Nassim Taleb is a huge influence for a lot of our thinking here at Fordhouse. One of our favourite ideas discussed by Taleb is that of ‘skin in the game’, the title of one of his books and worthwhile read. Taleb argues that skin in the game, in other words having a material risk tied to the outcome of the decisions you make, is a necessity for prudent risk management, fairness and efficiency.
We think that this concept is well understood by successful entrepreneurs (although usually as a product of their experiences and intuitions). When running a business, there are numerous applications of this concept which can help you be a better manager, leader and businessperson.
Your incentives: this is the most obvious learning from skin in the game. It goes without saying that an owner-manager of any business will have material wealth tied to their venture and therefore will be incentivised to make it succeed. However, it is always worth thinking about how your incentives change at different points in the company lifecycle. For example when raising equity, taking on debt or selling some or all of your own stake in the business.
Aligning your employees: employees must feel that they are an important part of the business they help to build and scale. Additionally, managers face the challenge of retaining and motivating star performers. Ensuring that your employees have an alignment to your business is another example of creating ‘skin in the game’. This can be quite simply achieved with a form of commission/bonus structure, giving out some equity or creating a share option scheme. It is important to weight these upsides relative to the contributions your receive back too. For example, key members of management should be heavily incentivized and tied-in for the long term. Generally, employees who share in the risks and successes of a company are more likely to stay on for the longer term and be more productive.
M&A: when it comes to acquisitions there are multiple applications of the skin in the game concept. Firstly, when selling your business, the buyer will likely seek to protect the value of their purchase through aligning exiting shareholders/management with near term targets. This make take the form of deferred consideration (pure downside protection) or an earnout (sharing some upside). However, if you are looking to acquire a rival business, you have the same toolkit at your disposal. Another important aspect of M&A, one which we have discussed previously, is using high quality corporate finance advisors to facilitate the sale of your business. Skin in the game applies here too; it is better to opt for an advisor who takes a contingent success fee (and is therefore incentivised to maximise the value of the sale) rather than a flat fee.