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THE STRATEGY: In business, like baseball, successful companies win with a strategy combining offense and defense. For service companies, offense is often tied to channeling human and intellectual capital to achieve bold goals, while defense is grounded in controlling costs and inhibiting competitors from executing a fast-follower strategy. To succeed, business leaders must provide incentives to their people and protect the value they bring, i.e., customers, ideas, and know-how.  Ask yourself two questions: could you be doing a better job 1) on offense – attracting, developing, and retaining key staff, thereby creating competitive advantage, or 2) on defense – fending off hard-charging competitors from invading your market and taking key talent and resources from your company. Most companies benefit in both areas by combining and leveraging powerful “carrots” (incentives) against “sticks” (disincentives) to attract and retain key employees and resources critical to success.

CUSTOMIZING THE CARROTS: Strong companies generally have core organizational DNA” that attracts talent and provides a foundation for meritocracy: strategy, culture, loyalty, vision, and career vitality. What are the best financial incentives to reinforce the core mission and attract and retain key executives?  Historically, employee stock options and similar approaches have been the knee-jerk reaction of companies hoping to “share the upside so all can share in success.” However, a surprising number of equity sharing plans are not optimally designed, are frequently taken for granted, and have simply become entitlement programs. Furthermore, many such plans are now less attractive given new accounting requirements to both book option-associated compensation expenses and treat option benefits to employees as ordinary income rather than capital gain.  As an alternative, pay-for-performance plans can often best achieve a company’s offensive goals, while limiting owner dilution.  These plans have custom formulas that can trigger generous deferred compensation. These plans can be effective in reinforcing the company’s strategic performance metrics, visible for retaining key talent, and affordable when properly structured. The flexibility of pay for performance structures can foster practical business objectives. Desire a meritocracy: allow the strongest performers to earn the majority of plan units. Desire division-centric autonomy: perhaps create simulated equity values for each division. Want to motivate an heir apparent to stay: consider top-hat supplementary plans that may provide salary continuation vested upon certain milestones. Have a time-based specific goal to achieve: then craft an overlay deferred bonus plan to foster that goal.  Furthermore, recent 409(A) tax regulations can provide companies with greater control over programs with deferred compensation, by among other things, inhibiting plan participants from seeking acceleration of certain payouts. This provides the business owner greater certainty in enterprise and personal financial planning.   

THE COMBINATION “DOUBLE PLAY”: Compensation incentives should come with a quid pro quo: protecting and preserving corporate assets though enforceable agreements. While this seems obvious, many companies fail to ask executives to agree to even basic business protections at a time at a time when the company has the most leverage, i.e., when hiring or otherwise offering the incentives.  Indeed, privately-owned companies are often misinformed and/or lag behind developments in failing to have comprehensive and integrated executive employee agreements to protect enterprise value. Combining deferred pay plans with restrictive covenants that protect intellectual property is fair and benefits executives, owners, and the company. Moreover, Sarbanes-Oxley, which increasingly provides best practices for all companies, requires publicly traded companies to identify, value, protect, and report on trade secrets as an asset class. 

CARRYING THE (BIG) STICKS: Surprisingly, many business owners lack discipline when it gets to defense (enforceable agreements.) Their agreements, if they exist, are frequently outdated, not reflective of changing business and legal needs, and have questionable enforcement provisions. There is a common misconception that restrictive covenants, such as non-competion agreements, are unenforceable.  To be valid, restrictions on the competitive activities of former employee’s must be limited in time, geographic scope, and substance so as to reasonable protect legitimate business interests; i.e., “don’t use a baseball bat to kill a fly.”  There are various tools that businesses can match to classes of employees to create enforceable legal rights and leverage for protecting trade secrets and preventing competition if employees leave. Used in conjunction with well-designed incentives, these sticks will “encourage” employee longevity.  Ranked in order of enforceability these restrictions are: 1) return of company property, particularly documents and files that containing confidential information; 2) confidentiality, precluding disclosure or use of information not generally known outside the business that would be of value to a competitor; 3) company ownership of intellectual property; 4) no-raiding, precluding the hiring of staff; 5) no-solicitation/interference, prohibiting contact with existing customers or prospects for competitive purposes; and 6) non-competition, precluding former employees from working for a competitor.  Compliance with these restrictions can be enhanced by requiring notice to prospective employers, linking eligibility for deferred compensation, and providing sanctions for violations through injunctions, liquidated damages, and payment of the company’s legal fees, which in many cases will provide sufficient deterrent. When deterrence is not effective, well-drafted “sticks” support a company in protecting its interests, such as in the restraining order recently obtained by Yahoo against former employees and their new employer for misappropriating trade secrets and staff. Likewise, as seen in the recent settlement by Microsoft of non-competition suit against an executive who joined Google, restrictive covenants can provide leverage for the a company in negotiating an acceptable settlement.  

THE WINNING COMBINATION: While our service driven region is driven by talent, it is difficult to predict the required combination of talent related offense (assembling, directing, and motivating the team), and defense (safeguarding the talent and intellectual property base) going forward. By using carrots and sticks, a company can establish a well-balanced and flexible approach to these issues to produce the best long-term returns for its business. PLAY BALL!!

REPRINTED FROM:
Association for Corporate Growth/Washington Business Journal - APRIL28, 2006
The Berger Law Firm, P.C. 1825 Eye St. N.W., Suite 400, Washington, D.C. 20006.
Phone: (202) 861-1361 Fax: (202) 861-1362

Legal advice is case specific and is not intended to be provided by this article.    The Berger Law Firm, P.C. may not be held responsible for any consequences that may arise in connection with the use of or reliance on the information provided.