Imagine that you are the CEO and founder of a healthcare start-up that is growing at fast pace, and you are now in need of a VP of sales because you alone, as the CEO, cannot get so involved in the commercial work. For that, you want to design a compensation package that is attractive enough, but at the same time that creates the necessary incentives for this person to perform well and have a long-term vision. Then you consider the following options:
- 1.You come up with an attractive package in terms of salary, bonus and benefits: put a salary 15% above the market average, an attractive bonus in terms of sales, and a complete benefits package;
2. You choose a salary and bonus in line with the market, and you attach equity to the agreement, creating a stock option program that works as long as the person stays in the company, delivering results;
3. You choose a salary and bonus in line with the market, create a stock option program, but in addition you offer to buy 0.5% of the company for a symbolic value, which he or she would have to pay money to obtain.
Which option do you choose?
Keep in mind that there is no right or wrong answer here, this is just a mental exercise that will even be answered, in some way, with the content of the article. I believe option 3 is the right one, because it's the only one that lines up with the "Skin in the game" modus operandi required for a sales VP , which will precisely be the topic of today's article dedicated to Elon Musk.
Elon Musk is the billionaire founder, CEO and CTO of SpaceX, and the CEO of Tesla Motors; vice president of OpenAI; founder and CEO of Neuralink; and co-founder and president of SolarCity. Sure he does a lot of things at the same time, and he even the man responsible for creating X.com, a company that would later become PayPal. Here's an interesting story: After earning hundreds of millions from the sale of his PayPal stake to Ebay, he reinvested everything he had in Tesla and SpaceX. Sounds like a pretty risky thing most of us wouldn't do, right? But according to him this is truly a rule of success for any entrepreneur, and that's what he tells us in the next statement:
"I think it's worth investing your own capital in what you do. I don't really believe in this idea of "other people's money", because I think if you're not willing to put your assets on the line, well, you shouldn't ask for other people to do it for you".
As far as anyone knows, the money Elon Musk made from selling PayPal to eBay was $180 million. Of that amount, he famously invested everything in his future business: $100 million was allocated to SpaceX, $70 million to Tesla, and then $10 million to SolarCity. What was left then? Practically nothing, which is why at that time, Elon Musk borrowed money from friends, and allegedly even slept on their friends' couch because at the time he didn't even have a house of his own.
Now, I don't know how much of this is real or not, but certainly the courage that Elon Musk had to reinvest everything he earned in his business is mind blowing.
Even though he is the richest person in the world, he has a very basic lifestyle for his level of wealth: after selling most of his real estate assets and moving to Texas last year, Elon Musk said he currently owns only one house located in the San Francisco area, and that his primary residence is a small prefab house he leases from his aerospace company, SpaceX. The tycoon's new home is just 37 square meters that typically sells for $50,000, and is located in Boca Chica, Texas, where SpaceX manufactures its Starships, and is "a prefab folding home" made by Boxabl, a startup specialized in prefabricated houses.
Sometimes we dream to have things that billionaires are tired of having... maybe we are looking for the wrong things? Let's leave this as a food for thought. To anyone interested in knowing more about the definition of wealth, I highly recommend the Metanoia Lab episode on Naval Ravikant's theories.
But now I want to focus for a moment on why Elon invested all that money in his companies: simple, because he doesn't believe so much in the importance of external capital, and he thinks that the priority is for the entrepreneur to put his own money in order to have real "Skin in the Game", in other words, to align your risks.
Let's take a moment to better understand the concept of "Skin in the game":, which was popularized by the economist Nassim Taleb.
What does his book tell us? That basically, "skin in the game" - that is, having a measurable risk when making an important decision, as for example in the case of a start-up founder putting as much capital as possible - is necessary for fairness, commercial efficiency and risk management, in addition to being necessary to understand the world, while aligning incentives and making the message you pass more trusted by your audience.
What does that mean? That if you're a founder that put as little capital into your venture as possible, and you're going to immediately try to raise capital with investors, they're going to look less confident than if you had put your skin on the game and put in as much capital as possible.
Let's take a look on how this "skin in the game" concept applies to the automotive market. We have to consider that because Musk has some serious "skin in the game," that has important implications for anyone evaluating Tesla's value against other automakers.
In theory, a company's leaders (executives and board members) always act in the interests of the company and its owners (shareholders). In reality, however, executives' short-term self-interests can diverge widely from the owners' long-term interests (not to mention the interests of customers, employees, and the communities in which the company operates). In economics this is called the Agency Problem, or agent problem, and it is a well-known phenomenon where in the business world, agents (i.e. managers) tend to have incentives to act in their own interests, which are contrary to their owners' interests (business owners). As legendary investor Charlie Munger, a partner at Warren Buffet said, “Show me the incentive and I’ll show you the result.”
This is where researcher Kevin Rooke recently, in an amazing article, compared the incentives that drive US auto CEOs, using four metrics: CEO equity, stock buying and selling behavior, salary, and reputation. (He only looked at GM and Ford, but an analysis of other global automakers would certainly reveal a similar lack of skin in the game).
A look at the CEO's equity reveals a big difference between Elon Musk and his colleagues in Detroit. “Both Ford and GM are run by CEOs who own small portions of the company, having inherited the CEO role without much equity,” writes Rooke. “Tesla, on the other hand, is being managed by a founding CEO who is the largest shareholder in the company.”
As of February 1st, 2019, Ford CEO James Hackett owned $8.2 million worth of Ford stock, equivalent to 0.02% of the company's market cap. As of April 1st, 2019, GM CEO Mary Barra owned $135.4 million worth of GM stock, equivalent to 0.26% of the company's market cap. Tesla CEO Elon Musk owned $16.6 billion worth of TSLA stock as of February 14th, 2019, more than 21% of Tesla's market capitalization. For Rooke, the implication is clear: “Elon has it all in. Mary and James, don't.” Underlining Elon's commitment is the fact that, at times when the company's finances looked bad, he often responded by buying more stock.
Tesla CEO Elon Musk bought 102,880 shares in 2019, increasing his already large shareholding by par. Elon Musk was the only one who bought shares this year!
Musk is also the only one who doesn't receive a salary. James Hackett's 2018 Ford salary included $1.8 million in cash and another $15 million in other compensation. Mary Barra get an even better slice by receiving $7.2 million in cash and $14 million in other types of compensation.
Corporations often justify the huge sums paid to CEOs by pointing to the huge profits made under their leadership. But how is this working at GM and Ford? According to Rooke, GM hasn't increased its annual earnings since 2015, and Ford hasn't seen an increase since 2017. Each of the company's stocks has been on a downward trend since 2017. But for James or Mary little has changed - they are paid regardless of how the company performs.
Elon's paycheck package goes a little different - he doesn't earn anything unless Tesla shareholders get rich. Under the terms of Elon Musk's 10-Year CEO Performance Award, he will receive stock options in 12 tranches, and each of the 12 tranches will be vested only if certain assessments and operating milestones are met. Poor Mr. Musk won't get a dime until Tesla's market capitalization exceeds $100 billion, and he won't get the entire package unless Tesla's valuation reaches $650 billion - which would make it one of the most valuable companies in the world, and the most valuable automaker in history.
It's not just money at stake. Elon's reputation is based on his success with Tesla and SpaceX. If one of the two falls, Captain Musk will also go down. Mary Barra and James Hackett, like coaches of failed sports teams, have the option of jumping ship for another company at any time, and their reputation would likely suffer little because CEOs do it all the time.
“Among America's three automaker CEOs, Elon Musk has a lot more at stake than anyone else, and he designed everything to be that way. Whether it's money or reputation, he practically lives with his neck on the line. And that's exactly how leaders should run companies.
That's something to ponder the next time someone tells you how crazy it is that Tesla now has a larger market capitalization than GM and Ford combined.
Overall, this is a fundamental element of good leadership: In 1802, E.I du Pont founded a gunpowder company, which later became the current Fortune 500 company, DowDupont. The gunpowder business is a risky business. He was serious about safety and even went so far as to build his house in the factory's blast radius. This ensured that he and his family took the same risks as the factory workers.
He realized then that "Skin in the game" is an essential concept for any business leader who wants to improve their decision making. This means that no one should be involved in any decision where they are protected from the negative consequences of the decision.
So I'd like to leave you with a practical challenge: as a leader, manager, or collaborator, ask yourself the following question: What kind of decisions do I make, where I'm constantly protected from the negative consequences of the decision and where I don't actually have enough skin in game?
Next, decide one of the following actions to take forward:
- How can I delegate these decisions to whoever has skin in the game?
- How can I grow my own skin in the game to ensure this is a decision I have to make myself?
Reflect on this as homework and tell me later.
Any idea, question, comment or even complaint just get in touch through the website Andrea Iorio.com.br, through instagram @aiorio_br.
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