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.
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Hayden Solomon
Age: 36
Position: President,
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.
