I know this topic comes up quite regularly - so please forgive me - but didn't quite find what I was looking for when I searched here.
Situation:
- Self funded searcher looking to acquire a ~30 person B2B-focused electrical installation business, ~1m EBITDA
- Co-owners (50/50) actively involved in the business are looking to retire / transition out, currently roles:
> CEO: customer acquisition / relationship mgmt, finance, project costing, HR, general admin, corporate topics (i.e. generally "non-technical" topics)
> COO: customer acquisition / relationship mgmt, project costing, steering project managers / ensuring appropriate staffing on projects, problem-solving on projects
- Idea is for me to step into the CEO's shoes - which in their (and so far also my) view is feasible despite my lack of sector background (I'm a finance guy)
- They have a current deputy COO which they have been grooming to step up - which we all agree will be critical to ensure he is on board and motivated for the transition / long-haul (given the technical side, and experience which I lack)
- We have discussed incentivizing / locking him in e.g. through a 5-10% equity stake although this is likely tricky to achieve on day 1 due to 1) uncertainty if he will really be the right fit with me (from both sides, I haven't met him yet but would get the opportunity later in the process) and 2) lack of capital from his side to invest
- There might be 1-2 other key staff which it could also make sense to tie in / incentivize in this way
- The sellers have put forward the idea of retaining this 5-10% equity stake (in practice re-invest into my acquisition vehicle) for an interim periood (feels like they're thinking months rather than years, basically only as long as they would remain operationally involved in the business) - to then allocate accordingly in due course
Thoughts / questions:
- Helpful that the sellers are open to find solutions but I'm not covinced this is the right one:
> In an ideal world I would get more committment/certainty from the future COO up-front (but I'm not sure how realistic this is in the fog of the deal)
> Structuring it this way (in terms of timing) probably complicates things from a financing perspective for his stake - i.e. he would need to benefit from the broader financing package in the same way I would, for him to have any chance of getting the cash together (I'm putting in 15-20% equity, with the balance bank (trad, not SBA, deal is in Europe) and vendor loan)
> "What's in it for him?" (beyond an attractive investment in the long-term), to actually put capital in, particularly in such a minority context
- Seems more realistic to incentivize him with some kind LT stock grant programme (ideas for typical way to structure this welcome!)
> This is then more of a structure to incentivize upside though rather than mitigate downside (worst case him leaving) which I'd have more of if he actually put something more that sweat equity in
- On the other hand I wonder if it might be wiser to keep things simpler by not bringing employees into the equity, to avoid 1) future governance complications and 2) sharing financials in full transparency - and instead work with cash bonusses tied to certain KPIs e.g. (but again this structure lacks the downside mitigation)
Any thoughts super-appreciated - even if just referring to other posts / resources I might have missed!
Structuring [equity] incentives for COO / key personnel
by a searcher from Vlerick Business School
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I need to read Built to Sell!
"Create a long-term incentive plan for your key managers. Each year, take an amount equivalent to their annual bonus and put it aside in a long-term incentive account earmarked for each manager you want to retain. Allow the manager to withdraw one-third of the account’s balance each year after a three-year period. That way, a good manager must always walk away from a significant amount of money should he or she decide to leave your company"
In this instance, I would top off the plan with an initial bonus so that there is something they'd walk away from on day 1. To me, this feels much cleaner than issuing equity and you can get very creative with this.