“This is how we incentivize our CEOs and ensure vision alignment between them and the HoldCo”
Our CEOs are paid a market-rate base salary. They also receive a percentage of distributed cash. That means that every time they transfer money to the HoldCo bank account, they accumulate a percentage for themselves. At the end of the year, this accumulated incentive is paid out to the CEO.
Here are the 5 most common questions I get regarding our incentive structure:
Why not just pay based on profit or some other metric? We, as the owners of the business, unfortunately, cannot spend profit. Profit cannot be used to buy another business or pay down debt. We cannot even pay our taxes with profit. The only thing an owner can use is CASH. Cash in the form of distributions. We want our CEOs to think like business owners. We incentivize them like business owners.
Who determines how much cash should be sent? We begin the year with a budget. Based on that budget and the industry we are in; a distribution target will be set. To qualify for the incentive this minimum threshold must be met. If it is not met, the incentive is at the discretion of the board of directors.
Does this plan incentivize short-term thinking over long-term growth? I do not believe so. A company (in the industries we acquire) growing at “normal” rates will not need to consume too much cash to do so. It will slowly increase inventory and receivables while still producing healthy cash flows. If a company plans to have very high year-over-year growth, then yes that may consume cash. But we would have seen that in the budget and accounted for it in our projection.
What about growth opportunities during the year? The CEO has the flexibility to move away from the budget. If they see an opportunity for growth and during the year the CEO wants to start purchasing more inventory or extending credit to achieve higher sales, he can do so. But just like an owner, he needs to be aware that the decision implies the use of cash, possibly fewer distributions, and a lower bonus. On the flip side, if the investment pays off, he should be able to distribute higher levels of cash going forward and participate in that upside.
What about major investments and CAPEX? All major investments and CAPEX are approved at the HoldCo level. A CEO can present an opportunity with their thesis and projected ROI. We will analyze it, compare it to other opportunities available, and make a decision. Any approved investment/CAPEX will be funded by cash at HoldCo. We do not charge anything to the OpCo for that cash.