Talent Trawl: What's The Best Bait?

Customized compensation allows small outfits to recruit and hang on to top hires

Jonathan King was an employer's dream catch. The 26-year-old had already run his own successful Internet design business and was happily employed as a well-paid securities lawyer at one of Chicago's more prestigious firms. Yet when another employer approached him with promises of something bigger and better earlier this year, King took the bait.

Was the successful suitor a giant deep-pocketed corporation? Guess again. King was picked off by American Information Systems Inc., a local Internet consulting company with 60 employees, which wanted him to manage sales of its Web site, Internet, and extranet services.

How did AIS do it? For one thing, the company offers employees a comprehensive benefits package that includes good health insurance, a 401(k) plan, and profit-sharing. But the coup de grace in King's case was a stock-option deal that could make him rich if the company ever goes public. "The key thing that pulled me away was opportunity," King says. "Besides being in an exciting industry, I am positioning myself to make a lot more money down the road."

LARGESSE. As for AIS, they don't begrudge him the extra bounty. "We recognized pretty early in our company that employee hiring and retention was going to be a key factor in our growth and success," says Chief Financial Officer Michael Hakimi. So while AIS gives all employees a benefits package, it directs extra rewards to particularly valuable executives.

Such largesse might have raised eyebrows in past years. But the short supply of talent is forcing small companies to raise the ante when they compete with larger rivals for new people--and to retain their best employees. That's no easy feat, because cash is short at many private companies. On top of that, federal rules don't allow employers to beef up the standard pension plan, health plans, or company insurance for a key individual unless everyone else gets the same terms.

The solution? Shore up your basic benefits to make sure they are competitive, then top them off with customized compensation that is carefully designed to avoid running afoul of federal fairness rules.

ROOM TO MOVE. It's not as daunting as it seems. For starters, the mere fact that you offer benefits at all gives you a leg up. Since 1996, the number of small companies offering retirement plans has declined by a third, to only one in five; just 39% offer health care, says Dun & Bradstreet Corp.

The reason is hardly a mystery: A good package of perks can cost 40% on top of salaries. If you had to improve benefits across the board for everyone in order to reward one key employee--which is what the federal rules imply--you couldn't afford to recruit.

But compensation experts say the rules can be bent to heap extra benefits upon top management--including yourself. One tactic is using multiple qualified retirement plans to boost compensation for top employees. Under federal law, only the first $160,000 of income can be used to calculate benefits under pension plans commonly used at small companies. This includes one of the most lucrative incentives you have to offer--pensions tied to profit-sharing.

SEEING DOUBLE. You can get around that by splitting your pension package into two identical plans--and enrolling your high-paid workers in both. If they earn, say, $200,000 a year, they can get credit for $100,000 of salary in each pension plan, thus skirting the federal limit. It's perfectly legal, says Dennis R. Coleman, a principal at PWC Kwasha, a benefits consulting firm in Ft. Lee, N.J., and none of your lower-paid employees gets hurt. (You will need to carefully set up each plan's roster to make sure you don't jeopardize its tax-deferred status. And the rules don't allow this maneuver with 401(k) plans.)

But the real powerhouse for key employees is the so-called "nonqualified" pension plan. These plans, also known as supplemental executive retirement plans, or SERPs, allow employers to set aside additional funds for their top workers without regard to federal caps. In some SERPs, the employee continues to contribute tax-deferred funds; in others, money is set aside by the employer, says benefits consultant Howard B. Edelstein, a principal of the Todd Organization in Cleveland. Federal rules also let you show a little favoritism by offering employee-paid supplemental insurance at bargain rates--and raising their salary to cover the additional cost.

Those measures should keep most of your smaller rivals at bay. But what if you are up against a larger company in bidding for someone's services?

Start by considering what the employee is most likely to want in order to be happy at your company (table). To woo an exec from a major company, for example, you probably can't match their salary dollar-for-dollar. But you can offer a chance to share in your company's future growth and profits.

AIS, for instance, gave Jonathan King stock options--an approach used by 12% of privately held U.S. companies that offers long-term incentives, according to The Executive Compensation Answer Book. Why so few? For one thing, owners are understandably reluctant to part with equity. Stock options are also very complex and can get entangled in securities law.

Instead, some owners have adopted so-called "phantom" stock plans. There's no real stock involved, but the value of the company is computed as if it were public, using a preset formula. The employee is entitled to compensation based on the implied value of the phantom shares. Often the value becomes part of a long-term retirement account, says Edelstein. That's a sweet deal for the company because it doesn't have to cough up precious cash until the shares vest--typically in three to five years.

The obvious flaw from the employee's point of view is that the value of the stock can fall even if his or her performance was terrific. In response, Christopher Rich, president of Lyons Compensation and Benefits in Waltham, Mass., says that some companies are turning to "performance units" that reward key employees based on increases in sales, market share, or cash flow. The employee receives the units upon reaching a fixed performance target, and they continue to rise in value based on subsequent performance.

The administrative costs are modest. Lyons can do the set-up paperwork on participation units for as little as $5,000, but you might be able to get started for even less. "It's not exactly brain surgery," Rich says. "Any good CPA could do the paperwork."

HAPPY HOURS. Beyond benefits and salary, don't overlook your secret weapon: the flexibility and intimacy of a small company. Some people simply aren't cut out for the plodding corporate lifestyle and vastly prefer to work for an entrepreneur. Then there are the sometimes unique lifestyle perks. At GoldMine Software Corp. in Pacific Palisades, Calif., all 135 employees have windows that front on the beach. And at the Institutes for Pharmaceutical Discovery, a drug-research company in Branford, Conn., catered lunches and weekly happy hours are window-dressing on top of a good--but not spectacular--benefits plan.

But what really helps Pharmaceutical Discovery steal top biochemists away from the major pharmaceutical houses, says President James M. Nolan, is figuring out what each recruit needs and wants. "Because we are small, we can give personal attention to our recruiting effort," Nolan explains. "There are things we can offer that the large companies can't." That's hardly a license to start lowballing your best prospects. But it might pay to remember that not all workers are in this game just for the money.

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