Episode Transcript
[00:00:00] Speaker A: Welcome to the Independence by Design podcast where we discuss what it means to be a business owner and ways to get unstuck from the day to day so we can design a business that gives us a life of independence.
[00:00:15] Speaker B: All right, Ryan, so today we're talking about module eight, executive compensation. And maybe a good place for us to start is just why does this module exist?
[00:00:25] Speaker A: What exists to align the three leaders, the functional leaders, the CRO, the CFO and the coo, which are the three buckets, the income statement. Again, if you also have the CEO who's on top of those three, tying the operations to the ownership's goals of free cash flow and the five year valuation target. So it's really about total alignment. I mean, honestly, it's total alignment and it's module number eight, Kim, because what would we build our comp plans to if we don't know our goals? And so I have this one of the clients that's in our community.
When I first met him, he had a $40,000 executive compensation plan sitting on his desk. And on the first call he's like, I just, should I do this? And I'm like, I don't know.
I know you probably need one at some point, but what are your goals? What's your cash flow goals? What's your valuation goals? He's like, I don't know. Do you have a financial model? He's like, nope, there's a lot there. But yeah, there's. That's kind of the answer point is like total alignment with the operations and the people doing the work, which helps us. I mean, that's. This is in the elevate phase, which is phase three, which is true leverage over the people at the top that are helping you.
[00:01:44] Speaker B: I love it. So, all right, I know you have lots of experience working with clients and that's what are some of the like the top two failure modes you see most often?
[00:01:53] Speaker A: I mean, people listening in are probably Vic, we're all victims. We're all guilty of this is we know we have some people that are either really, really good that we want to keep, we want to incentivize them more than what their base pay is. So if we're trying to help people out like we're trying, all the intentions are usually good, Kim. And we can talk about like how that, like what the intentions to be done the right way it will be, but the what happens when it's not done in the way that we're going to be unpacking.
Resentment breeds and like bubbles up because either people are underpaid or subjective. Like, oh, like my dad, he's happy today. He's gonna give us a bonus. Or like, I mean, I've, you know, parents and family businesses that, you know, it magnifies this whole situation. You probably have stories about that. And so it. When it's not aligned based on objective KPIs that are in the actual control of the executive doing the work.
Right. Like, so we want to.
[00:03:00] Speaker B: That's key. That's. I think that's such a key point. Like I said, their control.
[00:03:05] Speaker A: Talking to a family member who, their boss has a ton of responsibility and has none of the control. Like, my guess is she's pissed all the time. It's like, how would you know my cause? It's just a normal human thing. And so it's like, it's, you know, within your control.
Otherwise, resentment bubbles up and you're getting the opposite of what we want. Like, if you think about it, you and I, if you and I were doing that with our executive team, we would want to incentivize the people to own the outcome.
Own the outcome so the monkey doesn't go on my back. And owning the outcome means you can figure out the how, you know, in your own way, but the outcome.
So, like, you know, I think it's resentment, Kim. It's like when. When there's failure, it's like, that's the least productive emotion that breeds toxic culture. People are thinking about how to avoid work, how to screw over, you know, because they feel like things aren't fair. I mean, things are subjective, and it's not based on any kind of things that they can control. So, I mean, there's a lot there, but Any other. Anything else you would add to that?
[00:04:08] Speaker B: No, I think you did a great job kind of leading into my next question was what is actually at stake when a comp program goes wrong? Right. Like, it does boil into that resentment and then lack of productivity, and it actually has the inverse effect of the intention of the comp plan itself. And I've seen that so many different times. Whether it's, again, because it's things that were outside of their control that they're being comped by, or unrealistic scenarios that just are.
There's no way for them to try to even reach that goal. So why would they try?
So I think it's just demoralizing often when they're not put into place the right way.
[00:04:48] Speaker A: Yeah, I mean, like, I have so many examples of what not to do.
Let's get let's start with a couple of disasters that I, one of our largest sales reps got a comp plan.
Then he became greedy because he was trying to defend for himself making like 400 grand when the company was smaller. He was like, hey, well I might as well just do this my own because I built this company. And like I work harder than you started his own company. You know, three year lawsuits, suing each other's families, dumpster diving, trying to find documents because people are stealing customers. That was issue one. That's just one. Another one is one of our executives. The wrong incentive plan.
So it was like, hey, if you get these targets, you get 10% of the company.
Well he hit him because he recognized a four year contract in one year.
So he hit his comp plan. We're showing 50k in effing loss every month for the next four years and the bank's pissed at us while he owns. He gets 10% of the business. I mean like it's just like.
And like all like in where I think we.
And I watched us like try to. And I've, and I've been. That was my own story. I've watched this now with like I don't know how many other companies since is the intentions start off good and like I really like to hope that most people start with good intentions and then unravels because then again you have a mis. Misalignment of the actual numbers and you find that out after the fact and we can talk. I think we're going to talk about all the different KPIs you shouldn't be tied to and what ones you should be tied to. And then there's also like things people can control or not control. Getting an appropriate reward for the effort that is being put into place. So that way people don't like in an ideal situation, like if you're the CRO and you're making a shitload of money, I should be too. And vice versa.
[00:06:58] Speaker B: Right?
[00:06:58] Speaker A: And that's, I mean you and I are both literally sinking our work up together with IBD through an alignment of incentives. So I don't know. But there. But any other things you want to pull out of that?
[00:07:10] Speaker B: I think one of the things that jumped out at me and it's not in alignment with my predetermined questions that I had for you. Coming into the call, something that popped up was I feel like a lot of companies think that compensation packages are the responsibility of the HR department to put together, but I see it as a responsibility of the executive to put together. But I'm curious your thoughts on that.
[00:07:34] Speaker A: Yeah, well I would even go it has to start from the ownership, right? What the hell are we doing here? Like, because like, and let's talk about a couple other examples that I've got. And we, there's family businesses can relate to all this. But so it has to start from the constraint of time, cash flow, wealth, right? The independent 68 velocity of those three. Well what's the five year valuation target? Normalized EBITDA and the multiple and also the discounted cash. So we got the three lenses of value which is module two. So once we have that target, that's like a mathematical target. It's not just subjective.
The timeline between now and then, which is five years, will dictate the growth rate, how our margins and our cash and our working capital and all that, which essentially is cash. Like what's the cash constraint between now and then?
And then how much can we share? We have no idea until we put those freaking things together. And so you go okay, the owner says okay here's the valuation target in five years, here's the cash, the owner's distributions and the cash flow, working capital, debt, taxes, work and reinvestment. Then you can kind of go up the stack to say okay now and we'll talk about it's net normalized net operating income.
Then we can say how much can we share? And then we would look at the percentage and say well if we share this much that impacts owners distribution distributions by this much.
So it starts from ownership. Then we and the three milestones in this module is the company wide bonus pool, like the company wide profit sharing. And then how much of that entire pool do you want to share with the C suite executive of the CRO, CFO and coo? And then how much do you want to share with the CEO?
And if the owner operator is both the owner and the operator as the CEO, they should have that market comp and that market bonus pool. So like we have context when we put all that stuff together to say how much can we share?
So it literally trickles all the way down from ownership to then CEO to then the executives and HR and the CFO should be helping and legal should be helping with the consummation of all the documents and the contracts and all that kind of shit. But like how many people go to their attorney like we need an executive comp plan insurance person comes in like I can sell you a bunch of annuities. And then like next thing you know you got an Insurance person making a shitload of money, the attorney's drafting all these documents, the HR person's distracted, and it's tied to absolutely nothing that matters.
[00:10:03] Speaker B: And that happens more often than I think people would think.
[00:10:07] Speaker A: Wait, like most of the time it's like, oh, this is a good comp plan. This is, this deferred compensation plan made an insurance person fucking rich.
But guess what? The executive like maybe hits like, what if it's the wrong KPIs? And by the way, the owner is, has nothing to do with the owner's goal. I mean, it's just a.
[00:10:26] Speaker B: I think that ties in really well to the next question that I had. So you mentioned in module 8 that it has to happen after modules 1 through 7. Do you want to walk me through why walk me through that. I know you touched upon it already a little bit, but maybe we can dive a little bit deeper into that.
[00:10:41] Speaker A: And yeah, and as I do, before I, before I do Kim, I want to just make a note that the ownership roadmap that you and I are promoting all the time, let's ted the ownership assessment, which is the nine modules, 27 milestones, they go in order for a reason.
And I also am a realist knowing, okay, I'm flying this plane. I got Kim, who's on my team, who I've been promising an exec comp plan for four years to and haven't done. I just give her ten grand every year to make her shut up. Like we can't wait four more years. You know what I mean? So like I'm a realist and like you have certain things that you have to take into consideration. So I don't know, does that make sense for the, for everybody in the listeners? Like, hey, like I'm, I'm aware that like, let me just speak to like how to solve that problem. Then we'll go and we'll loop back to.
[00:11:35] Speaker B: I like it. Yep.
[00:11:36] Speaker A: So if someone. So I just worked through with a couple clients to bring on executives where we actually didn't have the financial model yet because it was the CFO that we were hiring.
And this is before Claude plugins part of that annual bonus plan was a project which is we want help building out this annual comp plan.
So you're going to get 50k if this project is completely done and the way, if that project is done, we have the three statement model built out, we have the forecast and the budget built out. So then we, next year you will have a objective KPI driven comp plan. So there's, you know, same thing with sales. You go, okay, if like I don't have the whole model built out. Kim, you're the sales, you're the sales director, the CRO.
If we hit these revenue numbers at these margins, like this is enough. Like, you know, like there's. So there's a way to have like a staged approach where you're saying like this is a temporary situation before we get the full blown thing.
[00:12:34] Speaker B: So I like how you're temporary solution. They're still tied it back to the owner's goals. Right. Like you have to, it's not just, it's not. Well, we'll put something, an interim plan in place while we figure out these other steps because we don't have time for it. It also to tie back to the ownership goals.
[00:12:52] Speaker A: Yep.
So I just had a call with one of my clients. They have a very large company and we were walking through their finalization of one of their executive comp plans. So the, what kind of walk you through the, the, the order of the modules and again there's three milestones per module for everybody but the, the high level first module is the ownership goals of time, cash flow, wealth, your owner scorecard over the next five years. So we've got the container going. Okay, like if I'm going to speak to you, Kim, if you're the owner, I'm like, okay, got you now know what you want and why.
Module two is the expand knowledge, which is the three lenses of value and valuations to understand what your valuation targets are. So you can insert that into module one, your owner scorecard. Module three is your monthly and quarterly and annual owner's plan from the boardroom. So you have an actual rhythm of executing all this stuff.
Module number four in the build phase is your sustainable finance. You go, okay, now I have my plan, I know my valuations, I got a rhythm. Build a fricking financial model.
You got the financial model. It's a three statement model. So you have visibility over all three statements for this year, five years and the valuation target. So you have a mathematical connection between where you are, where you want to be in five years and then the cash flow and the valuation constraints.
Module number five is your jam.
How are we going to do that with revenue? So how does revenue predictable revenue land on the income statement every single month and every single year within the client acquisition cost that we need so we don't burn money and we can actually connect the, the point A and the Point B. Module 6 is the operations and sustainable, sustainable Operation, I'm sorry, transferable operations. So that way we know we have the right margins. So the transferable margins become the right margins, which you and I just did a bunch of videos on.
That then gets us to the leadership team who then needs to be connected. So the three leadership team members who have the outcome and the job description of sale or revenue, finance and ops, revenue margins and cash, then we can build a plan for them.
So those executives that have a short term comp plan and a long term comment, we're just like, it's literally like connecting it. I mean like I watch people were like, they had a $40,000 comp plan sitting on their desk, like I said.
And like we have the plan, we have the math, we have the financial model. We can go to a freaking attorney and or Claude and be like, draft me the freaking legal document.
And now we have the ability to like see the liability that we accrue on the balance sheet. So we're not shocked when we have to pay it out. I mean, it's just like, it just like inverts this entire problem. You know what I mean? Like you're just like, okay, like, yes, I said a lot of words just now, but like there's a reason.
And then like I said and before I started, like, there's also a reason to do something temporary until you get there.
[00:15:59] Speaker B: Yep. Yeah. Oh, I like how it's all data driven and how it stacks on one another. It's very clear order of operations. But to your point, life is messy. So I like that. There's also that short term, short term way of getting to it too. One of the things that I want to call out really quickly was the what changes when comp stops being how do we motivate people and starts being how do we allocate capital?
[00:16:26] Speaker A: Well, the entire in module number one and two, it should all be about like, how are we getting a return?
Like, I mean, quit giving people, we're not a communist country. Like we're were trying to get a return.
I mean like, like when people say, well I'm gonna give someone this, I'm like, oh well, sign me up for the, the breadline here. I mean like so it's about the numbers, but like what I love about this came in and like I say that and like it. You know, Nick Bradley, my buddy from private equity said like, you know, it's numbers and people and it's the ying and the yang. And a lot of times people like think, well, IBD is all about the numbers and it's like, no, the numbers are the scoreboard. Like, I played soccer, we have a scoreboard, but the people play the game. And so, like, you know, there's so many isms that I can pull from. Like, I think that discipline equals freedom.
You and I, you and I were talking before I hit record. Like, I like more. More is always better.
And if we, we can focus on the people and focus on their, like, leadership and their education and their mentorship.
If we're not spending all of our time talking about how everybody's pissed off at each other because they have the wrong incentives and they're not treated fairly and they wish they wanted more money and all, blah, blah, blah. So it's like the return should be in proportion to get us to the goal, right? So if you said to me, I want to make 200 grand in free cash flow of ownership distributions on the way to a $10 million valuation, say, okay, well, do you have the people that are going to do that? No.
Well, do you want the people to do that? You mean? So you start to go back and forth, like, are you buying your time back and then like getting your. Increasing your chances that you're going to that valuation. So you should be able to see, when we have that right percentage, how it actually mathematically connects to your cash flow and your valuation.
So technically, it always would be part of the discounted cash flow because you would look at the free cash flow from owner to ownership distributions, like that number in the five year. Like, you'd see distributions. You take a discounted cash. Well, if the comp plan is tied into that and the people are going to do the work so you don't have to, that return is there and you can actually see it.
[00:18:47] Speaker B: Well, that makes a lot of sense. I doubt many people take the time to think about it and look at it in that way, but it makes a lot of sense when you explain it. One of the next things that we had here, and I think you kind of just even touched upon it, was this is where Pat Hobby always pushed back. Most people would default to gross profit or net income for bonus pool. But why are those wrong? And why does net operating income win? Like, what does it actually measure that the others miss? I think you just walked us through that. But do you have any, like, want to dive down a little bit deeper?
[00:19:16] Speaker A: I'm going to pull up my notes this. So that way I don't screw something up.
So, yeah, that's fair. Okay, so I'm, I'm not, I'm not just riffing on this all the time. So.
Because there's a very, there's stories about this, but I think to get it more specific, where we want true alignment, right? Where, like when I think, because I have designed a lot of comp plans for like very large sales teams and like when it's wrong, it's like you're pointing a rocket ship towards a wall.
I remember doing, I mean, you've done comp plans, right? And like walk me through the experience. When a comp plan works, like, what's your feeling? And like, and like how, like what's the experience?
[00:19:56] Speaker B: It benefits everybody. Like, they're excited, you're excited, they're happy, they're motivated. I'm happy that they're happy. Like when it, when a comp plan works in the right way, the company makes money and the person makes money
[00:20:07] Speaker A: and everybody feels like they're treated fair, right? Versus like when you, if you do it wrong and you're like, I'm sell, I'm not selling the right stuff or I'm selling the wrong stuff at the wrong margin. I mean you start to like go like this second, third, fourth order effect. So, so back to your question about what are the right numbers to drive off of? So normalized net operating income is what we want to target.
And there's a couple reasons behind that, is because it's the operations, like it's really the true measure of the operations for the staff.
Most people listening would be like, well, why not normalized ebitda, Ryan? Because normalized EBITDA is one of the valuation metrics. Well, the staff can't have any impact on your debt. You're like all the different cat like capex decisions, all of the stuff that are ownership, capital allocation decisions. We want to isolate just the normal level of operating for the rest of the company, right? So we say, okay, so a couple bad exam or things that could go wrong. So like return on net assets is distorted by your asset base because owner's capex and real estate decisions move the denominator and penalizes growth B investment.
So like if you're like return on net assets like you're, you're, you're incentivized not to reinvest because you're dinged by that. And you're like, well I don't want to ding anybody by that. And so like it's again, it's, you know, second order effects. Net income is distorted by financing decisions like the debt structure, the tax structure, accounting choices. Leaders don't control these A leader can have great ops performance and watch their bonus shrink because an owner refinanced. I mean like, you know, andor like, I mean again, my family member, who they are, their, their bonus is based on net income. And it's like, well, they did a bunch of acquisitions and if they integrate them so they hit, they had like for four years the, the old company sign on the building because well, I don't want to invest in that because
[00:22:08] Speaker B: I,
[00:22:10] Speaker A: it's so stupid. Gross profit doesn't include OPEX.
So a CRO can hire 10 reps and continue to crush gross profit and crater the net operating income.
So it's really, truly isolating how well did operations do? And the reason I say normalized net operating income is because I have a client that I worked with that, that the president and the, and the owner got into an actual screaming match in, in the room.
Oh yeah. And she, the president started crying and the owner put a bunch of roofs on all their buildings and her bonus got hit because it reduced net income because they were, they were having it in the SGNA opex.
And so it's like, well, if that's a capital allocation decision, you know where you're going to spend some cash to. Because if you own the building, it's like, hey, I'm not going to fault you for that.
The way to think about that decision is I'm choosing to spend 300 grand on real estate, not in private equity.
So then what I would say is like if that's the case, don't bitch that you didn't hit your growth targets for your company because you use cash for a building whether it's a conscious choice or not. But what we're doing, why normalizing that net operating income?
We're isolating how well if we did it for itr, how well did ITR actually do? How well did Imaging path my old company actually do, all things considered? So again, different than normalized EBITDA because, and I think a CEO should be compensated on normalized EBITDA is one of their KPIs. And we can talk about that later. But, but you can, you want to start with the whole company bonus pool to say hey, we want to share 10% of normalized net operating income. And then you take and say okay, of that company bonus pool, then how much do you want to share with the three executives at the top? How much do you want to share with the CEO? So you're literally contextualizing that whole pool. But like if you and I had that three statement model up.
We could see, let's say it was you know, a million dollars in that operating and normalized net operating income is a hundred grand for the whole company. And then you, you know, split it in, you know that, that a hundred grand you could still see at the bottom in that cash flow statement.
Kim still gets her 50k in distributions and we still have enough for taxes. We still have enough, you know, I mean like so you can see.
[00:24:40] Speaker B: Yep.
[00:24:40] Speaker A: The trade offs of everything.
[00:24:42] Speaker B: Yeah. No, that's a really great way to look at it. So well, if you want we can touch upon it. So you mentioned the EBITDA for CEO. So what are some of the other KPIs for some of the other roles?
[00:24:55] Speaker A: I'll touch on it. But I think you and I have another. Are we going to do another podcast.
[00:24:59] Speaker B: Yeah.
[00:25:00] Speaker A: After this about like where I'm. Because like we're going to what we're, what we're doing here. We'll kind of tee up and tease the audience where this is the whole module for executive comp which is module 8. And we're touching on the company wide bonus pool.
The which is the first milestone and then the second milestone is annual executive comp and then phantom stock long term, which is the but. And I've got some cool badass stuff for the short term executive comp stuff and how to interplay all these people and tie them all together so that way you're running the six legged race as an executive team and not running all over the ch. Over the place. So I would say like let's just leave it there because like there are very nuanced for the CEO, CRO, COO and CFO. How do we take their function and tie their KPIs to performance. But I would start like with the company wide bonus pool. Like how much are you willing to share for the whole company?
And then maybe this will help too is I had the as a base level, like how do we allocate that? Let's say it's 10%. And I, you know I've done a bunch of these, done a bunch of research on private equity and ESOPs. Like what is kind of the bell curve. Call it 10% of normalized net operating income.
And you could think about like allocating that the hundred percent of the ten percent tracking me.
So it's let's say if it's a million bucks, you got a hundred grand. You say how are we going to split that 100 grand?
You could do 25% for the CEO and then 15% each for each of the executives, the three in the CRO, CFO and COO. And then 25% for the total company and then 5% for discretionary, not 100% for discretionary.
So then you're saying, okay, it's just like this waterfall, Kim, to say, okay, I know that the 100 grand is fine while I make my distributions and the cash flow is fine. Of this a hundred grand, how do we split it up and divvy it up at the top? Then how about the whole company and then every manager? You should just trickle it down and say, how do. How does every person impact the entire plan? And this is where like the great game of business, which you and I both know Jack Stack and what's her name, that's you. There was a contact. Anyway, there's a couple people over at Great Game that you and I were.
[00:27:20] Speaker B: Steve Baker.
[00:27:20] Speaker A: It was Steve. And yeah, like open book management where you can see on the income statement how everybody's tied together.
And then that's how you would then tie like the company wide bonus pool and that dollar amount across everybody, which I think ends up being like camera what ended up being per person, I don't know. And then you just go, is that what does that make sense for you? Do you want more, do you want less? But it gives you a framework to kind of plug this transcription into Claude and start screwing around, see what you
[00:27:47] Speaker B: can do where it comes out well. So another of the follow up questions then that comes to mind is if a PE back CFO or board member looked at like that kind of a plan, do you think that they would have any pushback on that kind of a structure and why or why not?
[00:28:03] Speaker A: No, they would. They're going to do it anyways if they're, if they actually know what the hell they're doing, which isn't always the case.
The I don't know why Kim, people wouldn't want to do this. Like, I don't want the phone calls while I'm on my vacation.
[00:28:19] Speaker B: Right.
[00:28:20] Speaker A: You know what I mean? Like, I like, don't we want to pay people to think and do.
Like, don't call me if, like, it's like, okay, well this is the number. This is how it ties to your plan. This is what you're trying to do. Everyone understands how everyone's getting paid. Like, there's none of this going on. I mean, like, I don't know, but like, how was ITR with this stuff? Like, how are you guys as a spectrum of maturity on this, I would
[00:28:50] Speaker B: say not this sophisticated by any means. And it was very much a collaborative at the executive level. We discussed. And then the owner and president behind doors finalized. And then nobody knows the outcome for anybody else's situation.
[00:29:05] Speaker A: Yeah. And I got, I went upstairs last night.
This is perfect timing.
So five o', clock, Going upstairs for dinner. Megan's like, I got a $4,500 bonus today. I was like, why? She's like, no fucking idea.
I was like, so it, I mean, like, and it's a fairly large company. She's like, like, you spread that off to a bunch of people and just lighting money on fire. So, like, here you go. You got my wife, who is a fricking rock star.
No idea. Like, wouldn't it have been nice to get some extra effort out of her?
Such a waste of money. And like, oh my God, I don't know.
[00:29:51] Speaker B: Yeah. I say another common occurrence was really just if we had a certain amount, which nobody really knew how much amount, but if we had a certain amount of profits left at the end of the year, it would be divvied up. And so that was really common too.
One of the questions that I had in here for this, this version of today's episode was how do the KPIs each executive is measured, reconcile back to the owner scorecard and the annual budget? How do we make sure no one's chasing a vanity metric?
[00:30:21] Speaker A: Well, because if you build out the annual budget like it starts with, it's you and I, we'll be doing a bunch more of these at the end of this year as we continue to get this rhythm going on. We did a bunch at the end of last year.
We're going to start with the top down, October 1st in our annual summit in person summit. And then the bottom up happens and then everything reconciles and connects. December 15th. And so the bottom up and the top down should be starting for like, what does the owner want in distributions?
It has to start there because it like it's again, it stacks like. I mean, you have these constraints of cash. So you're doing it from the income statement and the cash flow statement, which are, they're connecting right, via the balance sheet. So you're just like, okay, well how does this all connect together?
And then you can refine, right? Like if you're like, well, like, I always overindex for paying people more and giving more juicy bonus programs because, like, I don't want to do the work.
That's the definition of buying time.
Buying buying time. And Giving people the outcome. And if I can see it, then I can actually, like, knowably, like, we had this with one of my clients. Like, all this is very clear. The person just didn't hit it multiple times.
So then you're not wondering, is it me? Should I incentive more? You know, I mean, like, all the. The head games that owner operators play with themselves to wonder if, like, they could have done something different. It's like, this couldn't be any more clear.
That answer your question?
[00:31:56] Speaker B: Yeah. Yeah, it did. All right, so I know we have. We're diving into this and more, but just to get us kind of started a little bit and grease the wheels. Why phantom equity instead of real equity? Most owners first instinct is to give a steak.
[00:32:11] Speaker A: Let's never say give again.
Let's say earn, earn. I mean, most people do that kind of like, let's give someone. It's like fire again. Are we giving handouts?
[00:32:22] Speaker B: We're not communist. This is not a socialist state.
[00:32:26] Speaker A: I was just working through this with a client too. And it's the outcome. Like, you're, you're, you're literally. It's all the edges of the puzzle. You say, well, if someone else, like, if you came were my CRO, it's like, okay, like, let's. This is the outcome.
And the question is, can I do it without you?
If I can't, I want to allow you to share in the upside that we're both creating together. And that's literally like. I mean, if you can see, like, okay, this is what I want, I don't think I can do that alone. So then you start, you know, shimming and, like, shuffling around that, like, goal, like, well, if I have these people, what can we actually all get there together?
And then like, with my client, it's like, okay, well, if your target is here in five years, let's say it's.
Say it's a. Here's a very large company, so I'll use more reasonable numbers. Like, let's say it's a $20 million valuation, which is still a lot. The.
Let's say that's the target.
Well, if I think I can hit that by myself without sharing and I could mix. If I could rip. Rip and replace your role with someone else, like, that's the definition of giving. But if you're like, I can't hit that. I know I could hit 10 by myself, but I can't hit 20 by myself.
And 20 seems reasonable with, like, the cash constraint and the growth rate. Like, Kim, let's grow Together and let's get you a percentage of that growth and whether it's 1%, 5%, 10% depends on how many executives depends on if you have open spots. I mean there's a lot of. But you have a frame that to say like what percentage of that growth am I willing to share?
And the way I think and I, I guess I'm more when I, when I think this way, like okay, well if my goal is $10 million, then everything above that is gravy. And if we're all going to do this together, we're sharing the upside that we're all caring that we're all doing together. But I don't want to dip into my base case.
So like let's start that long term plan at a dollar amount that is like the kind of the base case and then up above and beyond that we can share a lot more.
So then you're kind of taking the whole thought process that we'll go into at a later date. But like how do you divvy that all up into who and to why? But like why wouldn't you want people to be excited to stay around and work with you and build with you?
[00:34:54] Speaker B: Yeah, no, it makes a lot of sense. I like it.
[00:34:57] Speaker A: Well, let's have a couple other questions please or answers. I for a lot of reasons don't want anybody else on the cap table with my, on the companies. Like you and I have a very lucrative Rev Share program. So we can essentially be quote partners together. But my wife said if you have another partner, I'm going to divorce you.
So very personal reasons. Why Because I want to stay married that I like you and I are not a partner on a company.
Ein number a lot of reasons people don't want to do that, you know, because like next thing you know you have to share decision trees on like whether you sell the company, you don't sell the company. Like, well, like oh, I mean you're hooked at the hip, you're married.
[00:35:35] Speaker B: Yeah.
[00:35:36] Speaker A: So a lot of reasons you wouldn't want to do that. And then for executives, like I said, we were working with this one client, he's like the owner, the CEO or the C level examiner's like I don't want to be an owner, I don't want a K1 for taxes.
You know what I mean? So like you're still getting that value growth and then you're, you're accumulating that, that reward without having to have the risk, the personal guarantees, the sharing of the taxes and all that. Kind of stuff. So it's. And by the way, a phantom stock plan is an actual contract.
So it's actually a liability on the balance sheet. So this is not bullshit stuff. It's an actual like liability contract. This someone owes someone else and it's real money and it's tied to a real valuation. So it is, for all intents and purposes, it's real money. It's just how and what form it's taking. And is it really necessary to have someone on the operating partnership ein structure?
[00:36:30] Speaker B: No, that's a really good point. That's a very valid point because I don't think a lot of people realize that too, that it is a legitimate contract that's put into place. Like they hear phantom and they're just like, it's a nice product promise. But that's not actually the case. It is a legalized document.
So that's a really good point. So you tie LTI to a five year valuation target. How does that work mechanically?
[00:36:53] Speaker A: Long term incentives to a five year valuation.
So say that again.
[00:36:57] Speaker B: You tie it to the five year valuation target. How does that work mechanically?
And how does the executive earn the payout?
Save that for, for the next one.
[00:37:08] Speaker A: Yeah, for the, for that, that. Because we'll do the short term one talking through that. Right, and then we'll do the, the long term one. Yeah, yeah, we got a lot of thoughts on that. If people want to get ahead of that. Go into I think it's episode like 408 or something. Craig Rutledge, he's got some good stuff on that. We're going to be pulling a lot from some of the archives on that. But yeah, all those mechanics will save the, the juicy stuff for that episode.
[00:37:32] Speaker B: Is that the next one or the second one from now is that second one for now.
[00:37:36] Speaker A: The next one we'll do is like tying together the executive compensation on the annual bonus plan and then the one after that would be the long term one. Okay.
[00:37:47] Speaker B: All right, so stay tuned.
[00:37:49] Speaker A: Yes. Yeah. Or we'll, we'll, or we'll combine those. Well, you know, have to work through on that on episodes. But what have you seen?
Like, like, because you're, I mean being in sales your whole life, like you know, just any kind of commentary and incentives and like how what you like don't like what it's like when it works, when it doesn't work or any of these topics.
[00:38:11] Speaker B: Yeah, I mean for lower below the executive level, down on like the sales team level. I've seen it be high base, low cat Commission, high commission, low base.
They each have their pros and their cons to them. I think it also depends on the type of business and what it is that you're actually selling. Do you have recurring business or is it all new business? Is it large projects? Is it smaller dollar amount? So I think a lot of those factors need to be taken in to consideration when putting together like a sales team, actual comp structure for again the executive level. We always did it like what is market rate? So that way we were always competitive for base salaries. What is a good market rate and then make sure we're above the average, like that average, national average. So that way we were competitive with our, our bases. And then comp structures from there varied between like a quarterly bonus, depending on what role you have in the business, to an annual bonus program, which I
[00:39:12] Speaker A: think is all great too. And like that should fit within context of the whole as well. Yeah. Did you guys have a company wide bonus pool?
[00:39:20] Speaker B: Yes. That was if we hit a certain amount in profits by the end of the year, then we did. Everybody got a certain percentage?
[00:39:27] Speaker A: Yeah, yeah, it's. I haven't seen too many people where they like the ain't like the overall company.
I haven't seen a lot of people where all this is done the right way, let's put it that way. I mean, it's just so subjective. Like, oh my God, last year, you know, we gave everybody 100 grand. We don't do that, everybody's gonna be pissed off again.
Oh my God, at Christmas, everybody expects 2500 bucks.
Well, why don't you just increase their pay like that? I don't know. It's just, I just, I have noticed that, you know, when all of the compensation and it.
And then the company wide bonus, like all this is structured the right way, all of the anxiety, all of the resentment, all of the bullshit can dissipate. You might still have people that suck and don't do their job, get rid of them, you know what I mean? But like it's high performers and people that like to control their own outcomes thrive on this kind of stuff because it's very clear. And people that are, I've found that are really, really good, that don't have clear KPIs and clear outcomes, hate subjectivity.
[00:40:39] Speaker B: Yes, 100%. And that makes total sense though, because if it's not clear, then they're working their asses off, but they're not understanding how they can clearly achieve the next goal, to reward them for working so hard versus the person who just skates by is also getting a bonus. But you don't know why they're getting a bonus because you see them skating by every day and that turns into that resentment that you were mentioning earlier. So I think that's why you built this module though, right? Is to show this is what good looks like and this is how you go about this. So that way it doesn't have to be so subjective.
[00:41:11] Speaker A: Yeah, like all of the, all of these levers I think should encourage people that you can mess around with them to what good looks like for you. Like, you and I are not sitting here telling anybody, like, has to be 10% of net operating income. It's like, whatever, like, but like, if you're going to do a bonus, make sure you understand how it impacts your working capital. Debt, taxes, reinvestment and cash flow.
Oh, and by the way, in order to see that trade off, you need to understand that trade off in relationship to your five year goal.
That is a mathematical situation.
It's like not our opinion. So it's like, you know, you can start to play with these levers. But what I like, Kim, is like, I wish I would have had this. Because then it's like, okay, here are the five things that we actually need to decide.
But we don't go into a meeting being like, how does the whole world work? And like, should Kim get a $10,000 bonus or not? And it's like, well, I don't know, how does the world, you know, I mean, like, it's like we're trying to do way too much in those meetings as executives versus starting on the, you know, the, the 10 yard line going like, we just got to get this over the goal and it's actually going to be a lot easier. And like, you know, there's still decisions and trade offs to be made. But like, I don't know, man. I grew up with a lot of subjectivity and my dad and I were laughing about it on Friday. It's like, I'm like you. It was like, literally whether you were happy or not is whether I was punished or not.
It's like I said, dad, you. Isn't it shocking that I built an entire system about expectation setting?
15 year therapy session. Here we are.
[00:42:52] Speaker B: It's good to know what good looks like. And I like how it is all mathematical and analytical because you're right. Like a lot of it has been just subjective where it's that this seems right or that sounds good or this person will probably like that versus it being grounded in an equation?
[00:43:09] Speaker A: Yeah, yeah, yeah. Anything we haven't covered that you're thinking about or.
[00:43:14] Speaker B: I had some predetermined questions. I'm just scanning through them. I think we covered all of them except for the last two, which is when an owner gets this right, what changes for them? What does life look like? And then for the owner listening, who wants to start building this? Where should they begin?
[00:43:33] Speaker A: When I think about the experience, Kim, I use this in one of the training videos in the academy when I played soccer when the goal is very clear and the rules are very clear.
Like, I love putting all of my energy into something.
And I still remember like every soccer game, like getting home and being like, whether I won or lost, it was like that game was awesome, you know what I mean? Because like I knew that I couldn't have done any. I couldn't have done it any harder. Like I couldn't have played any harder versus going like, I wonder how it works. Like, that's just exhausting, you know what I mean? So I think it's what, what was the text I sent you yesterday? I love that quote. It was, I said, it's only when we understand how the system works can we develop a strategy to win.
And I think we should like plaster that everywhere that of what we're doing. Because it's like once we understand the system and the goals, then it's like it can be just like total execution.
And then that allows like people that are listening in who actually want to go on a vacation without being bothered and, or just being called for the fun things.
It's not just like the normal breaking of the drama and all the stuff that's going on. So I think that's the experience is just like total flow zone of having fun. And then what was it? Where do we get started? Is that the other one?
[00:45:00] Speaker B: Yeah. How do they start?
[00:45:01] Speaker A: You and I are going to be doing a workshop, right, on June 28.
Reference the show notes. So that way Kim and I don't mess nothing up. But we're doing one of those hundred dollar workshops coming up about this as well. If people are interested in the 90 day boardroom blueprint, which is our onboarding program on getting started with this whole thing, they can go to the website which is in the show notes.
[00:45:27] Speaker B: Awesome.
That's all that I had for questions for you, Ryan, Closing thoughts, things that we didn't touch on that you want to make sure we touched on.
[00:45:34] Speaker A: It's really fun doing this with you so I don't have to talk to myself.
[00:45:39] Speaker B: Yeah.
[00:45:40] Speaker A: Yeah.
Winning. Yes.
No, I appreciate you. This is fun.
[00:45:47] Speaker B: Good. No, I had a lot of fun, and I. I learned some new things today, too, so I enjoyed it going through this, so it was good.
[00:46:02] Speaker A: This episode is brought to you by Kastos Productions.
