Lending an E.A.R.

“We’re going to find the very best person available to run this company,” I told my two clients, “and he or she will be attracted not only by its upside potential but also by the prospect of sharing in your financial success during the next five to ten years.”

I have searched for and hired a lot of full-time CFOs and controllers in the process of transitioning out of my growing client companies from time to time during the past 29 years, but this was the first time that I was being charged with the responsibility for identifying, recruiting, and hiring a Chief Operating Officer.

My clients, a husband and wife team, have built their manufacturing company into a nicely profitable niche business in a rapidly-growing international industry. During the past three years, however, the Company has reached a plateau of about $10 million in revenue, and it has become clear that the challenges of resuming the 20% growth rates of the three previous years at this point require greater management strength and experience than the owners alone can provide.

Now – major disclaimer – I am not in the business of executive search. People in that profession earn significant fees for kissing a lot of frogs (and maybe a few alligators!) – on both the client side and among candidates – as they try to define both the job opportunity and the job prospect. For my part, based on six years of working with the Company as a part-time CFO, I already knew where the warts were, and I share the Owners’ optimism about the upside. I took on the search project for a lesser – but not insignificant – fee.

Five months later, thanks in no small part to my contact list (which includes you, dear reader) and to Execunet.com , I am happy to say that we have found our COO and, pending agreement on a couple of definitional issues, have achieved concurrence on an employment contract. At the risk of jinxing us at the eleventh hour, we look forward to his first day of work in a few weeks.

This COO job is about a lot of things, many of which are very attractive: a well-regarded company, a stable customer base, a veteran work force with little turnover, a hot industry, and a five-year history of solid profitability. It’s also about the absence of experienced senior management talent: each member of the current management team has come through the ranks as a functional specialist. The challenge of melding and molding a truly winning team is substantial, and the reward for the new COO needs to be substantial, especially since the Owners wish ultimately to keep the business in the family.

So my challenge as the CFO was to develop an attractive total compensation package in the absence of a stock opportunity. And then my challenge as an executive recruiter was to sell the package to the best candidate without selling out my clients. We knew that we needed these components:

  1. A very competitive base salary;
  1. A significant annual bonus based predominantly on achievable metrics;
  1. The appropriate benefits and tools, including a car and a laptop; and
  1. A long-term financial incentive.

The first three of these were in accordance with the advertised opportunity: base of $190-210,000; annual bonus up to 20% of salary; health care, vacation, and so forth. The fourth was designed to align the new COO’s interests closely with those of the Owners while recognizing that being a non-family, minority stockholder in a closely-held corporation typically has more downside than upside.

The alignment is predicated on the COO’s adding a lot of value, value which can be measured in dollars and rewarded in Equity Appreciation Rights (EARs), which provide the rights-holder with a financial share in the growth of the value of the firm. At least part of that increase will be due to his efforts, and he, having an appropriate sense of his abilities, wants to share in the upside. The EARmarks (you knew something like that was coming, didn’t you?!) of our metrics for the long term thus are the following:

  1. Avoid the need for a subjective valuation, today and in the future. It’s costly, potentially disagreeable, and you never really know the current score. Instead focus strictly on the increase in Net Worth, adjusting for changes in owners’ compensation, new equity, taxes, and other factors beyond the operating results.
  1. We’re together for the next decade or so. The COO’s financial interest vests over four years, but there’s no payout if he leaves voluntarily. However, if he stays the full ten years, he’s guaranteed a 20% share of the increased Net Worth between now and the end of 2020.
  1. Provide for the unexpected. The COO can withdraw his earned-to-date share at any time for personal needs, subject to a dis proportionate reduction of his prospective ten-year payout.
  1. Don’t play it by EAR (watch out – this metaphor is a stretch) – the COO’s cumulative incentive interest will be represented on the balance sheet and any payout will be done only over a two-year period.

There are compromises here on both sides. The incentive compensation will be taxed at ordinary income rates, not as more favorable capital gains. The value of the Company likely will have increased by several multiples of the increase in net worth, of which the COO shares 20% of just the base. The Owners are making a substantial early commitment (with restrictions on their right to terminate the Agreement) commensurate with the COO’s willingness to leave a favorable current employment situation.

With my recruiter’s hat on, I am happy to have structured a deal that is acceptable to both parties. Under my more familiar CFO chapeau, however, I know that in the best case, it may be a decade before we know how this works out. In the meantime, (I can’t resist) , I won’t be all EARs: my compensation is strictly a monthly retainer.

Alligator Bites

Another “take”…

“RHC Holdings, L.P., the former general partner of Western Refining Company, L.P., granted equity appreciation rights, (“EARs”) to certain employees of Western Refining Company, L.P. to attract and retain management, motivate employees to achieve our long-range goals, provide compensation competitive with similar business and promote our long-term growth in value. These EARs were granted to nine individuals, including eight non-executive officers and Mr. Dalke, our Chief Financial Officer. Each right entitled the holder to receive cash or notes, at our option…. In December 2005, the equity appreciation rights were amended to provide all participants with the right to receive cash and, when our initial public offering closed, shares of our common stock.

“…In connection with the closing of our initial public offering, all of the EARs were liquidated in exchange for $28 million in cash; of this amount, Mr. Dalke received $4.3 million in cash. In addition, we granted 1,772,042 shares of restricted stock under our Western Refining Long-Term Incentive Plan to holders of EARs, including 272,622 shares to Mr. Dalke. The shares of restricted stock vest ratably each quarter for two years.” [Emphases added.]

– from Western Refining, Inc. proxy statement, filed April 16, 2007

Gotta watch those full-time CFOs!

Draining the Swamp

The Massachusetts Economy: Rebounding

Unemployment Rates

Dec 09 10.0% 9.3%
Jan 10 9.7% 9.5%
Feb 10 9.7% 9.5%
Mar 10 9.7% 9.3%
Apr 10 9.9% 9.2%
May 10 9.7% 9.2%
Jun 10 9.5% 9.0%
Jul 10 9.5% 9.0%
Aug 10 9.6% 8.8%
Sep 10 9.6% 8.4%


Growth in Real Product (quarterly growth at annual rates)

3Q 09 + 1.6% + 1.3%
4Q 09 + 5.0% + 4.6%
1Q 10 + 3.7% + 6.1%
2Q 10 +1.7% + 5.4%


– Source: U.S.: Bureau of Economic Analysis; MA: Massachusetts Benchmarks

– via economists Barry Bluestone and Alan Clayton-Matthews at the Middlesex Savings Bank Economic Breakfast, 10/28/10