The Unkindest Cut of All
How one company's founders have sliced their pay to keep their business afloat.
"The truth is, I think we've done a pretty great job just surviving, given current conditions," says Jim Reiss Jr., the CEO and cofounder of Coollogic Inc., a Dallas company that provides software for Internet appliances and network devices.
The company that Reiss and Rob Wood, Coollogic's president, founded in 1997 is dramatically different from what it was during the technology industry's peak nearly two years ago. Then it had about 1,200 angel investors and saw an initial public offering just months away. "We were in great shape -- 100% debt-free," says Reiss. But when the IPO market collapsed, the partners realized that they wouldn't be able to go to the public market to raise the funds that they needed to manufacture Internet appliances.
In late summer a less-than-enthusiastic response from the private-equity markets led to a major overhaul of Coollogic that included its concentrating only on software, which is less capital-intensive than hardware. Coollogic now employs 12 people, down from as many as 40 at its height. "It's not too surprising that when you're in the midst of a major tune-up of your business, you're going to take a pretty hard look at owner and management compensation along the way," Reiss says.
Until the market downturn Reiss and Wood relied on a common technique to set their own paychecks: they bought research from their accounting firm and other reliable sources that showed the amount that top officers were earning at companies of similar size in their industry. And they paid themselves accordingly. The technique still has its advantages, mainly as a defense tool during IRS audits of executive compensation. But although accountants and other compensation experts still recommend that approach, it's useless in a business climate as risky and unpredictable as the one we're in.
SHRINKING PAYCHECKS: "It's the price you pay for being a founder. The cook always eats last," says Jim Reiss, CEO of Coollogic.
At companies like Coollogic, executives are rethinking their paychecks according to three key issues: the state of their companies, the economic realities on both the U.S. and global horizons, and the condition of the financial markets. When the monitors all point downward, no independent data can convince those executives that generous compensation packages make business sense.
So Reiss and Wood did what they had to do. "Our leadership team is off 45% from last year's compensation, and to be perfectly honest, I'm not even sure that it's going to end there. But we're at the point where the most important thing to us is doing what it takes to keep this company alive," Reiss says.
It can be difficult for an executive to figure out how much and when to cut, especially when economic conditions continue to deteriorate. By mutual agreement, Reiss, Wood, and one other top executive at Coollogic started out by deferring a major portion of their compensation. (See "Another Reason to Defer," below.) The deferrals showed up as a liability on Coollogic's balance sheet, negatively affecting the company's financial position. To maintain a healthy balance sheet, Coollogic's executives waived the deferrals and cut their pay.
For that trio, and for other managers struggling to quantify executive-pay cuts, there's no single financial result or trend that can dictate their actions. For businesses that are watching their profit margins slip, the best strategy is usually to calculate the potential impact of a range of compensation and other overhead-cost cuts on bottom-line projections. In Coollogic's case, since the company was still working toward profitability, the challenge was to reduce all expenditures, including payroll, to conserve working capital at a time when financing options were drying up.
But how far down the corporate ladder should top management push salary cuts? Coollogic's founders approached that as a management rather than a financial issue: they avoided cutting salaries for the next tier down, department heads, mainly because they viewed those employees as both valuable and likely to leave the company if they were hit in their pocketbooks. The pair also chose not to impose companywide reductions. "I'd rather cut bodies and add workload to the remaining crew," Reiss says, "than shear everyone and demoralize the whole crowd."
The two founders went out of their way to explain to staffers that the preservation of their paychecks had come with a cost: the layoff of more than half the staff. Reiss says, "We told them up front, 'This is going to be tough. You'd better be ready to work your asses off." Reiss and Wood know that their pay sacrifices haven't earned them any brownie points. Says Reiss, "Employees expect that. It's the price you pay for being a founder. The cook always eats last."
The personal adjustment, although not easy to handle, is part of a comprehensive set of financial challenges that many business owners face. In Coollogic's case, those challenges include keeping the company's large cadre of investors informed and committed while the company that they originally backed -- and that used to have a clear short-term exit strategy -- reshapes itself, redirects its product line and marketing focus, and sets its sights on a long-term payoff.
"I don't like having to cry and whine to the people who got us here," Reiss says. "But I've sent out four different communications to our shareholders this year explaining that this is where we are, these are the new contracts we've got so far, this is what we're moving toward, this is the reality about our working-capital needs -- and if you can help us out, give us a jingle, and if you can't, this is what we're going to do to try to raise new funds. Along the way, I've let our investors know that we've made real changes in owner and management compensation, as well as other changes. They've been incredibly supportive of us. But you know what? At the end of the day, investors are carnivores. They don't really care about what's happening to your paycheck. It's their own payoff that they're thinking about."
Is there a light at the end of the tunnel for executives making the kind of tough choices that Reiss and Wood have made? The answer is yes for those companies whose business models and cash flow prove strong enough to withstand the current downturn. Entrepreneurs should start raising their salaries as soon as conditions can sustain increases to payroll and other overhead items. If that decision must be postponed because of either a weak business climate or a fast-growth agenda, then company owners should explore such strategies as sporadic bonuses or some type of longer-term equity arrangement to reward themselves for their sacrifices and commitment.
Jill Andresky Fraser is Inc's finance editor.
When you're thinking about compensation issues, don't overlook tax considerations. Under the new federal tax-reform law, a schedule of gradually declining individual rates provides a compelling logic to boost your paycheck later rather than sooner. (The top rate will shrink from 38.6% in 2002 to 35% in tax year 2006.)
One strategy is to set up a moderate-term deferred-compensation package. Traditionally, such a package is designed to boost an individual's income during retirement years. But the recent tax reform creates a smaller window of opportunity, since individual tax rates are scheduled to stay at their lowest level for just five years, 2006 through 2010. (After that, the top rate will go to 39.6% from 35%.) So it may make sense for you to couple a low current paycheck with a compensation package that will reward you when the tax bite is more palatable -- and when, with luck, your company, the economy, and the financial markets are stronger than they are today.
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