Taking CEO job with plan to buy company in 1-2 years - align incentives?
December 02, 2021
by a searcher from London Business School in Johannesburg, South Africa
I am currently working as interim-CEO of a light manufactring company, with the option of taking the job full time.
The company is owned by a micro-PE fund, whose fund is closing in 2024 so they will be looking to exit the investment by then. Currently the compnay is in a turn-around situation, though progress is being made and I see great potential for the company going forward.
The CEO job itself is not a particularly attractive role for me, as there is little equity on the table. However, I would consider taking the job if I could see a path to acquiring the company down the line, once it has been stabilised and shown some consistent profitability.
I have a very good relationship with the managing partner of the PE-fund who is willing to discuss options.
Question: How could we structure an agreement now so that I take the CEO job, with the agreement that I can buy out the PE fund in###-###-#### months, without getting misaligned incentives?
I don't to end up in a situation where:
1) Any progress shown by the company just means that i'm driving up the purchase price, or multiple that I would pay to buy it
2) I put in a couple of hard years improving the company, only for the PE fund to find some strategic buyer who can offer to purchase at a price I can't compete with
Similarly the PE fund presumably doesn't want to end up in a situation where:
1) I hold back on implementing improvement initiatives, or sandbag performance until I own the company myself
2) They end up in a situation where I hold them hostage when time comes to sell, with the threat to leave the company without a CEO and difficult to sell to anyone else, unless they sell to me at a discount rate
I thought of discussing a sales multiple now, that would at least allow for us both to be happy with growth pre-sale - but this does not account for multiple expansion/contraction if things go better or worse than exepcted.
Another option would be to agree "first right of refusal" at sale - but this again leaves me at risk of putting in 1-2 years work to grow big enough for a larger PE fund or strategic buyer to swoop in and buy out at a price I can't compete with.
from Texas A&M University in Johnson City, TN, USA
To structure, you need to have a kind of put/call that you are both happy with. If you say want to buy company at 3x earnings, but they want to take offer at 10x earnings from a strategic, they need to be allowed to choose the 10x offer, but you need a compensation/salary structure that lets you take part in upside.
Let's say you get paid $100k/yr IF they let you buy at 3x in say 2-3 years. If not, then they pay you some fee of say $100k/yr if they sell to someone else (for any reason).
You then need to add a requirement that you stay employed/engaged or meet certain performance requirements to get this fee amount, so that they are confident that you will continue with the business. Perhaps tie the fee to the sale amount should they sell to someone else.
Stack this with typical bonus/performance based compensation structure for your base.
This should keep you incentivized by:
1. You need to make business more profit to get better base TODAY, which is guaranteed
2. You need to turn business around to make it financeable by bank for your planned buyout- you'll need a couple good years of tax returns
3. You will share in upside if they don't sell to you (bonus/fee is added, make it something you are OK with to compensate your time). This INCLUDES them just holding the business, as they would see that holding was more valuable than selling to anyone, and them wanting to keep you leading it.
4. If they do sell to you, then they judge it is their best option at that time, and they "save" the fee of selling to someone else, and everyone is happy.
5. If you are fired, you have extra protection with the Fee being on an annual basis.
6. They keep all options open, don't lose large potential upside.
Good luck.
from London Business School in Johannesburg, South Africa
In the end we weren't able to align timeline and incentives. It was clear to both of us that the company needed 4-5 years of very strong turnaround performance (20% revenue growth per year) to achieve the return the PE fund required. This was obviously a very bullish scenario, and even then would only result in a not great return for the fund, and not give them much extra "pie" to share. The fund was able to negotiate to extend their hold period for another 5 years to try and realise that potential.
They were not prepared to commit to sell to me in###-###-#### months as this would have resulted in a big loss for them. I was not prepared to wait 4-5 years to purchase the company.
The fund offered for me to be CEO for that 4-5 years, at a market matching salary +5-10% equity. However, in the end I decided that if I was going to sign on to run and grow a company at +20% a year then I would rather do it through the self funded Search Fund model, where I could have >50% equity.
Obviously with the SF model I will have to spend time searching, and will face a large acquisition risk - but then I expect to be buying a much more stable company that isn't in a deep turnaround situation.
In the end I extended my contract as interim-CEO to allow the fund time to hire, and do a handover with another CEO who seems like a very good candidate. Some great experience for me, and outcome from them as well.