🔑 Investors, stop giving your money to these types of managers
Welcome to The Business Academy. Here's what we have in store for you today:
- Show me the incentive, and I'll show you the outcome
- Outsmart the startup game (by buying a business)
- $10m in revenue from bathroom stalls
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(Note: alongside being a happy customer, I am also an investor in the business)
"I want my executives to act like owners"
I hear this a lot.
"Show me the incentives, and I'll show you the outcome" ~ Charlie Munger
Let's talk about Aligning Incentives to motivate the behavior you want.
Here's how we align incentives with our executives...
Hiring CEOs
Since we own 20+ businesses, we have to find great managers to steward our businesses.
The most important question: How do we align our incentives with those of our management teams?
We want our CEOs to measure success by the same standards our investors use to measure performance.
Those include:
- Maximizing free cash flow distributions to our holding company
- Maximizing the long-term value of the business
Here's how Warren Buffett thinks about CEO compensation:
The relentless focus on how much CEOs are paid diverts public attention from the real problem—how CEOs are paid. In most publicly held companies, the compensation of top executives is virtually independent of performance. On average, corporate America pays its most important leaders like bureaucrats. Is it any wonder then that so many CEOs act like bureaucrats rather than the value-maximizing entrepreneurs companies need to enhance their standing in world markets?
- Harvard Business Review, on how Warren Buffett incentivizes his CEOs
The Incentive: Large salaries, huge time vesting option grants, and large severance packages
The Behavior: CEOs are paid to stick around just long enough for their shares to vest. If things go well - they win.
If things go poorly, they can just leave because they have no "Skin in the Game". They collect a generous severance if they're fired, and they get another well-paying job elsewhere.
Performance doesn't matter that much. Either way they win.
The problem with this picture is in any business you're guaranteed to have hard times.
You want executives who are going to fight through the hard times and make the company win.
Our philosophy on executive compensation
We as business owners (i.e: shareholders) want executives to behave like owners.
This doesn't magically happen.
The best way to get executives to act like owners is to give them an incentive that aligns their interests with ours.
One of the most common ways is through ownership in the business. I disagree with the common practice of giving executives shares for free. I got some heat on X last week for this take.
Giving out shares might make sense for startups where executives are trading short-term pay and benefits for equity and an exit opportunity (by the way in the majority of cases those equity packages become worthless)
But in our world, that dynamic does not apply.
We buy highly profitable or soon-to-be profitable businesses. We also prefer to hold great businesses.
So what's the right answer?
Here are the structures we use.
The Incentives:
- Equity Skin in the game. Executives buy into the business as co-investors OR use their bonus to purchase shares in the company at market price.
- Pay employees well + profit share. Many people want a strong, reliable paycheck. Our executives get a fair salary and their bonus is based on our goal: distribution of profits (they get a percentage)
The Behavior:
- Downside and Upside alignment (both): If they bought shares in the business when things go well, they win alongside us. If things are not going well in the business, they have a meaningful part of their wealth
- Profit Distributions: CEOs focus on running an efficient business, and growing and distributing profits to the holding company.
🔑 One interesting read: How to Buy a Business
Buy Then Build is a great book about buying a business and "outsmarting" the startup game.
This piece is the author's thoughtful breakdown of how to buy a business, informed by years of lessons from buying 7 businesses.
One of my favorite lessons: Don’t put too much weight into why the seller is selling.
Sellers want out of their businesses for all sorts of reasons, and most of them have nothing to do with the business itself.
Take a look at this piece for some other good business buying lessons:
🔑 One interesting deal: A bathroom stall company
I love when I find a business making millions of dollars doing something that no one ever thinks about.
This company in California does almost $10 million in annual revenue making and installing bathroom stalls.
What I like
This one checks a lot of boxes for me:
- Big enough (if I was buying a biz for myself I'd want a minimum of $700k+ in cash flow on any business I look at)
- In business for 28 years
- Vertically integrated
- Grown 20% over the last 2 years
- Real estate available
The multiple of 3.9x cash flow is directionally reasonable given the size.
What I don't like
At a high level, there's not a lot to dislike here. The real estate is offered at $8.5m, making this a pricey $20m acquisition. But given the location (Orange County, California) the real estate may be realistically priced (need to do an assessment).
🔑 He sold his business for $65m and bought it back for just $5m
Imagine selling your company not once, but twice. That's what David did after building up his marketing agency to a multi-million dollar business. He first sold it for $65m, bought it back for $5m, then re-sold it again for much more than $65m.
Check out my conversation with David to learn how he pulled this off:
Have a great week,
Sieva
P.S. if you're thinking about buying your first business, check out my free email course. It's 6 days of my top lessons on business buying after acquiring several multi-million dollar companies.
Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.
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