This is an add on post to Incentivizing CEOs :
1. Simplicity - The best incentive plans are easy to understand, achievable, and align incentives. We have used numerous plans in the past and have found that our current system is best. It is extremely simple. I do not even need an entire napkin to map it out for the CEO. It also aligns them completely with the HoldCo because, yes, we want cash sent to the HoldCo.
2. The importance of Cash - I write a lot about cash flow. My OpCos sell products and services. From water heaters to pizzas. Couches to Cinnabons. At the HoldCo level my product is…CASH. That is my tool. My partner and I make all investment decisions. We continuously look at deal flow, read about businesses, and think about our portfolio companies. All with the goal of allocating our cash to the most attractive risk adjusted return possible.
3. Investment decision makers – My partner and I make all investment decisions. This is why we do not charge a cost of capital to the OpCos when they use cash for organic growth. It is also why we do not hold them to some metric of return on equity or other KPI. We already made that decision when we decided to proceed with the investment or bought the company. Those returns are on us.
4. Underwriting Risk – Our investment decisions are based on cash flow. We pay based on how much cash we think the business can produce. As the business begins to distribute cash not only does it prove our thesis right, it also lowers our underwriting risk. Once I have recouped my investment at the HoldCo level I have in essence derisked. If I choose to reinvest in future growth for that OpCo that is a separate underwriting and will be treated as such.
5. Milestones – We do occasionally set stretch goals. If a CEO is highly motivated and has a solid plan, we will give them a stretch goal based on its achievement and pay them a large one-time bonus (think 2-3 years of base pay). This is in addition to their typical incentive plan and is used rarely.