Executive Compensation in Privately Owned Businesses: How It s the Same and How It s Very Different

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1 Executive Compensation in Privately Owned Businesses: How It s the Same and How It s Very Different Don Delves, Director, Willis Towers Watson June 6, Willis Towers Watson. All rights reserved.

2 The continuum of private companies Employee owned (ESOPs) Co-ops Family owned Investor Owned Private Equity Venture Capital 2

3 Privately owned businesses are the future The total number of US companies is increasing Approximately 5 million companies While the number of publicly traded companies has fallen 6,000 to 7,000 in ,300 today (and holding) Uninvested PE and VC funds: $1.3 trillion Private companies staying private e.g., Uber, valued at over $60 billion Source: Fortune, June

4 Privately owned businesses are the future (con t) Private (family owned or controlled) businesses 80% of companies worldwide 60% of workers in U.S. Create 78% of new jobs in U.S. However: 30% of family businesses survive to 2G 12% to 3G 3% to 4G And: 10% of family business boards say they are effective at attracting, retaining, hiring, diversity Source: Harvard Business Review, April

5 Privately owned businesses are the future (con t) Successful private (family) businesses: Establish good governance as a baseline Preserve family gravity Values Vision Long term focus Customers and employees first Social responsibility Develop of future leaders Emphasis on values and cultural fit Disciplined CEO succession Source: Harvard Business Review, April

6 Public vs. private companies What is different Employee owned Co-ops Family owned Investor Owned Private Equity Venture Capital 6

7 Wide differences in executive pay practices in private companies Compensation policies are driven by ownership structure However, private companies are competitive with publicly-traded companies for talent Cash compensation tends to play a larger role in the pay mix Salary and bonuses are typically comparable to what public companies pay, though private companies often have a bias to somewhat larger bonus levels Total compensation is typically lower because private companies use less equity While less prominent, private companies increasingly offer some form of long-term incentive (LTI) LTI grants are often lower, but payouts are more consistent Note: The balance of our comments generally reflects norms among companies expecting to remain private (as compared to portfolio companies and those with an IPO trajectory) 7

8 Emerging best practices in private companies Although not required to do so, more private companies today are adopting governance practices common in public companies Formal advisory and fiduciary boards with independent directors Independent compensation committees Formal compensation philosophies to guide decisions Greater use of benchmarking and annual pay reviews Tailored ongoing LTI plans In short, leading private companies today are taking a more thoughtful and structured approach to how they target and design their executive pay programs than was common a decade ago 8

9 Pay mix observations Pay components are typically similar in both private and public companies; however, for private companies, cash compensation tends to play a larger role in the pay mix than in publicly owned companies Private Companies Public Companies 14% 24% Base Salary 23% 64% Annual Incentives Long-Term Incentives 19% 56% 9

10 Pay level observations Base salary and annual incentive levels are comparable at private and public companies However, private company LTI values are typically less than public companies; as such, total direct compensation is lower at private companies Private companies that do not provide LTI significantly lag public company total direct compensation Average (n=15) Private Company LTI Providers Pay as a % of Public 87% 99% 97% Chief Executive Officer 67% 95% 102% C-Suite/Top Tier (n=3) 79% 92% 100% All Other Executives (n=10) 89% 100% 98% Average (n=8) Private Company Non LTI Providers Pay as a % of Public 98% 92% 55% Chief Executive Officer 31% 81% 93% C-Suite/Top Tier (n=4) 52% 90% 98% All Other Executives (n=3) 66% 97% 97% 0% 20% 40% 60% 80% 100% 120% Base Salary Target Total Annual Cash Target Total Direct Comp. 10

11 Pay level observations Average Top Benefits Executive Top Internal Audit Executive Top Procurement/Purchasing Executive Top Information Security Executive Treasurer Top Compensation and Benefits Executive Top Marketing Executive Top Talent Management Executive Top Tax Executive Chief Information Officer Financial Controller Top Admin Executive (Major Functions) Top Human Resources Executive Top Legal Executive Chief Executive Officer Private Company LTI Providers Pay as a Percent of Public 80% 77% 75% 75% 67% 99% 97% 87% 106% 100% 103% 99% 98% 97% 93% 102% 98% 93% 102% 101% 92% 100% 98% 89% 102% 86% 99% 93% 93% 86% 100% 85% 97% 102% 96% 85% 96% 88% 101% 92% 97% 88% 98% 91% 102% 95% 115% 112% 0% 20% 40% 60% 80% 100% 120% Base Salary Target Annual Cash Target Total Direct Compensation 11

12 Private company long-term incentive observations Approximately half of the private companies in the sample provide LTI The financial summary for private companies is provided below The median revenue size is larger for companies that provide LTI 73% of private companies with revenues of $3 billion or higher provide LTI, as compared to 49% of companies with revenues below $3 billion Private Companies without LTI Orgs Average 25th Median 75th Revenue ($M) 80 $4,506 $337 $1,331 $3,210 Assets ($M) 29 $8,786 $316 $578 $3,803 Stockholders' Equity ($M) 14 $921 $3 $170 $923 Net Income ($M) 30 $20 -$3 $18 $93 Total Employees 80 8,569 1,041 3,000 6,875 Private Companies with LTI Orgs Average 25th Median 75th Revenue ($M) 86 $9,475 $1,200 $2,543 $5,011 Assets ($M) 42 $69,814 $1,446 $3,501 $14,226 Stockholders' Equity ($M) 21 $1,790 $214 $600 $2,300 Net Income ($M) 40 $558 $46 $168 $525 Total Employees 86 14,369 1,985 4,772 14,203 Breakout By Revenue Bucket Revenue Group Provide LTI Do Not Provide LTI Less than $1B 36% 64% $1B - $3B 63% 37% $3B - $6B 66% 34% $6B - $10B 100% 0% $10B - $20B 100% 0% Greater than $20B 64% 36% Less than $3 B 49% 51% Greater than $3 B 73% 27% 12

13 Private company long-term incentive observations For those private companies that provide long-term incentives, they typically use one vehicle: a cash-based performance plan Type of Award Percent of Companies Stock Options Performance Plans Restricted Stock Companies Using One Type of 79% Long-Term Incentive Award 59% x 19% x 1% x Companies Using Two Types of 13% Long-Term Incentive Award 7% x x 4% x x 2% x x Companies Using Three Types of 8% Long-Term Incentive Award 8% x x x Overall Prevalence 36% 78% 15% Note: Stock Appreciation Rights are included in Stock Options 13

14 LTI design market practices private company vehicles A large majority of private companies that provide long-term incentives rely on performance plans: 100% 80% 78% 60% 40% 36% 20% 15% 0% Stock Options Performance Plans Restricted Stock/RSUs 14

15 Incentive Design Guiding Principles Plan should reward the effective long-term management of the Carlson portfolio of businesses and investments Plan will be based on maintaining and growing the value of and distributions from the portfolio Purpose (Shareholders) Alignment (Shareholders & Management) Plan must promote and foster alignment of long-term financial interests between management and shareholders Management only wins if shareholders win Plan will be based on a valuation that is not subject to adjustments for business conditions, unforeseen events, etc. The LTIP establishes and reinforces management s longterm accountability to shareholders for maintaining and increasing long-term value, returns on investment and consistent and reasonable distributions Management responsible for ethical business practices and accountability to employees and community Accountability (Shareholders & Management) Note: Management is also accountable to shareholders for generating annual financial results. The mechanism for rewarding this is the annual incentive plan. Engagement (Management/ Employee) The LTIP must provide effective long-term motivation and retention to Management. As such, the plan should have the following characteristics: Provide competitive levels of long-term compensation opportunity Follow competitive practices in terms of design Be relatively simple and easy to understand, communicate and administer 15

16 Alignment of business objectives and LTI design Company State Spectrum Perpetual Private Transaction Perpetual Public Objective Sustained Long-Term Performance Performance Cash Phantom Stock Value creation to max out deal price Design Stock and Options Pay for performance, shareholder alignment, long-term holdings, retention Stock Options, Performance Shares, Restricted Shares 16

17 Direct influence of shareholders on incentive design Private company stakeholders present several key variables in the design of LTIs Who the owners / investors are End game Importance of value Cash flow needs Risk tolerance Appetite for growth / investment Purpose / mission / values 17

18 Plan designs may be cash or equity-based however consider timing of a public offering (exit) Cash- Based Perf Cash / Unit Phantom Plan Issues: Valuation Charge to earnings Performance criteria Funding Timing Private Company Contingent on an IPO Current Grant IPO Date Grant Issues: Dilution Successive rounds of financing Compensation contingent on uncontrollable event Lack of retention value Holding period Intermediate exercise / sale Regulations Disclosure Equity- Based Not Contingent on an IPO Share Purchase Share Grants Share Options Issues: Charge to earnings Termination Loan provisions Settlement alternatives Put/call rights Third-party sales Holding period Minority shareholder Valuation Funding 18

19 Private company rules and regulations 19