Executive Compensation: How Fear, Scarcity and the Wrong Measures Drive the System

Over a decade ago, I wrote an article entitled, "Worth Every Penny" for a local Silicon Valley business publication. My position was that the entrepreneurs who were building their dreams into companies should be compensated for the work they were doing.

My reasons for making that particular case at the time were that:
  • The entrepreneurs were building a new industry
  • They bootstrapped in for months and years before getting their funding
  • I had no idea that they were burning cash as stupidly as they were once they had it - nor that their investors were allowing them to do so.
This was the beginning of the executive compensation anger that is so rampant now.  Frankly, had I known then exactly how insane the compensation system would become for executives in all industries, I'd never have written the article at all.

If we want we can go into the blah-blah-blah of:
  • The reactive VC/Angel investment model of the day that led everyone to jump on the bandwagon and get their bucks in first (which led, interestingly enough, to the need to legislate to protect stupid investments by dentists - or stupid dentists, you choose)
  • The fear that someone else would take over the market before there was - or would be - a market
  • How eyeballs were considered currency...
You know the rest.

In fact, as you look at the newest social media IPOs out there, in some ways we're seeing the same thing.  Plus ça change...

But I digress.

Today, as the Governor of the Bank of England is calling for cuts in bankers' compensation, I listened to an interview with Ralph Silva, Director and Banking Analyst with SRN, talking about that subject.  He said:
"The assumption is that the actual shareholders care. The truth is if you tell the shareholders how much these senior executives are getting paid they're probably going to want them to get paid more. Why? Because they want the best of the best and the shareholders simply don't have a problem with these huge salaries."
Yes, in fact, they do have a problem with them.  Fund managers - in the form of shareholders - may not...but even they're getting a clue.  Because, just as eyeballs were considered currency in the lead-up to the DotCom Bust, so, too, are the measures of executive "success" tied to completely wrong measures now.

What, you ask, are those measures?  In too many cases, as long as the guy - or, in far fewer cases, woman - shows up, the money flows into their pockets in the form of cash, stock, options, perks....You name it.

The logic of this argument comes from the thought that there is a scarcity of talent to run these organizations.  That, too, is wrong.  In fact, too many executives currently in those positions make exactly the case for their own demise - because, clearly, the decisions they're making aren't good ones.

How do we know?  Because the measures that underlie what is considered "success" in these organizations are flawed.  Where there is no growth, there is no success.  Where there is only short-term thinking, there is no future.

The problem is, by the time the shareholders Mr. Silva is talking about realize their mistake, the executives in charge will have moved onto greener pastures in their next jobs.

It's time to get a clue.  Executive compensation is out of whack - but it's fixable.  Change the measures and create accountability for those in their positions.  At the same time, forget the fear and scarcity argument and look at the real talent pool that exists.

Very quickly and without too much difficulty, compensation and audit committees will find that there are a lot more good choices - at much more reasonable prices - than they think exist now.

And Now for the Hedge Funds: More on Your Financial Strategy

In my post a few days ago about VCs versus Private Equity, I talked about what your strategy should be as you look for money based on the agenda that each investment type has to offer.

In very short, VCs are in with you for the longer term as you build your enterprise.  PEs are looking for the money they can make from your organization on a much faster flip.

It's not that one is good and the other bad.  It's that you go to them - or they look with interest at you - based on what they are trying to achieve for their investors.

Now enter the Hedge Funds.  In an interesting - and somewhat disturbing - article in the New York Times today, it turns out that Hedge Funds are starting to take the place of banks in lending money to mid-sized businesses.

After all, the banks aren't lending these companies the money - so someone has to.  And Hedge Funds are.  Even some of the PEs are getting into the act.

That's the good part.

The not so good part is that the Hedge Funds are charging comparatively usurious interest rates (12.5%) and bring the same orientation to your organization's future as a PE fund.

There's even concern that the Hedge Funds - a pretty much non-regulated player in the financial arena - may cause the next economic meltdown as they grow their (and your) debt to astronomical heights.

So, as you look at what you need, put the Hedge Funds into your thinking - but, as always, ask yourself:

How much does this money really cost?


VCs, PE and the Cash Infusion Question (OA)
Bank Said No? Hedge Funds Will Fill a Void in Lending (NYT)

VCs, PE and the Cash Infusion Question

I take a lot of meetings.

Some of them, of course, are with my clients.  Others are for business development.

And then there are those meetings that look like being for one purpose and end up for another altogether.

I had one of those last week.  It was with a management consultant who works with Private Equity (PE) firms.

Being a Silicon Valley sort of person, I'm far more oriented toward the Venture Capital world.  That's for a lot of reasons:

  • First, of course, it's because it's the venture guys who have made the Valley possible all these years.  They deserve a world of credit for that.
  • Second, it's because I like their purpose.  They see something out there - in most cases something that doesn't yet quite exist but shows all the potential in the world - and they invest in it.  They invest in the future not only of start-ups but also of companies that need help in later stages to scale and fulfill their potential.
  • The third reason is because, if you know anything at all about how VCs work, they invest as much in the people who bring them the opportunity as they do the opportunity itself.  You do a pitch to a VC and, as well as having a viable, preferably already revenue-generating, product or service and you'd better also have a really strong management team.  If you don't, they'll find someone else with a similar product but better chances of bringing the business to fruition.

And that's why, for a lot of reasons, taking the meeting with a person who lives in the PE world was, I knew, going to be a fascination - no matter the outcome.

She's seriously smart.  Talented, too.  She knows how to create success for her clients - and that's a good thing.

But the clients are the PE firms - not the companies they have bought.  Which makes all the difference in the world.

In her world, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) isn't just a key indicator - it's practically the only indicator.  And in the PE world, that makes sense.  Because the value of the company they bought is wholly dependent upon how much they can get for it when they sell it - preferably the sooner the better.

Because their goal is to sell.  So the companies need the highest levels of earnings possible.  And the faster the sale, the better.  (I know.  I'm repeating myself.  But if there's one thing you need to understand, it's that one fact.)

The whole issue of speed and investment and commitment was very much on view in Tamara Mellon's recent FT interview about the sale of her company, Jimmy Choo (of the eponymous and beautiful shoes and accessories) out of its third PE relationship to a "long term partner," Labelux.

She even went so far as to say that PE isn't a good fit with luxury because PE doesn't understand a long-term relationship.  PE isn't willing to invest the up-to-30 years that it may take to adequately build the brand.

She's right.  Because that's not the PE model.

To be fair, neither is it the model for VCs.  They want - and need - a faster turnaround.  But the thing you very often see is that the VCs involved in taking a company to success stay with that company for years to come.  On the Board and as major shareholders.

I'm not romanticizing these guys.  I promise.  But, in the world of business building, it's the VC model that wins.

Which brings us to you.

As you build your company - no matter where you are in your developmental arc - there will be times that you need a cash infusion.  It can come in the form of a straightforward loan.  Or, if you're in start-up, a VC or Angel Fund may your answer.  Or, if it makes sense and you're at that point, you may be looking at an IPO.  Or, particularly if you're further along in your development, you may want to see what the PE community has to offer.

When you do, the questions you have to ask yourself are:

  • What is my purpose in getting this money?
  • What is my commitment to this organization?
  • What am I looking for in my financial provider?  (Don't ever call them partners.  They're not.)
  • What kind of commitment do I want from them?
  • What value - beyond their money - do they bring to helping my organization succeed?
  • What are the best and worst case exit scenarios I can imagine - and which of those providers plays into each scenario?
The more you are focused on the long-term, the easier it will be to determine how best to strategize your organization's financial needs from outside sources.

Start now - whether you need the bucks or not.  Because it's always good to have a plan in place.

Especially when it comes to money.


Tamara Mellon makes new love match, predicts luxury/private equity divorce (FT)

Staying on Message

Executives who have to face the fire on programs such as CNBC's "Squawk Box" are well trained to stay on message.  That's why they're always worth watching.

Think of it like a free post-doc in how to get your point across in difficult matter what anyone throws at you.

So, whether it's in preparation for your first media appearance or you're going in front of your friendly local VC, C-level executive or Board members - you want to know what your message is and then keep to it.  Through thick and thin.

An excellent example was when Cisco's CEO, John Chambers faced the CNBC fire to give a very different perspective than the one the analysts had chosen to adopt.  Even though, as he was speaking, his company's share value had taken a 12% drop in morning trade.

His key message throughout:  We control our own destiny.

By stating and re-stating that - supported by all sorts of data for all the different markets in which Cisco plays - his purpose was to allay fears that market forces would drive the company's valuation and performance down further.  And then further.

I don't know if it will work over the long term.  After all, it has most recently resulted in the shut-down of the Flip video camera and laying off of 550 people.  But it is a great example of the messaging art.

The resource below will get you to the All Things Digital page with the video.


John Chambers Plays Defense as Cisco's Shares Tumble (ATD)