SKIN IN THE GAME
January 28, 2021
by Brad Mook
A while back in my career I was a capital allocator for a large manager of managers. I was fortunate to have a real-time laboratory through which to study industry practices around a whole host of issues, one of which was ownership vs compensation. I learned a lot through the experience—through my successes, failures, and the unremarkable fat middle—and strongly believe that an ownership culture provides competitive advantages over a compensation culture. You’ll get the best out of your people when they have skin in the game.
One of my biggest “failures” as a PM was one of my best learning experiences. A boutique manager we had invested with was acquired by a larger financial services company, and was to maintain its “independence” and “autonomy” within the larger company. At a high level it all checked out, and we maintained the investment despite the change in control. For a time, all went well aside from some seemingly inconsequential skirmishes between parent and affiliate. Eventually, however, investment performance hit a tough patch, assets dipped, team members left and the firm folded. And instead of weathering a performance fluctuation with a long-term view on a high-conviction manager, we were forced to implement contingency plans and reallocate the capital at an inopportune time.
What I later learned was that the parent company had swapped out the investment team’s equity for a profit share structure, which maintained the team’s take home comp, retained some alignment and seemed like a reasonable step. What it also did, however, was create a trap door in what had been a solid foundation. Without equity value, the comp structure became interchangeable with compensation schemes elsewhere, particularly as the business experienced a decline in economics. While ownership in the entity might not have completely maintained the status quo, it would have made it harder for valuable team members who effectively became at-will employees to jump ship for similar or better money elsewhere. It just might have stopped the death spiral that put the firm out of business.
An ownership culture provides financial, structural and psychological benefits that are hard to replace. The notion of building and participating in equity value – and sharing in equity risk — can be a strong center of gravity for hard-working and talented employees. It also creates a sense of stewardship and continuity, a sense of belonging. For an industry often accused of mercenary or self-interested behavior, a tight-knit team focused on building a successful firm can be a powerful draw to clients and new employees. While not perfect, employee ownership structures can reduce conflicts of interest and agency problems, ultimately aligning owners, employees and clients toward long-term success. When allocators describe ideal scenarios, it’s hard to divine better setups.
The notion of alignment is powerful, but too often we don’t dig deep enough to understand the mechanics of alignment and too often we accept platitudes or self-motivated reassurances. The truest measure of alignment is the amount of skin you share in the same game. Much of the transaction structuring among buyers and sellers today does not meet this test; preferences, revenue sharing arrangements, and other instruments designed to separate the buyers outcome from management’s is inherently misaligning and dangerous.
At Rosemont, we invest alongside employee owners so we all have skin in the same game, and we believe in the employees owning the majority so it really is their asset. My ill-fated investment all those years ago went down a different path, and the employees—the investors—checked out, forced clients to reallocate, and left the owner with nothing. Perhaps surprisingly, I respect and remain friendly with the head of that boutique; it was a learning experience for both of us and, while the outcome was unfortunate, it was handled professionally. That said, the experience left some scar tissue and has been formative in my beliefs around best practices. Ownership matters. Belonging matters. Skin in the game matters.