories, drove a beat-up VW bug and lived in little more than a hovel. Nowak, who was once a premed student majoring in microbiology, recalls a visit from his parents in the early days of his company. They came, they saw, they left in tears. Their son the doctor was not to be.
Nowak, as it turned out, was married to his business -- and still is. (His wife has known her share of anguish when it comes to being a growth-company widow.) Nowak has always fed the company first. "If I have extra cash, I lend it to the business," he says. "If the company died, I'd probably be right behind it."
Nowak has always been able to keep things lean and simple, because his devotion to the business has always been so pure -- and because he believes his ultimate reward will come from building equity in his company. Currently, he pays himself $72,000, a sum he considers generous, even though his company this year will generate about $7.5 million in revenues, a 50% jump from last year's figure. (Until a few years ago Nowak paid his chief financial officer all of $30,000.) Nowak bases his pay simply on his living expenses.
On the other hand, he knows he must raise salaries, given his ambitions for the company. Next year he sees revenues hitting $10 million, which might mean paying up to six figures to top managers. That boost will occur because Nowak aims to make the business more professional and compete with much larger companies. That means recruiting the best talent he can find in the industry, which entails recruiting top managers from $100-million companies, many of them in California, a high-cost/high-wage area to begin with. He adds, "I want to work with the best. I'm good at figuring out what makes people tick."
Nowak appears to be skirting an issue that trips up some zealous entrepreneurs. He understands that not everyone shares his passion for the business and, accordingly, is not primed to work for minimum wage. But that raises a second quandary faced by people like Nowak as they try to make their businesses more professional: dealing with the inevitable divide between loyal long-term employees and fresh, high-powered talent. Nowak recently envisioned either giving or selling equity to employees. His accountant, Jerry Biggs, had one word of advice in response: "Don't."
Biggs says that some entrepreneurs like Nowak identify too readily with their employees -- and become convinced they can make them rich. Biggs says, "The guy who owns a business wants to give his employees an incentive. He puts himself in their position and says, 'What do people want? They want equity.' We have found that that is not a positive incentive." He explains, "When you have stock, it doesn't mean a lot. There is generally never any dividend distribution. There are no voting rights." And, says Biggs, most important -- and something that's often overlooked -- is that most employees are not long-term thinkers, nor are they risk takers. "Otherwise, they'd be out starting their own companies."* * *
Position: President, CareAdvantage Inc., Islen, N.J.
1994 financials: $4 million in revenues; operating at a loss
Equity ownership: 20%
Number of employees: 145
Business founded: 1994
Challenge: To attract top talent with big bucks
In a former life John Petillo was a Catholic priest. In this one he appears to have negotiated favorable terms with Mammon. If he meets his profitability targets this year, he could earn as much as $1 million. Petillo cautions, however, that that's a remote possibility. His 1995 revenues should come in at $15 million, but the company will be only at breakeven.
His company, CareAdvantage Inc., is coming fast out of the gate, and he took it public last June. Thus, like a lot of entrepreneurs looking to quickly build -- and maintain -- value in a company, Petillo uses compensation as an integral piece of his growth strategy. He believes the best way to build a company that will endure is to pay for top-notch talent -- including his own. "We pay a premium for executives," he says. "If they do what you want, you don't want them looking around to leave. If they don't, you always have a severance agreement to fall back on."
Petillo's journey has been a varied and eventful one. After leaving the priesthood and academia -- he was the chancellor of Seton Hall University -- he ventured into the private sector. He became the head of Blue Cross, Blue Shield of New Jersey. During his three-year tenure there the company went from having a deficit of $127 million to having $135 million in positive reserves. "At Blue Cross we were given heavy incentives to save money," says Petillo.
That is also the driving force at CareAdvantage, a medical-management-review company. CareAdvantage sells its information-intensive services to large employers or insurance companies. If one of their insured employees needs, say, bypass surgery, CareAdvantage will review its database of the 2.2 million people it already tracks for its customers and determine what in that case would constitute appropriate care and reasonable cost. Petillo says that in a good year, one-third of revenues can result directly from savings shared with customers.
CareAdvantage has instituted a highly structured compensation system -- modeled on the Blue Cross system -- which Petillo is convinced can grow with the company. "We wanted to be able to develop a structure that you don't have to demolish. You just raise the goals." Petillo earns $500,000 in base salary. In the future, if targets are met, that figure would be 50% of his total compensation. Another 25% -- for himself and his key executives -- would be a short-term bonus based on the company's hitting an operating-profit target. Petillo readily admits that his own compensation is "over and above what the market would pay." On the other hand, it is predicated on his belief in shelling out for people with "tremendous experience or great contacts." He maintains that because of his Blue Cross, Blue Shield tenure, he has both.
The long-term bonus for himself and his key managers, 25% of total compensation, is deferred for three years on a rolling basis and then converted into stock. Petillo says the long-term bonus, which, like the short-term bonus, is based on profits, may not amount to much for some time because CareAdvantage is still in a start-up phase and thus is not very profitable. "You may have to get to years 8 through 10 to have it really pay out."
That's just how Petillo wants it. He views the long-term bonus as little more than an alternative pension plan that will pay out only if the company takes off. "We want to really stretch out these incentives." Petillo has been able to lure 12 key executives with his compensation plan, but he needs to have those people in place for the long term. He adds that now that the company has gone public, long-term bonus money will convert to stock options, again keeping any big payoff amply deferred.* * *
Position: President, Hamlin Power Reaves Ltd., Springfield, Ill.
1994 financials: $10 million in revenues; profitable
Equity ownership: 89%
Number of employees: 50
Business founded: 1989
Challenge: To bring in more sales and take out more money
To Bill Hamlin, building a business is a game -- one he plays with apparent gusto. His compensation is just one more way to keep score. He explains: "Whatever this company makes, I make sure my personal net worth goes up by at least that much." Hamlin Power Reaves Ltd. is actually two companies -- or maybe three, depending on how you count things. Hamlin's an entrepreneur with an entrepreneur's characteristically green thumb.
The core business does sales training and direct marketing for automobile dealers. Recently, it grew a new subsidiary, which Hamlin started a year ago: a dealership, complete with an eight-bay service facility, that sells low-mileage used cars as if they were new. At Hamlin's "superstore" you can walk in and buy a nearly new 1995 model for a good 25% less than a new one.
Asked where the capital came from to start the used-car business, Hamlin matter-of-factly refers to business number three. "I do some real estate development." He paid $325,000 in cash for the superstore, with $250,000 of that coming from a loan from the real estate business. By June of this year he had the loan paid off, and the superstore had produced a pretax profit of $280,000.
Hamlin claims he has always focused on paying his employees a good wage, and that has given the business a strong foundation. Recently, he sold 11% of the company to 14 key employees in order to better align their interests with his.
Hamlin says this year his total compensation will likely amount to $200,000, about equal to what his top salesperson will make. Hamlin has structured his pay to focus on the most immediate task -- selling. Like all managers at the company, each month he earns a base salary of $3,000, plus from 1% to 3% of gross sales (standard in the industry), with the percentage rising within that range in tandem with sales volume.* * *
Richard Mudge and Ken Rubin
Richard Mudge: $125,000
Ken Rubin: $125,000
Ages: 50 (Mudge) and 47 (Rubin)
Positions: Copresidents, Apogee Research, Bethesda, Md.
1994 financials: $5.8 million in revenues; profitable
Equity ownership: 33% each
Number of employees: 70
Business founded: 1986
Challenge: To build equity
Apogee Research is a consulting firm in the areas of economics, finance, and public works. Typically, clients are federal, state, and international governments. Growth at Apogee is fitful, with one or two fast-growth years followed by a flattening, during which the company pauses for a breather. Richard Mudge and Ken Rubin each own a third of the company, and they have, over time, privately placed a third of the stock with a few outside investors and with key employees and board members.
Money can often come between people and ruin a good partnership. Mudge and Rubin, Apogee's founders, know that, and that's why they agree on two things. First, they pay themselves the same salary. Second, they pay themselves reasonably, with a base salary of $125,000 a year each and a bonus of 30% to 40% in a good year. Rubin considers himself underpaid "on a risk-weighted basis." He points out that he and Mudge have personally underwritten Apogee's line of credit, which means they are on the hook for about $750,000 in operating expenses each month. Mudge adds that the partners' pay is not based on a formula but rather is designed to be below market rates. "We took pay cuts when we came here," he says.
But all their efforts to create consensus between themselves may pit them against the rank and file at the company. It's not unusual, after all, for entrepreneurs and employees to be at cross-purposes when it comes to compensation. Entrepreneurs worry about equity and the future. Employees often want cash -- now.
"We want to get away from reflexively paying a bonus," admits Mudge. "Last year we paid no cash bonus, even though things looked good." Sales and earnings were up, but a couple of divisions were well below targets. Mudge was unhappy that those problems hadn't come to light faster. Ergo, no bonus. "There was some grumbling," Mudge admits.
Mudge and Rubin say they have wanted to create value from day one. That has entailed aggressively growing the business -- creating new divisions quickly and moving managers around at will. "Beneath the top level, it's chaotic. Ken and I are very happy with that. The staff is not," Mudge admits. "We want fluidity and people moving from profit center to profit center. We want compensation based on what people do, not their titles."
Mudge and Rubin are moving Apogee toward being an open-book company so that employees can better understand management's value-building bias. And yet abstraction still looms, since Apogee is a company rich in intellectual assets, where value can be slippery and fleeting, a common affliction for many small service companies.
To overcome that, Mudge and Rubin have placed a number of investment bankers and accountants on the board. Applying a conservative yardstick, Mudge and Rubin have valued the company at five times earnings before interest and taxes, which, they feel, creates a "public value" for their stock. The nature of the board has the secondary intent of conferring credibility, since the management's credentials are somewhat unorthodox. Mudge and Rubin have Ph.D.'s in economics and engineering, respectively, and their business education has occurred exclusively at Apogee. (The company's controller is a former concert pianist.)
Mudge admits that equity ownership remains largely a puzzle to most employees. "I'm not sure how to sell equity to people. We try to get managerial people to own stock. But below that level people can't always afford it. They need the cash."* * *
Position: CEO, J.B. Dollar Stretcher Magazine, Cleveland
1994 financials: $4.5 million in revenues; profitable
Equity ownership: 100%
Number of employees: 49
Business founded: 1985
Challenge: To maximize personal gain
Bob Minchak will never be mistaken for one of those New Age entrepreneurs who bends your ear about sharing, empowerment, and the world-class day-care center in his building. His sentiments about who gets what are a bit more unvarnished than that: "The formula is for me to get all the money."
Minchak publishes a regional "shopper" in northeastern Ohio that is loaded with advertising. The paper gets mailed out free to 2.8 million readers once every seven weeks between February and December. Sales this year will be about $6 million, and as Minchak puts it, "30% of those sales come my way." Nice work if you can get it.
Asked how much he makes, Minchak replies, "My salary is $5,000 a week -- or is it $10,000? I forget. My wife signs the checks." Minchak says that at the end of the year he tries to take as much out of the company's bank account as he can. "We try to leave just enough money in the company to limit the tax liability."
Minchak and his wife are the sole stockholders. "Our mission is to maximize our own personal gain," he says. "You can't rape your company and make it unhealthy, but it is a cash cow." Minchak further allows: "I have all the toys -- a yacht, a pool, fountains, maids. I don't have to do anything except work. Sometimes I screw off massively, and then I get bored and go back to work." He calls entrepreneurs "extremists," for whom " moderation is a difficult word to understand." He hastens to add, "That describes me, unfortunately."
In case you're wondering, J.B. Dollar Stretcher Magazine does have other employees. It has five vice-presidents who run the sales operation. "I clone them to do what I've done," says Minchak. The company has a bonus pool that can amount to up to 6% of sales. Between commissions, base salary, and the bonus, Minchak's clones can earn from $65,000 to more than $100,000.
Minchak says selling equity to other investors would be a mistake. "I'd probably offend any shareholders I had by pillaging the coffers of the company, but they are not the ones working 7 to 11 every day." Nor does he fear alienating those around him -- perhaps because he doesn't know what fear is. "I am a mutant. I flourish with competition," he says. "No one has launched a competing company against me in this area. I take no prisoners. I steal my competitors' customers first, then I go in the back door and raid their salespeople." Minchak, at 36, has no regrets. He says that at the end of the day "there's loyalty, love, and confidence" inside his company.* * *
Position: President, Computer Equity Corp., Chantilly, Va.
1994 financials: $16 million in revenues; profitable
Equity ownership: "Majority"
Number of employees: 76
Business founded: 1987
Challenge: To make more millionaires
At 63 John Ballenger is a bit more seasoned than Bob Minchak -- and surely more restrained. But then, maybe he can afford to be. Ballenger has already built two technology companies that have paid off handsomely for him. His net worth is in the millions. Ballenger is a classic entrepreneur in the sense that he believes in the power of equity not just to enrich but also to motivate. For him equity is an organizing principle that renders the company-building process coherent. In that sense, Ballenger brings to compensation issues a discipline and perceptiveness not often seen in fast-growing companies. And as an afterthought, Ballenger pays himself a token salary at year's end to signal where his priorities lie. "There is no real reasoning behind my salary," he says. "It's just by habit and custom. It sets an image for the rest of the company. We want to keep our overhead to a minimum, work hard, and make things happen." Ballenger adds that employees in a high-tech company like his are not stupid. He says were he to pay himself excessively, "they would either steal my ideas and leave, or grow indifferent to the fate of the operation."
Ballenger's first company was started with no money in the bank and currently has 2,500 employees. "The only way to build the company was to give key employees enough stock so they could feel like owners from day one and you would get the extra mile out of them," says Ballenger. "I have carried that philosophy through each of my companies."
Computer Equity Corp., Ballenger's third high-tech company, is a systems integrator that primarily markets computer and telecommunications equipment to the federal government. Late this year or early next, Ballenger expects to do an initial public offering.
At Ballenger-run companies, key early employees -- usually about six people -- get from 1% to 5% of the stock. In paying those key employees Ballenger ties bonus compensation strictly to sales. What matters most to him initially is having people who can bring in those early sales. To him, it's a rare talent. "The world is full of professional soldiers who can follow orders," says Ballenger. "There's only a handful of people who can make things happen quickly."
As the business matures Ballenger divides the bonus compensation differently, with half based on revenues and half on earnings before interest and taxes. That is because, he says, "profitability starts to matter more than revenues."
As the company grows further he brings in a second wave of employees. That group earns a higher base salary and bigger bonuses, but it receives stock options as opposed to stock. Explains Ballenger: "You want to make sure the people will work out. If you can stretch out the option plan, you can better gauge their performance." Ballenger notes that at this stage in his company's development -- it will have $25 million in sales this year -- more employees will be eligible to receive stock options.
As Ballenger reiterates, his main goal is to take Computer Equity public and turn all the hard work into something liquid. That means keeping salaries and overhead low. He rents inexpensive space and buys used furniture when he can. "That keeps our costs down and maximizes the chances of a later public offering. We want to show how tight we run. That attracts investors."
Ballenger proudly points out that in his previous companies he has made more than 30 other people millionaires with net worths ranging from $1 million to $50 million. The risk is that with such high expectations, if Ballenger's company stumbles, morale could sour.* * *
Position: CEO, Switch Gear Systems Inc., Irving, Tex.
1994 financials: $2.4 million in revenues; profitable
Equity ownership: 100%
Number of employees: 21
Business founded: 1985
Challenge: To continue hitting his own performance targets
David Muir started Switch Gear Systems Inc., a custom manufacturer of electrical-power-distribution equipment, when he was just 22. Since then he has grown the company to a projected $3 million this year. But for Muir, keeping that growth on track means doing what he can to stay close to the business. Although Muir is the company's CEO, founder, and sole owner, he casts himself in a more hands-on role as one of Switch Gear Systems' three salespeople. And he pays himself accordingly.
Muir earns a base salary of $48,000, with commissions of 4% on whatever he sells. Last year those commissions brought his total compensation to $92,000. Muir bases his combined salary and commissions on the $1 million in sales he personally expects to generate in a given year. He says that as long as his salary plus commission totals less than 10% of the sales he generates, then he has built sufficient profit into his sales to meet his company's goals. In a normal year Muir also earns a bonus based on company performance. Specifically, he must hit targets related to earnings before interest, taxes, depreciation, amortization, and operating profit. He says that usually brings his bonus to about 5% of operating profit.
But last year Muir didn't take his bonus. "We moved last December," he explains. "I left my bonus in the company. The move cost us $90,000. It took twice as long and cost twice as much as we thought it would."
Muir's compensation depends not only on his sales performance but also on how well he manages another key aspect of the business: inventory. Switch Gear's profitability relies heavily on how well management tends inventory. Muir notes that there are substantial deals available in the marketplace if he buys right. "Some of our inventory may sit for a year, but we can recoup that cost by selling just 15% of it."
While Muir plays the game daily to produce a good outcome, strategic long-term decisions also affect his compensation. The recent move to a larger building was made because Switch Gear ran out of room for inventory. Now there's plenty of space, allowing Muir to buy inventory even more advantageously -- further decreasing the cost of goods sold and raising operating profit. For Muir that will mean a bigger bonus in the short term and enhanced equity in the long term.* * *
Hydro-Environmental Technologies Inc., Acton, Mass.
1994 financials: $3.8 million in revenues; at breakeven
Equity ownership: 100%
Number of employees: 42
Business founded: 1986
Challenge: To make a decent living
No one would accuse Hayden Solomon of overpaying himself, but then Solomon could do with a little more old-fashioned excess. He'd like to fatten his paycheck, but that could set the business back. Hydro-Environmental Technologies Inc. is a small environmental consulting firm trying to make the transition into something more professional. But first it must smooth out its revenue stream. Business has been flat for a couple of years. "We've been through a restructuring. Initially, we did a lot of work for oil companies. There were good margins there," says Solomon. That attracted competition and depressed margins. So the company has now refocused on the industrial-insurance industry and related "due diligence" claims, in which Solomon sees a more open niche.
Last year Solomon paid himself $42,000, a sum roughly equal to his living expenses. About how he arrived at that figure, Solomon says simply, "There was nothing scientific about that." It was what he needed -- and what he could afford. In a good year he'll take more out of Hydro-Environmental, which is an S corporation. (In an S corporation, profits flow through to the owner and therefore are not taxed doubly, at both the corporate and the personal levels.) Solomon's problem is that the company, in trying to shift markets, hasn't seen a good year since 1993. In 1992 Solomon took a $250,000 "bonus" out of Hydro-Environmental to make some improvements on his house. He then plowed more than half that sum back into the company, using it to buy his building and pay off loans for company vehicles.
But Solomon has tired of living from hand to mouth, and in that sense he embodies a common dilemma faced by company founders. Like a lot of entrepreneurs who own most if not all the equity in their companies, he's willing to bleed for the company today in order to build value tomorrow. On the other hand, he risks seeing a bigger -- and steadier -- paycheck continue to recede into the future if he doesn't get around to institutionalizing a compensation system that injects discipline into the process.
At present most of Solomon's employees, including key managers, are on a straight salary. But he has hired a consultant to design an incentive-based compensation plan, a move that's in sync with prevailing trends. He wants to see his managers compensated in part based on how successfully they bring in new business and manage the ensuing projects.
That would help take some of the emotional component out of the compensation process, another variable that tends to bedevil company founders. "The tough part is payroll; you can't just cut people," acknowledges Solomon. "You have a personal relationship with people. You can't give people something and then take it away." Compounding the problem, the sharing of equity -- another issue that often divides owners and managers as a company grows and begins to assume value -- has reared its head at Hydro-Environmental. "A lot of people have asked about ownership," says Solomon. "But they don't know what it entails. They think that if you have ownership, it means you have more money."
Solomon wants to build value for the long term -- and raise his salary in the process. To make his case he has begun sharing financials with key managers -- in some cases to no avail. "One or two think the numbers are made up. And one of these people makes $100,000 a year."
Time to get that consultant in.