By Brady Fletcher
In a survey of Canadian companies, the National Bank of Canada found that family-owned businesses outperformed publicly traded companies by 120.3% over a 10-year period. Why would these family ventures be so much more successful than other public companies? One of the most likely differentiators is that their owners rise and fall with the success of the company, while executives without “skin in the game” aren’t personally impacted by the outcome of the business.
Among the first questions investors ask when looking at venture-listed companies is: “How much does management own?” When management teams have skin in the game, it means they’ve either invested their own capital upfront or have a significant equity stake in the company. This directly ties their potential income to the company’s performance.
Small growth-stage companies often need to put their limited funds to work in growing the business, prompting them to be creative in how they compensate their top-tier management teams. Skin in the game offers an additional compensation stream—all while ensuring executives are held accountable to deliver on a company’s business plan. When compensation is based on company performance, managers are invested in creating value for shareholders.
This isn’t just a hiring tactic. Institutional Shareholder Services and other institutional advisory services set forth clear recommendations on alignment between executive compensation and company performance.
Anytime investors put money behind a particular company, they’re taking a risk. As such, in order to engage investor interest, it may make sense for the people running that company to incur similar risks. This helps keep management teams that operate the business aligned with their investors, making skin in the game one of the key metrics for investors evaluating a company.
Greater Risk for Greater Return
Executives with a vested interest in their companies may produce better returns because they’re aligned with the growth of the business. With a large enough position, management has the potential to earn more through the company’s share price performance than their compensation package. This ties individual interest to share performance—benefitting both management and shareholders alike—and keeps busy team members focused on the company’s growth.
When managers tie their own fiscal success to the performance of the business, it’s also a good indicator that they may genuinely believe investing in the business will deliver stronger performance. For example, when the managing director of PepinNini Lithium, Rebecca Holland-Kennedy, exercised options at more than six times the company’s share price, she gave the company a strong vote of confidence.
This is a phenomenon replicated in various types of investment opportunities. The TSX Venture Exchange’s capital pool company program requires skin in the game: Members of the deal-making community become merchant bankers, profiting off their equity position in the CPC only when they find an attractive qualifying transaction that turns into a success story.
Along with management’s financial commitment to a company, there are numerous other factors to consider when making investment decisions, such as market opportunities and the political climate. But reviewing this checklist can help you source organizations with management teams that have an interest in the company’s performance.
1. Check public filings. Look to resources like Bloomberg, the System for Electronic Disclosure by Insiders and Ink Trading that report on not only existing equity positions, but also on activities by insiders and management. While there are legitimate reasons for management teams to sell positions—rebalancing portfolios, ensuring there’s an appropriate level of diversification, etc.—insight into these changes gives investors a way to see how much the team stands to gain or lose depending on the success of the company.
2. Investigate board independence. A successful board is meant to represent shareholders and provide governance over management teams, and the ideal board should operate as an independent body, removed from day-to-day operations.
Checking that a company’s board doesn’t have deep affiliation with management or material business dealings with the company can go a long way to ensuring that there is a system in place to hold management accountable. Glass Lewis recommendations for board independence, compensation and governance structure offer good metrics for evaluating a board structure from the outside.
3. Track company communication. Following its merger with DuPont, Dow announced that it intended to present its entire operating and financial priorities during an upcoming shareholder event. For advisors and investors alike, this grants insight into the performance and potential of a company.
One of the benefits of working with brokers is that they can provide access to press releases and management presentations and help investors utilize these materials to inform investment decisions. This can help provide insight into whether management establishes clear metrics for the company to be evaluated against or whether the story changes from quarter to quarter.
4. Assess executive and director compensation programs. When researching a company for investment opportunity, assess the company’s compensation framework to see whether it’s consistent with ISS guidelines for management compensation and alignment.
Current guidelines dictate that companies should adhere to five global principles in terms of executive pay: “maintain appropriate pay-for-performance alignment with emphasis on long-term shareholder value, avoid arrangements that risk ‘pay for failure,’ maintain an independent and effective compensation committee, provide shareholders with clear and comprehensive compensation disclosures, and avoid inappropriate pay to nonexecutive directors.”
After settling a lawsuit that sought to recover shareholder losses, Akers Biosciences had to re-evaluate how it meets these guidelines. The company recently announced that it’s looking into strategic alternatives to improve and maximize shareholder value.
When I was in banking, our corporate finance shares and broker warrants aligned us with the success of our clients. In other words, when our clients were successful, they became worth much more than the pure cash commission. By evaluating the points above, advisors can focus on companies that share this alignment mindset when helping their clients find potential investment options.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage readers to do their own diligent research first before making any investment decisions.
Brady Fletcher is the managing director of TSX Venture Exchange, a global platform for facilitating venture-stage capital formation.