The Private Equity for Families Blog

Compensation Series—Culture of Accountability

A critical factor to a successful portfolio company is attracting and retaining motivated, high-quality executives. To motivate those executives, it is imperative for private equity-backed companies to implement compensation schemes that nurture performance-based cultures and align management with ownership.

High performing, middle market portfolio companies employ lean management teams focused on top line growth as well as margin expansion. Portfolio companies are meritocracies where top managers shine and poor managers are quickly exposed. It is truly sink or swim in a sub $100 million company trying to go head to head with multinational corporates and their endless resources. Managers who thrive in the small company environment need, want and deserve compensation that rewards short term ego and long term value creation. Likewise, owners want these managers to feel appreciated and share the opportunity for true wealth creation.

Given the importance of the topic, we’ve devoted the next three blog entries to a discussion related to compensation. We hope to stimulate thoughts on topics ranging from how to build a performance-based culture as well as issues related to short and long-term incentives.

In this week’s blog, guest author and compensation expert, Alex Freytag of ProfitWorks, discusses the first step to creating a “culture of accountability.”

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Eradicating Entitlement Mentality from Your Family Business

by By Alex Freytag, ProfitWorks

Alex FreytagAn entitled person feels they should get things because of who they are, and not what they do. Unfortunately, this type of thinking permeates company cultures all over our country today. Employees feel entitled to their jobs, entitled to the use of company assets, entitled to the use of company time for personal tasks and so on.

Where did this entitlement mentality come from? Self-esteem is certainly important and my feeling is that over the years, as our nation has gotten wealthier, we have tried to give self-esteem to our children and our employees. We give our children trophies just for participating. We don’t use red ink anymore in classrooms because it might hurt their self-esteem. We insulate them from the little failures in life so they can feel better about themselves — we try to give them confidence. But the only way to truly develop self-esteem is to earn it, and undoubtedly that means there will be some failure. Actually, fear of failure is an excellent motivator for individuals to learn and become accountable. It helps people develop confidence in their abilities and a sense of self-worth and purpose.

So, how do you eradicate entitlement and create a culture of accountability in your family business? Here are five steps you must take:

  1. Teach your employees the fundamentals of business and finance. When employees understand the finances of their company, they make better decisions because they begin to understand the ramifications of their actions relative to financial performance. Additionally, in the absence of information, people make stuff up. If we don’t share any information with employees, they will assume the company is making 50 percent profit, and that all of that money is going into the pockets of family owners and management. Or they will assume that the company is going bankrupt. From my experience employees absolutely have the interest and the capacity to understand this.
  2. Identify the measureables that will drive the financial, operational and shareholder value of your family business. The reason most employees feel disconnected from financial performance is that the only mechanisms to keep score in their company are financial statements (income statements, cash flow and balance sheets). There are three problems with this.  First financial statements are only about dollars and cents. They don’t focus on the operational measureables (the people stuff) that make the dollars and cents happen, and so they do not effectively connect tasks to financial performance. Second, most people can’t read financials, so they are of no use to them relative to their role in the company. Finally, they are historical documents. Important to be sure, but not leading indicators of financial performance. Instead of financial statements, develop simple scorecards that list a few financial measures but focus primarily on leading activity based measures. These are the measures in which your employees can really relate.
  3. Create an organization of high visibility and high accountability by using your measureables to monitor performance and keep score. Once you have identified your measureables, create scorecards with them, and assign the responsibility of monitoring those measures to the individuals who have the greatest influence over them (not your CFO!). Each member of the leadership team should “own” at least one measureable and should be taught how to forecast results against budget, rather than simply looking at historical data. In addition, your front line employees should be taught how to forecast numbers that they can influence in daily or weekly meetings. If there is some unease about sharing a high level of financial information throughout the company, then departmental scorecards may be focused primarily or entirely on operational measures such as order accuracy percentage, number of picking errors, picks per hour, damaged product, expedited shipping costs, on time delivery percentage, obsolete inventory and the like.
  4. Regularly involve your employees in creating and participating in “mini games.” A mini game is a tool to focus employees on one area of opportunity that will 1) improve financial performance, 2) create a learning environment, 3) fund an incentive plan, and 4) make work fun. Select a measureable that has significant opportunity for improvement (e.g., obsolete inventory dollars, picking errors, damaged product, rework, collection days, overtime, on time delivery percentage, etc.) and build your mini game. Ensure the results are quantifiable and that a specific timeframe is identified, and then identify people who need to participate and the activities that need to take place. Last, identify a prize for winning: nothing expensive, because every time you “win” a game, your employees are funding their incentive plan. One family business client focused a mini game on Overtime percentage with a theme related to March Madness. The “Nothing But Net” theme was fun and kept the employees interested; at the same time they were financially focused by reducing overtime.
  5. Design an effective incentive plan and make sure it is clearly tied to your organization’s measureables. Most incentive plans don’t work. Why? Because they are overly complex. They are tied to financial performance yet we don’t bother to teach participants about finance. Consequently there is no connection between activities and bonus, and the plan becomes nothing more than an entitlement: Great when I get it, a rip-off when I don’t. Creating a good plan is not that difficult. The trick is keeping it simple, making it self-funded, and giving all employees in your company the tools discussed above to become active participants in funding the plan.

To be sure, entitlement mentality is a disease that only seems to be getting worse. However, following the above steps will help you create a culture of employees who are accountable and actively engaged in improving your company’s financial performance, especially important in today’s economy. Additionally, companies who do business this way create cultures of employees who are learning and growing and who are part of a purposeful organization.

Click here to download our free eBook. For more information please visit our website at www.profitworksllc.com.

Alex Freytag, partner at ProfitWorks LLC, helps business owners get what they want from their businesses. In 1996, he co-founded and built the training and coaching firm to help entrepreneurial leadership teams achieve vision, traction and healthy and to teach financial literacy to employees. In addition to his training and coaching work, Alex spreads his mission and message by speaking to audiences of all types, including Vistage, the world’s largest membership organization of CEOs.

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Your insights are welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

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