what about those pesky shareholders?

8/14/2019 What About Those Pesky Shareholders?

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COPYRIGHT 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

TABLE OF CONTENTS

Essential Knowledge1. What is the Purpose of Your Business?

2. Avoiding the Kiss of Death

3. Managing the Stock Price Side of the Business

4. Overhang and the Risk of Stock Price Catastrophes

5. What if You Ignore the Second Side of Your Business?

Best Practices and Trade Secrets

6. How to Analyze and Understand the Shareholder Base

7. Moving Stock From Weak Hands to Strong Hands8. Why Investors, Not Traders, Are Desirable Shareholders

9. How to Identify Shareholders

10. Methods for Communicating to Shareholders

11. Methods for Marketing to Desirable Shareholders

Organizational Structure that Supports Both Sides

12. Bet on the Jockey

13. Musical CEOs

14. The Compensation Debate15. How Many Millions Are Enough?

16. If Senior Management Compensation is Wrong

17. How to Get Yours

18. How to Recruit the Right Board

19. Conclusion

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1. What is Your Purpose in the

Business?

I am not looking for yourmarketing spin here. I dont want

your grand vision of how you are

transforming your product or service

and I could care less about your

elevator speech. I am looking for

that lackluster but essential answer

that lurks in the rst chapter of every

nancial accounting textbook. What is

the purpose of a business? Why does

it exist?

The maxim states that the primarygoal of a business is, to add value for

the shareholders.1 If adding value for

the shareholders is the purpose of the

company, then, ipso facto, it is also

the goal of Senior Management.

So, what is this shareholder

value? I am asking a little tongue-

in-cheek, but consider that private

companies with a limited number

of shareholders have the luxury of

being able to decide what maximum

shareholder value means. They might

be non-prot companies formed to

serve a cause which might be social,

personal, political or even altruistic.

Public companies on the other hand

(or private companies with a trading

shareholder market) only deliver

maximum shareholder value in one

wayby increasing their stock price.

It is a simple, universal, value per

share formula.

The transition a company goes

through from before it has signicantnumber of shareholders (or more

specically a trading shareholder

market) to the time when it has a

base of shareholders is fraught with

the desperation and heads-down

operational execution that are the

hallmarks of a company in the midst

of rapid growth. The obligation of a

new shareholder focus tends to sneak

up on these teams and is easy to miss.It may not be part of the companys

DNA or even a blip on the radar of

Senior Management.

Whats more, Senior Management

tend to be unaware that there is

another side to their business, are

resistant to admitting its importance

and are reluctant to embrace the added

responsibility. In fact, if you have read

this far, you are already ahead of most

of your peers.The rst key to success in leading

a growth company with a shareholder

market is to recognize that you are

running two sides of the business. It

is like you are running two companies

with linked but separate goalsand

neither one can really succeed without

the other.

First, you manage the business

you are used tothe revenues


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and earnings side that comes from

solid execution and smart decision-

making. Leadership teams may be

already adept at this. After all, this ispart of the reason they attracted the

shareholders in the rst place.

Second, you manage the

shareholders and the stock price. Why

is the second side so critical? Success

in managing the stock price means

you have fullled the purpose of your

company (add value for shareholders)

and increased the value of your

company. Senior Management likelydo not even understand that this side

of the business exists, let alone how to

execute their obligations to it.

Familiar or not, Senior

Management must embrace the fact

that they have this dual responsibility

or else reap the weighty and

unpleasant consequences of ignoring

it. Reluctance is understandable.

If you are one of the reluctant ones,

read on. I have included all the criticalinformation necessary to get you

started on the right track.

2. Avoiding the Kiss of Death

Now, let me indulge in one

example for the sake of the

understandably skeptical.

To those of you who say, Wait

a minute. Shareholders, certainly

the early ones, bought stock in our

company because they believed in our

business. We won their condence by

executing on our business plan, by

meeting the needs of our customersand by driving earnings and revenues.

Our job isnt to inuence the stock

price. If we look after earnings and

revenues, the stock price will take

care of itself. The market is full of

people preaching that stock price is

not part of the responsibility of Senior

Management teams.2 In ignorance,

CEOs steer clear of anything

resembling an attempt to impact stockprice fearing regulatory misconduct.

But, this is not an area where

business leaders can afford to remain

ignorant.

I have seen many many companies

led by individuals who professed the

attitude that somehow the stock price

will take care of itself. I call this the

kiss of death. Of the many examples

we could cite, perhaps none is more

illustrative than that of Robert L.Nardelli.

Bob Nardelli, was a talented

executive who joined GE in 1971

and climbed the ranks to become

the President and CEO of GE Power

Systems. He was mentored by famed

GE CEO, Jack Welch, and was even

referred to as Little Jack. When

Jack Welch retired as CEO, Bob


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him from the repercussions of not

shepherding the share price.

It is easy to see why CEOs of

growth companies might resist theidea of tackling an entirely new

dimension of their business. It is the

basic psychology of human nature. We

resist change and fear the unknown.

For these executives, the revenue

and earnings side has been their whole

focus. To get to this point, they must

have already mastered many of the

critical skills necessary to drive this

side of the business. To suggest thatthey take on an another side of the

businessabout which they know

nothingis uncomfortable. It is like

telling a child who has learned to ride

a bike that that is all well and good,

but what really counts is how good

they are at rowing a boat.

If you feel this, acknowledge it

and discipline yourself to learning the

other side of your business. Like it

or not, Senior Management actuallyrun two companies and they bear the

twofold responsibility to manage both

sides of the business: revenue and

earnings andstock price.

3. Managing the Stock Price Side of

the Business

Another thing most Senior

Management teams do not understand,

is the relationship between the

shareholders and the value of the

company. In fact, they may know very

little about their shareholders.

Shareholders drive the value of thecompany!

The behavior of the shareholders

directly affects the value of the

company whether you have ten

shareholders or ten thousand.

Managing your shareholders directly

affects the stock price and your ability

to raise money and grow the business.

What is the mechanism for

this relationship? The value ofa company is a function of the

price and volume of its stock. The

behavior of your shareholderspast,

present and futureaffects the supply

and demand3 of your stock, and

ultimately the value of your company.

Do they buy? Do they sell? What are

their intentions?

Notice how price is affected as the

volume of supply or demand goes up.

The goal of the SeniorManagement team should be to

increase both the volume and price

of the companys stock. Rapid

uctuations in volume, however, yield

disastrous results on price. Managers

need to grow the stock with as little

volatility as possible. So, the aim

should be a steady increase of both

price and volume, keeping in mind


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the balance, the equilibrium between

supply and demand that dictate price.

There are a lot of choices whenit comes to buying stock. Why does

someone buy a particular stock?

Well, if a stock is on the S&P 500 or

the DOW 30, people will buy it just

because it is on the index. What about

companies who arent on an index?

What ifyourcompany isnt on an

index? Increasing the value of the

company depends on someone buying

your stock.

Well, lets just get everyone we

can, any way we can, and crank up the

shareholder base, right?

Not so fastnot all shareholders

are created equal. Companies do

things in order to make their stock

desirable to potential shareholders.

If a company is careless or does not

understand what type of shareholder it

wants to attract, it could easily end up

beholden to a shareholder it does not

want.

Your shareholder base4should not spring up by accident.

Companies need to understand

who their ideal shareholder is and

tell a story that attracts that type of

shareholder. Whether intentional

or not, Companies are recruiting

new shareholders and the Senior

Management needs to understand how

to attract and market to the right ones.

This is impossible if you do not know

who they are!

In the end, Senior Management

needs to understand who its

shareholder is if it is to have any

chance of inuencing its stock price

and ultimately the value of the

company.

Figure 1

Volume / Quantity

Price

SupplyDemand

Volume / Quantity

Price

SupplyDemand

D-1

D-2

P-1

P-2

Volume / Quantity

Price

SupplyDemand

S-1S-2

P-1

P-2


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4. Overhang and the Risk of Stock

Price Catastrophes

Not only do most SeniorManagement teams not understand the

relationship between shareholders and

valuethey often dont understand

their shareholders at all.

In my years consulting with

dozens of growth companies, I found

that Senior Management could usually

tell me a lot about the companys

customers. I mean they practically

knew what each customer had for

breakfast: they know the detailedprole of their target customer and

what the key demographics are. They

can tell me about the psychographic

prole of their customers, about their

lifestyles and about their interests,

attitudes, and opinions. They have

crunched the numbers and know what

it costs to attract that customer and

how much they expect to earn from

each transaction.

Then I ask them to tell me about

their shareholders.

I hear crickets.

These competent and skilled

executives look at me with blank

stares. A few start grasping at straws,

but most dont even know how

many shareholders there are, or

what the average number of shares

per shareholder is. Somehow, they

are entirely ignorant of how the

shareholder relationship will impact

the success of their business.

So what? What are the risks of

this kind of ignorance? For starters,there are what I callstock price

catastrophes.

Remember supply and demand? A

stock price catastrophe is typically the

result of a ood of supplysomeone

is unexpectedly selling large amounts

of stock and the price plummets in

a very short time frame. If Senior

Management does not understand

what is happening within theshareholder base, they are unprepared

to mitigate stock price catastrophes

that otherwise could have been

averted.

On the other hand, management

teams who understand their

shareholders will notice precipitating

events, or catch the warning signs that

are the fruits of some basic and simple

analysis. Underlying any analysis

of the shareholders is the concept ofoverhang.

What is overhang?

To understand overhang, you

need to understand some things about

the psychology of how individuals

think about their stock. One of the

irrationalities of people buying and

selling stock is that they often weigh a

stocks current price against the price


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originally paid, not whether or not the

stock is worth its current price.5

As the difference between the

current price and the price paid grows,so does the psychological pressure to

sell.

For example, lets say that an

individual bought $1,000 of stock in

a growth company at $1 per share.

Then the price starts going up. It goes

to $1.50, then $2.00 per share. The

investor is thinking he is pretty savvy

to have made such a great return, but

in the back of his mind he knowsthat the general market average only

delivers returns of just less than 8%.

He has beaten the average by ten

times already. Then the stock goes

to $3.00, then to $5.00 per share. He

starts to get nervous. This might be

too good to be true. What if the price

goes back down? Where is this stock

going to peak? If I have already made

500%, cant I be happy with that?

And so it goes. As the differencebetween the price paid and the current

price grows, especially as that growth

outpaces the market, so to does the

itch to sell. If the pressure to sell

motivates a sale of any inordinate

volume, you have the perfect

conditions for a sale that is likely to

cause a drop in stock price.

With that in mind, overhang can

be dened simply as cheap stock.

Shareholders who bought stock

at a cheap price should be a red

ag for Management because these

shareholders represent a threatthat stock could suddenly and

unexpectedly come onto the market.

And of course, a sudden inux of

shares will most often cause a drop

in price. Whats more, since many

investors get their investment advice

from other investors around them,

a move to sell by one could bring

a ock of imitators6 and cause a

full-blown stock price catastrophe(remember our supply and demand

curves).

5. What If You Ignore the Second

Side of Your Business?

Here are two typical examples

stories I see all the time; one

represents individual shareholders

and the other represents institutional

shareholders. Both illustrate the

reason why it is a fatal mistake nottomanage your shareholders:

Example 1.

An aggressive young and growing

company makes its Initial Public

Offering. To raise the cash necessary

to bring the company to this point,

the company used its equity and sold

stock to an individual investor looking

for big returns on ownership of a pre-


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IPO company, but who cares little for

the company.

The CEO and founder of this

company is focused on execution. Heis in his stride driving revenues for

the company and making his dream

for the company come true. Raising

money and even the IPO are only

stepping stones in his companys

growth.

The individual shareholders

forgotten, he gets up every morning

and checks the stock price. He has

been working tirelessly and has ledthe company to stellar earnings and

takes great satisfaction in watching his

stock price climb accordingly. Its up

to $14 per share!

Then one morning he stares at

his screen in disbelief. The stock has

fallen to $8 per share overnight.

What happened?The individual investor dumped

his shares onto the market as soon as

his six month holding period expired.

He is allowed to do this, right? YES,

and the entrepreneur just saw his stock

price (ie. his companys value) drop

by 43% overnight because this ood

of shares is equal to ten times the

daily trading volume of his companys

stock.This is almost exactly what

happened to Lululemon. Lululemon

Athletica made its IPO in July of 2007

at $18 per share. Existing shareholders

Figure 2


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were under a 180 day lockup

agreement which would have expired

around mid November. Over the

next four months, successive volumespikes cause the price to tumble from

a high of around $60 to a low of

around $20 per share.

Example 2.

Here is a company that has been

courting individual shareholders, but

along the way has attracted one or

two institutional buyers. They might

form a fat tail (which we willdiscuss a little later). They dont really

fall within the normal shareholder

distribution, and since they are an

outlier, Senior Management ignores

them.

Like our previous example, Senior

Management has managedthrough

extraordinary effort and driveto

generate earnings that represent a 20%

return! The company is riding high

and individual investors love it.Then the day after earnings are

reported, the institution sells in bulk.

Stock price drops and instantly erodes

the hard won gains.

Why did they sell? The company

was generating stellar returns!

Understanding this example

requires a closer look at the

differences between individuals and

institutions as shareholders.7 These

two behave very differently.

Purchases by institutional

shareholders are often made byinvestment managers. Institutional

managers are not as interested in

growing their personal wealth, or

even the wealth of the institution, they

tend to act more interested in keeping

their jobs and avoiding blame. The

ideal investment for them would

consistently return a few points over

the market in generalno more, no

less. They are like Goldilocks. Theywant their stocks not too hot and not

too coldthey want them just right.

These managers may purchase

on the recommendation of internal or

external analysts, who are focused on

calculations like Earnings per Share

(EPS) or PE Ratio or even world

events. Analysts issue reports that may

recommend investors buy, hold or sell

certain stocks.

The manager needs the opinionsof the analysts, in case an investment

goes bad or does not yield as

expected, so he can claim that he has

made his decisions using the best

advice in the industry. They manage

to mediocrity and follow the safety

of the herd. As a result, they set up

criteria that govern their purchases.

Institutional managers have an

incentive to play it safe.


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Individual buyers, on the other

hand, dont read analyst reports as

often and dont usually use the same

type of rigid criteria that institutionalbuyers use. They may care more about

the background of the management

team or the companys position in its

industry or any of a number of other

investment data points when they

make their purchases.

So, why did the institution sell?

The institutional manager looked at

earnings growing more than double

the general market. While superbfor individuals, this falls outside his

established criteria and he regards the

growth as unsustainable. It has fallen

outside his safe zone and even though

it seems like good news, he sells. (Its

not like its his money anyway.)

Other reasons the fat tail

institution/investor could

unexpectedly sell is that someone

in the company did something

that disappointed or angered ananalyst. The analyst retaliated with

a bad report. Or maybe he had bad

information and published a negative

analysis. Remember, institutions live

and die by the analysts because their

managers live and die by blame. Net

resultyour company loses value

which it could take years to recover.

Both of these stories are

oversimplied to make the point that

Senior Management must understand

its shareholders. Institutions may

hold the company to a higher or

stricter level of performance than anindividual investor or use different

criteria altogether in deciding to

buy or sell. The principle is not

one of endorsement for or against

institutional or individual investors,

but an endorsement for understanding

your shareholders, and understanding

them in-depth. The industry saying

goes, You live by the institutions;

you die by the institutions. Thismeans that if you have, or more

importantly try to attract, this type of

investor you need to understand the

way they play the game.

And its no different with individuals.

If you want to be able to meet your

obligations to increase shareholder

value and to head off the catastrophes

that may be lurking within your

shareholder base, you absolutely must

understand them.There is no shortcut.

For example, within each of these

groups there are subgroups. There

may be investors in your space who

only buy companies that are pre-

earnings. Others only buy companies

after they produce earnings. Either of

these types of shareholders may be

ideal orat wrong for the company,


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but Senior Management needs to

know which.

By understanding the

shareholdersmore specically,by understanding the shareholders

who are overhang and represent a

signicant number of shares either in

or entering the oat8 (trading shares

of your stock), you can take steps

to head off stock price catastrophes

and full your obligation to increase

shareholder value.


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6. How to Analyze and Understand

the Shareholder Base

Understanding the shareholdersstarts with some basic analysis. Senior

Management should look at the

shareholder base just as they would

their customer base. Basic analysis

starts by collecting statistics and

demographic information and, at a

minimum, answering the following

questions:

How many shareholders are

there? Is the number increasing or

decreasing? How long do shareholderstypically hold the stock? What are the

demographics of the shareholder base

(institutional vs. individual, investors

vs. traders, old vs. young, etc.)? How

many shares does each shareholder

own?

With this information,

shareholders can be segmented and

some simple statistics can be applied.

What does the distribution look

like? Is it normal? Is there more than

one peak? Are there any fat tails?

Are there restricted shares out there?How many? When do they become

tradable? Who owns them? At what

price do they own them? What are

their intentions of holding or selling?

How many shareholders are in each

standard deviation from the mean? If

we consider three standard deviations

() to be the base, how many outliers

are there? Who are they and how

many shares do they own? Are therewarning signs or positive indicators

showing up in the data?

Outlier clusters and fat tails are

indicative of potential overhang.

In this image, we are showing

shareholders on the Y-axis and

number of shares on the X-axis. The

graph on the left shows a normal

distributionhigh at or near the

mean, with a bell-curve sloping off to

Figure 3


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the two tails on either side. Everyone

is accounted for.

However, the graph on the right

has most of the shareholders within anormal distribution, but a shareholder

cluster or fat tail exists which needs

to be analyzed. This likely represents

a risk of overhang. If it does, a plan

needs to be put in place to buffer the

impact of an unexpected sale.

7. Moving Stock From Weak Hands

to Strong Hands

While it is illegal to manipulate

your stock price, it is not to

orchestrate it. In fact, Senior

Management has an obligation to be

strategic about orchestrating its stock

in order to create the most value for

the shareholders.

When overhang is owned by an

investor who may sell unpredictably,

these shares are in weak hands.

As long as this investor holds the

shares they are outside the free oatwhere market forces keep the price in

equilibrium with supply and demand.

As long as there is overhang, the rm

is at risk of a stock price catastrophe.

One way to mitigate the risk of the

overhang is to work on patriating9

the overhang into the oat. By

getting these shares into the freely

trading circulation at an acceptable

volume, the risk of an articial price

uctuation shrinks. This also means

that shares tied up in any fat tails are

absorbed into the normal distribution.

Note that the weakness of ashareholder holding overhang, is a

way of describing the unpredictability

of their behavior. By understanding

the shareholder base and what

shareholders intentions are, Senior

Management works to minimize risk.

A shareholder could own a great

deal of cheap stock, but if the Senior

Management knows he is holding the

stock out of a belief in the long-termsuccess of the company and that he

has a longer investment horizonif

this was an investor whose behavior

was predictable and acceptablehis

stock would be considered to be in

strong hands and not a risk.

Senior Management should be

vigilantly looking for weak hands and

making efforts to move those shares to

strong hands.

8. Why Investors, Not Traders, Are

Desirable Shareholders

What is the difference between

an investor, or newer investment

criteria, and a trader? These two buyer

types are operating from different

paradigms.

Traders are not primarily

interested in your company. They are

interested in the ebb and ow of your


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stock price. They are trading to make

money on the uctuations. They watch

for the momentum in your growth to

fall off, and then they sell. Becauseof this, they can create instability and

become overhang. They dont invest

because they believe, they are just

playing the numbers.

Investors, on the other hand, are

betting on your company for the long

haul. Because they believe in your

company they are more predictable

and less panicky.

The moral of this story is that youwant to develop shareholders who are

investors instead of traders.

9. How to Identify Shareholders

The rst step in understanding

your shareholders is to know who they

are. Understanding the shareholder

base is essential to inuencing stock

price and protecting the rm from

unexpected uctuations like those

mentioned above. By proling yourshareholder base, you will start to

have the information you need to

anticipate what your shareholders are

thinking and what their actions will

be.

Typically, it is not very

challenging to make a list of the

shareholders classed as insiders.10

These are members of the Board

of Directors, ofcers & Senior

Management, directors, key

employees (control persons), or

shareholders with over 10% of the

issued shares.Before a company goes public,

it is also fairly straightforward to

get a list of shareholders. A great

practice for pre-IPO companies is

to review their nancial statements

for the Records of Certicate that

show stock has been sold. Private

companies keep their own records

(they can, but usually do not, use

a Transfer Agent, dened below).They keep a shareholder list or can

extrapolate one from their cap sheet.

The original ling will indicate the

original shareholders and subsequent

lings should provide a paper trail

for what stock has been issued and to

whom since that time.

What if you are public? Things

can get a little more complex.

Public companies are required to

have a third party who handles thetransferring of shares of stock. The

third part is called a Transfer Agent

and the Transfer Agent is responsible

for keeping the transactions out of

the companys hands. Each company

can only have one Transfer Agent at

a time, and part of what the Transfer

Agent gets paid to do is keep a record

of all the Shareholders.


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Resources are also available

through The Depository Trust &

Clearing Corporation (DTCC).11

The DTCC was formed in 1999 asa holding company to combine the

Depository Trust Company (DTC),

and the National Securities Clearing

Corporation (NSCC) which had been

formed initially to handle the needs

of the New York Stock Exchange

(NYSE), the American Stock

Exchange, and later the NASDAQ.

DTCC now serves the needs of all US

and many foreign stock exchanges.The DTCC is owned by those who use

it and is regulated by the Securities

and Exchange Commission (SEC).12

The DTCC is basically the

framework upon which all trading

happens; it is a warehouse for

public companies which facilitates

transferring between brokers and

dealers electronically.

They record and secure all the

transactions. All trades in the US gothrough the DTCC. A guide published

by the DTCC,Following a Trade,

which outlines the mechanics of

what happens as shares are traded, is

available from the DTCC web site.

The DTC is the actual legal

owner of the shares, but has no

benecial interest in them.13 The

shares, while legally owned by

the DTC are benecially owned

by the participants14 or clients of the

participants. Benecial ownership

gives one voting rights and the right

to dispose of the shares. The namesof benecial owners are pseudonyms

or street names in order to keep the

owners anonymous.

In order to penetrate the street

names and determine who really owns

the shares in your company, you need

to request a list of the Names of

Benecial Ownership, or a NOBO

list. The DTC is the only entity who

can penetrate the street names via theNOBO list. NOBO lists are typically

used for preparing an Annual Report.

After collecting the names of all

your shareholders, what next?

10. Methods for Communicating to

Shareholders

How do you communicate

with your shareholders (other

than a dutiful entry in the Annual

Report)? Some companies trulyunderstand this and have become

experts at communicating with their

shareholders. One example is BASF.15

With a tagline like we dont make a

lot of the products you buy. We make

a lot of the products you buy, better,

their ads are clearly not targeting

consumers.

Try buying anything from BASF

at any retailer; you cant. They are


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not speaking to consumers of their

products; they are speaking to people

considering what their 401ks and their

mutual funds are invested in. This is

an unusual example of a rm who

knows that it needs to speak to its

current and potential shareholders.

So, where do you start

developing your communication?

The key to communicating with your

shareholders is to recognize that you

want to build a relationship with them.

Shareholders need a little TLC.

Investors are news junkies. They

want any crumb of news about the

companies they own. So ask yourself,

are you giving them the news that

they need? How often are your press

releases going out? People within the

company possess nauseating levels of

information about whats happening,

but investors are often starved of

even the most trivial morsels of

information.

Figure 4


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Do you have a mailing list? An

e-mail list? Are you sending anything

out? Do you have an Investor

Relations department?In my consulting, I often ask a

rm to tell me about their investor

relations department. They say, Oh,

we hire that out. What!?

If you understand that investor

relations is more than just a

department (and is in fact more

than merely investor relations),

that it truly is the second half of

your business, if you understandthat it is like the Yin to the Yang of

serving your customers in order to

create revenues and earnings, then

you have to ask yourself, does it

really make sense to subcontract out

such a vital part of your companys

success? Would you try to hire out

your companys ability to generate

earnings? Of course not.

The shareholder side of the

business is at the heart of the strategicvision Senior Management has for the

company. It must be done right in its

totality. Which means that it simply

requires too much care and attention

to allow someone else to do it for you.

Another question I often ask is,

how much do you spend on marketing

and selling your product or service?

Answers vary, of course. Then I

ask, Now tell me what your budget

is for improving your stock price

how much are you willing to spend

to market your stock? Consider a

company with 10 million shares. Ifthey could get the stock price to go up

even $1 per share, it would be worth

ten million dollars in valuation. But,

how many companies dedicate even

$50,000 or $100,000 to this side of

the business? Very few (almost none

in the micro cap sector) even have

budgets allocated for marketing their

stock.

Executives have to remember thatif they dont nd a home for every

share of stock, every single day, then

the value of the company is going

to go down. Demand has to exceed

supply to keep the price moving in the

right direction. How can management

know what demand to generate if they

dont even know how fast their oat is

turning over?

The CEO has to understand and

be able to champion the InvestorRelations effort. I often ask, where do

investor relations and public relations

t on your org chart? This tells me

something about where IR ts in the

list of priorities.

Think about it. If you do not give

your shareholders information about

you, where are they going to get it?


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11. Methods for Marketing to

Shareholders

If you dont reach out to the rightshareholders, how will they nd you?

The relationships you build with

your current shareholders are a great

vehicle for reaching out to others.

What really drives anyone to buy

stock in a company anyway?

People buy stock because

they perceive an opportunity. The

psychology is simple. Almost

universally, they believe that, at some

point, the value of the stock theypurchase will go up.

In order for a company to attract

the right shareholders, they need to

tell a story that resonates with their

target shareholder. It has to be very

compelling. The target audience

should feel like they will struggle with

a lifetime of regret if they dont make

the purchase.

So, what makes a story this

compelling? Senior Management

needs to communicate to their

shareholders that they have vision.

They need to be enthusiastic, but

grounded in the facts. They need

to represent that they are executing

on growth strategies, which could

include: uses for the cash they are

raising by selling stock, expansion

into new products or new markets,

merging with or acquiring another

rm. They may strategically acquire

private companies at private valuation

and converting them at their public

valuation.Wrapped inside of that story

is a reason to believea rationale

that answers the question: how can

I make money. The message should

be communicating authentic value.

Ultimately, management needs

to pull this together in a way that

communicatespotential.


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12. Bet on the Jockey

Over the past twenty years, I

have seen company after companycome through my door looking for

funding or help in executing their

growth strategy. I am a believer in the

sentiment, Bet on the Jockey, not the

Horse. Experience has taught me

this lesson over and over again. The

Leadership within the company is

more critical than the elements of the

company itself and a great company

with weak leaders at the helm is a

recipe for failure, no matter how goodthe company looks on its own.

Senior Management teams who

understand both sides of the business

are critical, but we know that most do

not. How can companies encourage

the types of leadership and execution

that support both sides of the business

when all or part of the Senior

Management is ignorant or reluctant

to embrace both sides?

Management compensation is a

critical component to successfully

managing both sides of the business.

Your key executives are smart

individuals who understand exactly

which side their bread is buttered on.

The right compensation structure is

essential for them to be successful.

Likewise, the wrong comp structure

creates a huge risk that you need to be

able to recognize before it comes back

to bite you.

Just like shareholder base, you

can identify and take the rst stepsto mitigating the risks of the wrong

executive compensation structure by

understanding it and its implications.

13. Musical CEOs

Senior Management and the Board

of Directors are not always on the

same page. Often the rst CEO of a

growth company is the founder. He

or she is entrenched in the history and

roots of the company. Entrepreneurs

are, by nature, control freaks. They

have brought the company to its

current state by sheer force of will.

Sometimes that same strength of

personality that created the company

starts holding the company back

oftentimes there comes a point when a

company is ready to grow beyond its

roots, but the CEO is not.

Its a tough road. Entrepreneursare required to navigate many

transitions. One of these is the

transition from owning all the stock

at a low value to owning a portion of

the company and working to increase

value. This can get a little ugly. So,

the simple truth is that a lot of CEOs

get red or otherwise transition out

of the CEO job (maybe to take seats

on the board or provide a consultative


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Page 20


role) shortly after a company raises

its rst equity nancing and hits the

throttle on growth.

Finding a great CEO is not easyand often companies go through two

or three generations of management

trying to nd the right t. In the end,

it is not uncommon for the board of

directors, tired and desperate to get the

company on solid footing, to become

focused on one side of the business:

the earnings and revenue side. They

typically end up with management

who are operations experts, butwho know nothing about stock or

nancing, or the relationships on the

investment side of the business.

In other words, they just hired

themselves the Kiss of Death.

14. The Compensation Debate

I am going to outline the secret

to compensating your executives

in a way that incentivizes them to

create the most value, but I would beremiss not to acknowledge that there

is a furor raging in public discourse

over this issue. On the one hand,

market forces dictate the going rate

for CEOs in any industry. On the

other, shareholders are asking tough

questions about the justication for

big salaries and they are wielding

increasing power. Needless to say,

executive compensation is a hot and

divisive topic.

Earlier I cited Bob Nardelli as an

example of a high prole CEO whosecompensation package was a sore

point for shareholders, but Bob is not

alone. Disney, and the NYSE have

all had high-prole CEO res where

compensation was an issue. Currently

CEO compensation (and particularly

severance packages) are one of the

issues at the heart of the mortgage

crisis.16

Shareholders are raising eyebrowsat CEOs exiting businesses with

very large severance deals at a time

when these rms are in real jeopardy

ostensibly because of the leadership

decisions of the departing executives.

Shareholder activist groups, like

AFL-CIO, are increasingly organized

and able to garner enough votes to

force decisions from the board of

directors. Often executive pay is the

issue that causes them to pick up thetorches and pitchforks. Shareholder

activism has gained popularity as

management compensation at publicly

traded companies and the rising cash

balances on corporate balance sheets

have risen.17 Some of the recent

activist investment funds include:

Icahn Management LP, Santa Monica

Partners Opportunity Fund LP and

Relational Investors, LLC.18


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Where many of the large cap

companies may have gone too far

with their activism, small and micro

caps need to be increasingly awareof the issues surrounding this debate.

The issue has grown in interest to

the point that during his time in the

Senate, President Barak Obama, even

sponsored a bill that would require

a non-binding vote on CEO pay

by shareholders: the Say on Pay19

bill (S. 1181/H.R. 1257).20 He has

since pressed the issue of executive

compensation as part of his economicpolicy.

15. How Many Millions Are Enough?

Senior Management is the group

responsible for running the company.

The Board of Directors and the

Shareholders are responsible for

managing the Senior Management.

The Board of Directors has a

responsibility to establish a

compensation plan for managementthat ties the self-interest of executives

to increasing shareholder value and

harnesses their drive in a way that

motivates them to achieve that goal.

Here is a textbook reference that

starts to outline the issues at work in

establishing appropriate and effective

management compensation.

Managerial goals may be different

from those of shareholders. What goals

will managers maximize if they are

left to pursue their own, rather than the

shareholders goals?

. . . managers obtain value from

certain kinds of expenses. In particularcompany cars, ofce furniture, ofce

location, and funds for discretionary

investment have value beyond that which

comes from their productivity.

. . . Corporate wealth is that wealth

over which management has effective

control . . . . Corporate wealth is not

necessarily shareholder wealth.21

My point is that this is not an issue

that naturally resolves in a way that

supports both sides of the business.

So, what is the right strategy forestablishing executive compensation?

How do you align management goals

with investor goals?

To start with, the Board needs

to establish a Compensation

Committee.22 Compensation

Committees are often organized

with a charter and they develop

certain principles as guidelines

for their objectives in makingrecommendations about executive

compensation.

The core principle is that bonuses

and stock are the two elements over

and above a straight salary that tie

in to the two sides of the business.

This much is pretty straightforward.

Bonuses tie to earnings and revenue

goals, while ownership of the business

through stock or options create an


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Page 22


incentive for executives to increase

shareholder value because they are

numbered among the shareholders.

In practice this can be morecomplex. For instance, a CEO who

was the original founder has to make

the transition from owning all the

shares to owning only a portion

of them (and seeing that a smaller

percentage of a bigger pie is the

more valuable of the two). It may be

foreign for this individual to think of

his or her compensation plan from

the perspective that the ownershipelement is worth more than the salary

and bonus element. It may never

have been considered that salary and

bonus were the minority players in the

compensation plan.

Here are some elements to

consider...

16. If Senior Management

Compensation is Wrong

Senior Management, andparticularly CEO, compensation

that is aligned incorrectly begins to

show signs of the mismatch. As the

saying goes, the sh starts to stink

at the head, so CEOs with the wrong

compensation package start showing

symptoms that they are set up with the

wrong compensation package

For example, if management

does not have a signicant ownership

stake in the company, they tend to

look for other means of compensating

themselves besides increasing the

stock price (ie. shareholder value).These could be wages, perks, travel,

entertainment, cars, side deals, etc.

Even if they have high salaries,

small or no ownership equates to no

incentive to grow the stock price.

17. How to Get Yours

It is an unfortunate fact that very

few entrepreneurs can execute their

business plans completely. Research

shows that most entrepreneurs want

two things: to make a lot of money,

and to call the shots in their business.

The same research shows that less

than 25% of entrepreneurs are still

CEO by the time their company

makes its IPO.23 It takes a different

set of skills to get your company off

the ground than it does to manage it

through the phases of growth.

With that in mind, demonstratingthat you can develop and execute

on a growth strategy is one of the

best ways to ensure your stake stays

strong. Showing that you are a

management team that can execute is

the same as demonstrating that you

are worth the ownership stake.


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18. How to Recruit the Right

Board

Why do you have a Board? Whodo you want on your Board? What do

you want out of them?

Board members provide several

things to a growing company. Having

members who are experienced and can

provide mentoring and leadership to

the Senior Management team is a real

strength. Board members also help the

company raise money and make key

introductions and forge relationships

that help expand the business. Ineffect, Board members bring their

network of contacts, their experience

and their clout to bear in evening out

the roadblocks that companies face in

their path to growth.

Board members should not

just be a rubber stamp for the aims

of management. They need to

understand that they have a duciary

responsibility to all the shareholders.

Members need to be recruited who

will ensure the best interest of the

shareholders.

Prior to Sarbanes Oxley, it was

common for Board selection to be

a process of dipping into the Good

Old Boys, throw in some nepotism

and take a devil-may-care attitude to

independence. SOX changed all that.

In order to be SOX compliant, you

need to have an independent Board.

The company also needs to

provide for Directors and Ofcers

Insurance. Board members take on

signicant risk. Growing companiesare by their natures involved in the

risky business of being in business.

When something goes wrong and

a growing company has to declare

bankruptcy or gets involved in a

lawsuit, the members of the Board are

exposed to signicant liability.

Often Board members come to

the board as successful ofcers from

other companieswhich means whenthings go south, they represent the

deep pockets for litigators. Remember,

the average business person is sued

every three yearsthis is a real

concern that can be mitigated by

proper D&O Insurance.

19. Conclusion

Entrepreneurs and Senior

Management teams are usually ill-

equipped to realize the impact of thestock price side of the business. As

I consult with growth companies in

many industries, I nd that rare is the

company who really understands the

impact of the investment side of the

business.

What that means is that there

is a great opportunity for growing

companies to create an advantage

for themselves through competing


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Page 24


along both fronts. How much would

it mean to you to receive funding

when your competitors do not? How

much would it mean if you drove thevalue of your business by dedicating

resources to increasing stock price and

to marketing to your current and ideal

shareholders?

By embracing the responsibility of

increasing shareholder value and by

equipping yourself with the essential

skills and strategy necessary, not only

to do it, but to be wildly successful

at it, you will rise above your peers.Even better, they wont know why you

are growing when they are shrinking

(because they dont know about the

second side of their business either).

Finally, by focusing on both

sides of your business, you will be

creating real value in the company

as the stock price increases as well

as understanding and capturing the

best terms for yourself. You will

understand the mechanics of howcompanies increase in value and gain

the skills necessary to turn that into

a winning growth strategy for your

company.


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Page 25


Kirby Cochran is an educator, speaker and thought leader in the eld of management andnance and is a leading expert on capital structure and shareholder value. He has been teaching

new venture nancing and entrepreneurship to graduate students for over a decade. Kirby

currently serves as an adjunct professor in the Finance department of the David Eccles School

of Business at the University of Utah. A veteran of the venture capital industry and a pioneer

of emerging approaches to raising capital, Mr. Cochran has been at the forefront of the growth

company nancing and management trends for over twenty-ve years.

In his new series of articles entitledLeadership Insight, Mr. Cochran reveals secrets used by

entrepreneurs and CEOs to drive growth in their companies. This information has always been

difcult and painful for Senior Managers to acquire, found only in the ruthless university of

experience and obtained through costly tuition at the school of hard knocks.

North Point Advisors, the rm founded by Mr. Cochran, advises growth companies on theimplementation of the best practices discussed inLeadership Insightfor increasing shareholder

value.

ACKNOWLEDGEMENTS

Chad Jardine, my close associate and friend,was responsible for much of the leg work and

physical writing of this article. His contribution allowed the principles and practices of my

consulting process to come to life in written form and bring my insights, personal experiences and

unique voice to a new audience via the printed page.


28/28

1. Ross, Stephen A., Randolph W. Westereld, and Jeffrey Jaffe. 2005. Corporate Finance, Seventh

Edition. 15. New York: McGraw Hill/Irwin.2. D&O Diary blog, The. http://dandodiary.blogspot.com/2007/01/executive-pay-shareholder-activism-and.

html.

3. Note: Price is directly affected by the equilibrium of supply and demand.

4. Note: Shareholder base is all the shareholders cumulatively.

5. Armstrong, Robert, and Jacob Ward. 2008. Money Minded: How to Psychoanalyze the Stock Market.

Popular Science, February.

6. Ibid.

7. Note: Institutional investors are typically hedge fund, mutual funds, insurance companies, etc., and

they typically make large buys or sales (compared with individual investors) and are managed by a

professional manager.

8. Wikipedia. Float (nance). 2008. http://en.wikipedia.org/wiki/Float_%28nance%29 (accessed July 15,

2008). Note: The oat, free oat, or public oat is usually dened as being all shares held by

investors other than insiders and shares that are not restricted.

9. Note: Patriating refers to the process of moving shares from risky overhang into the free oat wheretheir price is determined by the market for the stock.

10. Wikipedia. Insider Trading. 2008. http://en.wikipedia.org/wiki/Insider_trading#General_Information

(accessed July 15, 2008). Note: Corporate Insiders are members of the Board of Directors, ofcers &

Senior Management, directors, key employees (control persons), or shareholders with over 10% of

the issued shares.

11. DTCC: The Depository Trust and Clearing Corporation. 2008. http://www.dtcc.com/

12. 2007. The US Model for Clearing and Settlement: An Overview of DTCC. 1. DTCC.

13. Goodman, Amy L., John F. Olson, and Theodore B. Olson, editors. 2001.A Practical Guide to SEC

Proxy and Compensation Rules, Third Edition. 12-6. New York: Aspen Publishers.

14. Ibid. Note: Participants are the member organizations of the various national stock exchanges, such as

Merrill Lynch, Goldman Sachs, etc.

15. BASF. Print Advertising. 2007. http://www.basf.com/corporate/printadvertising.htm

16. AFL-CIO. 2008 Executive Paywatch. 2008. http://www.acio.org/corporatewatch/paywatch/

17. Wikipedia. Activist Shareholder. 2008. http://en.wikipedia.org/wiki/Activist_shareholder18. Ibid.

19. CRO: Corporate Responsibility Ofcer. Say on Pay Gets Its Day. 2006-2008. http://www.thecro.com/

node/462

20. AFL-CIO. 2008 What You Can Do. 2008. http://www.acio.org/corporatewatch/paywatch/what2do/

index.cfm

21. Ross, Stephen A., Randolph W. Westereld, and Jeffrey Jaffe. 2005. Corporate Finance, Seventh

Edition. 14. New York: McGraw Hill/Irwin

22. Note: Compensation Committee information is readily available. Here are links to the

Compensation Committees for Microsoft (http://www.microsoft.com/about/companyinformation/

corporategovernance/committees/compensation.mspx), Dell (http://www.dell.com/content/topics/

global.aspx/corp/governance/en/compensation?c=us&l=en&s=corp) and Dow (http://www.dow.com/

corpgov/board/comp.htm).

23. Wasserman, Noam. 2008. The Founders Dilemma.Harvard Business Review February, 2008.

what about those pesky shareholders?

Documents