An acquisition changes the relationship between management and ownership.
Executives who previously worked directly for a founder may now report to a board or holding company. Some may have sold shares. Others may be new to the business. The company may need faster growth, stronger cash control, or a significant operating change.
A management incentive plan should support that ownership plan without encouraging short-term or distorted behavior.
Start with the required behavior
Before selecting metrics, define what management must accomplish.
Examples may include:
- improve cash conversion;
- grow recurring revenue;
- protect gross margin;
- integrate an acquisition;
- reduce customer concentration;
- build management depth;
- enter a new market;
- improve quality;
- prepare the company for a transaction.
The plan should reflect the company’s actual priorities.
Use measures management can influence
Management should not be rewarded or penalized mainly for factors outside its control.
External market growth, currency movement, or an unusual commodity cycle may improve results without better execution.
The plan should combine outcomes with measures that reflect operating performance.
Balance financial and operating measures
Financial measures may include:
- operating profit;
- cash flow;
- gross margin;
- return on capital;
- working capital;
- revenue quality.
Operating measures may include:
- customer retention;
- delivery performance;
- quality;
- management recruitment;
- system implementation;
- strategic milestones.
Too many measures reduce clarity. Too few create gaming risk.
Protect long-term value
A plan based only on annual profit may encourage:
- delayed investment;
- reduced maintenance;
- excessive discounting;
- poor customer selection;
- unsustainable cost cuts;
- weak employee decisions.
Part of the incentive should reflect performance over a longer period.
Choose the right instrument
Incentives may use:
- annual cash bonus;
- deferred cash;
- phantom equity;
- real equity;
- options;
- transaction bonus;
- retention payment.
Each instrument creates legal, tax, accounting, governance, and behavioral consequences. Qualified advisers should structure the final plan.
Define leaver and transaction terms
The plan should address what happens when:
- an executive resigns;
- employment is terminated;
- performance is poor;
- the company is sold;
- additional capital is raised;
- the executive dies or becomes unable to work;
- the ownership structure changes.
Ambiguity creates disputes at the worst possible time.
Review the plan annually
Company priorities change.
The board should assess:
- whether the plan influenced behavior;
- whether the measures were controllable;
- whether management understood the calculation;
- whether the payout reflected real value creation;
- whether unintended behavior occurred.
A good incentive plan is clear enough for management to understand and disciplined enough for ownership to defend.