What Happens When CEOs Cash Out? - YouTube

INTRO: CEOs and founder CEOs are by far the richest

people in the world.

While there are some oddballs on the billionaires list who are directors, investors, and even

athletes, the vast majority are company leaders.

Unlike most jobs though, company leaders are rarely paid in cash.

Many of the top CEOs take a cash salary of just $1 per year.

And even for the CEO’s that take a moderate cash salary, the cash portion is an extremely

small portion of their total compensation.

For example, out of Sundar Pichai’s $281 million salary in 2019, only $2 million was

paid in cash.

Considering this, how do billionaires even access the extraordinary wealth they have

without crashing their’s company’s stock.

And what about founder CEOs that own 40 or 50% of a massive conglomerate.

For example, Bernard Arnault owns 47% of LVMH which gives him a mind boggling net worth

of $123 billion.

But is it even possible for him to cash out?

Well, at his age, the answer is probably not, but here’s how billionaires access their

paper fortunes and how they live a rich lifestyle without cash.

TIME-BASED STOCK VESTING: The first thing to note about most of these

billionaires' compensation structure is that they can’t cash out their salary even if

they wanted to.

This is especially applicable to non-founder CEOs who don’t already have a lot of equity.

You see, the last thing board members want is for a CEO who either quits or is fired

under negative circumstances to dump all of their shares and crash the stock on their

way out.

So, a restriction they implement to protect against this is stock vesting.

The first type of stock vesting is time-based stock vesting.

Time-based stock vesting is usually most common amongst non-founder CEOs.

And as the name suggests, these CEO’s are restricted from selling any of their stock

compensation for a set period of time.

This rule doesn’t just apple to executives either, employees at these companies are generally

subject to the similar restrictions.

Both Google and Apple for instance follow a 4 year vesting schedule with a 1 year vesting

cliff for employees.

The vesting cliff simply means that you can’t sell any of your stock within the first 1

year, and after that you’ll get access to your stock on a linear basis over the next

4 years.

So, really, you wont get access to all of your stock till 5 years after your given that

compensation.

And if you leave during this time period, you of course lose access to your remaining

stock.

CEO’s follow a similar structure, but their vesting periods are way larger given that

their compensation is also way larger.

For example, when Tim Cook was hired as CEO in 2011, they gave him 1 million shares of

Apple, but the stock vesting period was 10 years.

The first half million shares would unlock in August of 2016 and the other half million

would unlock in August of 2021.

This is why we saw insane headlines about Tim Cook receiving $750 million worth of stock

last year.

While this is technically true, it’s also kind of misleading.

When Tim was awarded these shares in 2011, they were worth $384 million.

And given a vesting period of 10 years, this basically translates to $38.4 million per

year which is still an insane amount, but it’s no where close to $750 million in a

single year.

Tim actually went ahead and sold this entire compensation right after he got it.

But, thanks to the vesting period, Apple stock had grown to a point at which it could easily

sustain this selling pressure and protect shareholder value.

MILESTONE-BASED STOCK VESTING: The other most common type of stock vesting

is milestone based vesting.

Instead of tying up stock access to a time period, this option ties up stock access to

various milestones.

This type of vesting is most common amongst founder CEOs who already have loads of equity.

Given that they already have plenty of shares, it’s not the board members’ top concern

to get these CEOs even more invested in the stock.

For example, Bernard Arnault already owns 47% of LVMH.

So, pumping up his stake 55 or 60% probably wouldn’t motivate him that much more.

As a result, board members are able to be much more strict with their compensation plans,

requiring these CEO’s to not only put up time but put up results.

A great example of milestone based vesting is Elon Musk and Tesla.

Elon Musk receives no salary, no bonus, and no time-based equity.

The only way for him to earn more stock is to reach the milestones outlined in this compensation

plan.

As you can see, this plan consists of both market cap milestones and operational milestones,

and he must hit both of these numbers to be compensated.

When these milestones were established in 2018, Tesla’s marketcap was just $59 billion,

so reaching a $650 billion market cap was quite an ambitious goal.

But Elon has since crushed these numbers which has given him paydays worth tens of billions.

It should also be noted though that if he didn’t reach these ambitious milestones

within 10 years, he would’ve gotten no compensation for 10 years of work.

This is obviously rather harsh, so many companies tend to go for a more softened approach.

They’ll often combine time based vesting with milestone based vesting to create a hybrid

vesting model.

This way, CEO’s don’t have to achieve insane growth numbers to be paid, but at the

same time, they can’t just sandbag their time at the top either.

For example, this was one of the caveats that Apple introduced to Tim’s compensation plan

in 2013.

They clarified that Apple must also beat the S&P 500 for Tim to receive his full compensation.

For a company like Apple, beating the S&P 500 throughout the 2010s definitely wasn’t

that challenging of a goal, but it did introduce some level of accountability.

DEBT: Alright, so companies use time and milestone

based vesting to keep executives loyal to the company over the long term, but what about

during the meantime?

For example, from Tim Cook’s perspective, it’s great that he could receive up to 1

million Apple shares in 10 years, but how can he enjoy the benefits of that right now?

This is obviously a rich person problem, but the solution is rather interesting to discuss.

The answer to this problem is usually debt.

While Tim couldn’t sell most of the stock he received in 2011 he could use it as collateral.

Now, trying to collateralize RSU income or restricted stock income is not the easiest

of tasks for us normal people.

But, for company leaders, this is rather easy and it’s not just because they’re in a

powerful position.

The main reason is that the items that they’re trying to buy are usually a small fraction

of their income.

For example, Tim recently bought a $9.1 million house.

I have a feeling that he just paid cash for this property given that he bought this house

right after his stock compensation unlocked.

But, it wouldn’t have been that hard for him to take out a mortgage either given that

the house costs less than a 1/30th of his compensation plan.

Similarly, Elon took out $61 million worth of mortgages in 2019 which was likely a large

amount compared to his cash reserves but a miniscule portion compared to his net worth.

This reasoning obviously doesn’t apply to the average person who’s buying a house

that’s worth 2 to 5 times their gross income.

For billionaires though, this strategy doesn’t just apply to housing, it applies to basically

every facet of their life whether they’re buying a private jet or Twitter.

Also, this strategy isn’t just to work around stock vesting periods either.

There’s loads of benefits to leveraging debt from maximizing returns and minimizing

taxes to benefiting from inflation.

So, these stock vesting periods are just even more reason to take on debt for this billionaires.

LOOSE CANNONS: Everything we’ve covered so far accounts

for the vast majority of CEOs.

It’s usually just a case of borrowing against your RSUs to fund your lifestyle until you

unlock your compensation packages.

There are a few dozen people in the world, however, who have significantly more power.

For example, no one can prevent Jeff Bezos, Bill Gates, or Elon Musk from selling their

initial stakes in the company.

So, technically, these guys could try to sell all of their stock in one go and crash the

market.

But, given that these guys are founders, it’s extremely rare that they make such a decision,

but it does happen from time to time.

And I don’t think you’d be surprised to hear that one of the CEOs that was bold enough

to do this was Steve Jobs.

In 1985, Steve Jobs got entangled in months of vicious battles with the CEO at the time

John Sculley.

And as you would guess, this resulted in him eventually being ousted in September of 1985.

Out of rage, Steve would go ahead and sell his entire 11% stake in Apple except for 1

share.

Looking back at Apple stock during the time, it doesn’t actually look like Apple fell

that much when Steve actually sold.

Rather, most of the sell off took place leading up to Steve being fired.

By the time Steve departed the company, the stock was down a painful 77% from their all

time high.

So, while Steve selling his entire stake was a monumental event, his sale itself didn’t

impact the stock too much given that most of the fear was already priced in.

Another example of a founder selling out is Travis Kalanick and Uber.

Like Steve Jobs, Travis was ousted from Uber after months of boardroom battles in December

of 2019.

And he of course sold all of his stock right after he was ousted.

What’s interesting though is that he also sold near the bottom just like Steve Jobs.

Now, Uber is at even lower levels today, but that’s besides the point.

The point is that by the time a founder sells all of their shares in a rage fit, the stock

is already in the toilet, so their selling itself doesn’t hurt it all that much.

If they were to just randomly sell out of the blue though, the stock would no doubt

get obliterated.

CASHING OUT: Aside from loose cannon examples, most founder

CEOs cash out extremely strategically.

For example, Jeff Bezos sells a few billion worth of stock every year, but he doesn’t

do so without months of warning and he sells it small digestible batches.

So, the stock price is rarely affected by his sales.

Likely the closest example to randomly selling out of the blue is Elon’s recent sale for

Twitter.

In late April, Elon Musk sold $8.5 billion worth of Tesla stock or about 1% of the company.

This led to Tesla stock selling off about 10% by the time he finished selling.

This means that selling 1% of the company correlates to about a 10% selloff.

So, if a founder was to sell 10% out of the blue, that would likely cause the stock to

crash 70 or 80%.

And that’s not even taking into account that the sell off will accelerate as the founder

continues to sell.

The only way for a founder to sell out of such a position is to spend decades slowly

selling their stock just like Bill Gates did.

When Microsoft went public in 1986, Bill Gates owned 45% of Microsoft.

Today, he owns just 1.34% of the company.

Now, this puny 1.34% stake still correlates to a massive $25 billion.

But, given that Bill Gates has over a hundred billion dollars, the vast majority of his

wealth is no longer in Microsoft.

This makes him one of the most liquid billionaires in the world.

But, to get to this position, it took him 36 years.

And, if any other mega cap founder wants to cash out without destroying the stock, this

is really the only option they have as well.

And that’s how CEO’s cash out of their massive positions.

If you were the founder of a mega cap company, would you hodl your stake to your grave or

would you slowly sell off like Bill?

Comment that down below.

Also, drop a like if you wish you had rich people problems instead.

And of course, consider checking out our international channels to watch our videos in other languages

and consider subscribing to see more questions logically answered.