This article originally appeared in the November 2013 issue of Smart Business Philadelphia magazine.

Owners of privately held midsize companies are increasingly using performance-based bonuses as a key way of compensating executives. Companies will pay for performance, but they want to see value. Whether it’s a CEO, CFO, COO, vice president of sales or vice president of marketing, it’s about how they can create value for owners in an organization. If it’s a CFO, for instance, it’s not just about crunching numbers; it’s about being a strategic business partner.

Why has there been a trend toward performance-based pay?

A lot of companies have been through tough times, but they’ve also learned to better operate their businesses. Many have available cash right now and are wondering whether to incentivize the current team, pursue an acquisition, launch a new product or upgrade their talent.

For some who’ve decided to incentivize the current team, one option has been to reward their top performers by creating phantom stock or stock appreciation rights plans. These plans can motivate key executives to stay, and also reward them as the company grows.

If they’re hiring an executive, the interview process is now much longer than it was five years ago because they can’t afford to make a mistake. When they upgrade talent or bring in a new CEO, companies want the entire management team involved in the decision. As a result, the chosen executive candidate can build trust and rapport with management before they even start. This allows him or her to hit the ground running.

Companies want to make new executives happy from a compensation perspective, but they don’t want to give away everything. So, they’re designing packages that provide long-term rewards. They’ll negotiate a base salary everyone is happy with, and then determine how to link the bonus to company performance.

How do phantom stock and stock appreciation bonuses work?

Companies are increasingly using these plans that put a percentage of an increase in revenues over a specified period of time into an executive’s retirement plan.

With these plans, the executive doesn’t own equity in the company but shares part of the increase in value. These vehicles reward executives for growth and profits with a focus on specific goals and objectives that need to be accomplished.

Are companies trending away from any particular types of compensation?

Mid-market companies — $20 million to $500 million — realize there is a talent war and know they need to pay for top talent. However, they want to share risk. One way to do this is by offering more in bonus compensation than salary. Executives might be asked to accept less cash upfront in return for the potential upside in bonus compensation and earn-outs.

Some owners might be reluctant to negotiate upfront agreements relating to severance because they may have been burned in the past, such as having to pay severance to a sales professional who was not driving revenue. While many companies do not proactively offer severance, depending upon leverage, executives can have success in gaining some change of control protection.

Most companies are trying to avoid employment contracts as well. Instead, the offer letter now summarizes expectations and includes some measures of protection.

All of this comes back to companies expecting value creation from their new hires. When an executive joins a company, it’s difficult to know upfront exactly where or how he or she will add value. But if the executive helps generate leads that double revenue, for instance, companies are willing to revisit compensation because they want to reward that behavior.

Companies have become more transparent — owners are more willing to allow key team members to know the company’s cash position, and understand why bonuses are down if it’s not a great year. Their philosophy is that everyone is in this together, and, if the business grows, everyone will win. ●

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