All the options were exercisable immediately (most options have a vesting schedule). One of the engineers was single and had few debts; he was happy to go cash-poor and bank on the company’s growth. At the same time, there are real advantages to being small. Opinions expressed are those of the author. Critical to the company’s success were five software engineers who would write code for the first product. The minority co-founder may face an uphill battle to prove his/her claim, but this situation would be a thorn in the side of any star… He also allowed them to buy shares at a discount. Other creative policies may not only cost less but they also may better suit the interests and needs of executive recruits. Compensation at a startup company is largely made up of three components: salary, benefits, and equity. There is an inevitable temptation, as a company shows its first signs of growth and financial stability, to enlarge salaries and benefits toward market levels. To gain some insights into the matter I am planning to attend a special session of the Technology Executive Roundtable on Atlanta technology executive compensation tomorrow. You may opt-out by. Most companies on their way to an initial public offering or a sellout to a larger company must register particular earning patterns. Firas Raouf. The lure of cashing out quickly was a great motivator for this company’s top executives. The obvious solution: supplement cash compensation with stock. Startups with $10 million or more in funding saw their average Chief Executive’s pay rise 8% from $160,000 in 2018 to $173,000 in 2019.” How to Determine a Startup CEO SalaryStartup CEO Salary Calculator Once you understand the benchmarks and industry trends, it is time to determine what your annual salary should be as a CEO. They receive the financial benefits of owning stock without the risk of buying shares. Executives pay no taxes on any capital gains until they sell or exchange the stock, and then only if they realize a profit over the exercise price. This program allowed for maximum flexibility. Executives may receive options on 1,000 shares of stock, but only 25% of the options vest (i.e., executives can exercise them) in any one year. NSOs can be issued at a discount to current market value. Companies can choose among various book-value plans, under which they offer to buy back shares issued to employees according to a pricing formula. Your business plan is based on sound strategy and thorough market research. While the vice president of marketing watches marketing, the CFO keeps tabs on finances, and the CEO snuffs out the fires that always threaten to engulf a young company, who is left to mind the personnel store? If a company does decide to issue shares, the next question is how to do it. Startups often prefer ISOs since they give executives a timing advantage with respect to taxes. Your business plan is based on sound strategy and thorough market research. As with restricted shares, stock options can create golden handcuffs. Editor's Note: In the early years of your Compensation career? Many employers match a portion of their employees’ contributions.) These programs can get complicated, however, and they require thorough accounting reviews. It did not make sense for the company to raise venture capital to pay the engineers their market-value salaries. Equity is the great compensation equalizer in startup companies—the bridge between an executive’s market value and the company’s cash constraints. One startup learned this lesson after it polled its employees. Expertise from Forbes Councils members, operated under license. They decided to forgo cash compensation altogether for the first year. When evaluating compensation, the manner in which you filter the data can change the story significantly. Peter Thiel has actually set an upper limit for startup CEO salaries. Young Entrepreneur Council (YEC) is an invitation-only, fee-based organization comprised of the world's most successful entrepreneurs 45 and younger. Some company founders are unwilling to part with much ownership at inception. Equity establishes a commitment from the CEO through personal stake-holding, but there’s another significant factor that makes it a substantial component: potential return. Ways Entrepreneurs Can Stretch Their Capital, 2 Million Professionals Polled On How To Make Virtual Conferences Better— Here Are Their Top 10 Hacks. They grant NSOs at a below-market exercise price that reflects the amount of salary deferred. What is the competition doing? ‘Booking.com’ Is A Trademark – Does This Matter To Your Business? If a substantial benefits program is in place, someone has to handle the day-to-day administrative details and update the program as the accounting and tax rules change. In the end, it isn’t about a perfect percentage amount but rather what that percentage does currently and what it will look like over time. Any startup that is either not turning a profit yet or just beginning to after a lengthy period of developmental costs simply cannot compete with that on a dollar-for-dollar basis. In such cases, it may make sense to create an artificial market for stock. Questions about an article? If this co-founder feels aggrieved, he or she might sue the company and the other founders personally for failing to pay the minimum wage. The list of traditional employee benefits doesn’t have to stop here—but it probably should. You’ve networked your way to just the marketing candidate you need: a vice president with the right industry experience and an aggressive business outlook. The best strategy is to keep benefits modest at first and make them more comprehensive as the company moves toward profitability. Tax laws impose stiff technical requirements on how much stock can be subject to options, the maximum exercise period, who can receive options, and how long stock must be held before it can be sold. The value of each depends on the stage of a company’s growth, the role , … As an alternative to traditional hourly billing, we offer flat fees and monthly subscriptions. Pay for performance is a compensation strategy to align executive compensation with the company's success. With this in mind, Graham says there are three places where a company needs to focus on compensation and have specific ideas about how to handle it. Your background and training have prepared you for the challenge. The obvious risk with linking compensation to any one metric is that becomes pursued blindly and at all costs, while other important goals for your startup are ignored. When he sold the business a few years later for $10 million, certain executives, each of whom had been allowed to buy up to 4% of the company, received as much as $400,000. Most options, whether ISOs or NSOs, involve a vesting schedule. Even if you have raised an initial round of equity financing, there is seldom enough working capital to go around. Explore by role, location, skill, or market. Reporting rules for artificial stock plans are very restrictive and sometimes create substantial charges against earnings. The company, meanwhile, can deduct the spread when its executives exercise their options. The choice of whether to issue actual or phantom shares should also be consistent with the company’s strategy. As your company scales, however, managing an ever-growing set of priorities can prove difficult, even impossible. Founders rightly worry about diluting their control before obtaining venture funds. What are the tax implications? You can’t possibly commit that much cash, even if you do raise outside capital. Events at a Boston software company illustrate the potential for flexibility in startup compensation. (This program allows employees to contribute pretax dollars into a savings fund that also grows tax-free. Of course, if companies generate taxable income before their executives exercise their options, lack of a deduction is a definite negative. The founders devised a solution to meet the needs of the company and its prospective employees. After some negotiation, they settled on a maximum of 2% for each of the five engineers. Email feedback@yec.co. As with phantom shares and SARs, book-value plans require a thorough accounting review. That included all of the components of what we call Total Compensation: Base Salary; Annual Incentives: target % and actual; Total Cash Compensation (TCC) = Base Salary + … That is, they should award shares to key executives and second-tier employees in a way that protects the long-term company interest. You’ve decided to start a company. After all, cutting the greatest slice possible even for a superstar performer can be disadvantageous if it later deters their ability to make offers to needed players. Creativity and flexibility are at a premium. Self-insuring smaller claims also conserves cash. executive compensation and option plans. But two problems arose. For companies that plan to grow more slowly over the first three to five years, resist acquisition offers, and maintain private ownership, the stock alternative may not be optimal. With that history comes the security of established cash reserves and proven markets. While it’s easy to understand cash salary, the equity portion can be difficult to assess, particularly for someone new to tech or startups. Cash compensation must be a lower priority. So it set up writing boards in the cafeteria, provided all employees with daily lunches from various ethnic restaurants, and encouraged spirited noontime discussions. A keeper. For these and other reasons, companies usually issue NSOs as well as ISOs. Any candidate coming from a larger, established place in their career may very well have significant offers from other companies that have a more established history. Cafe Classic: It's a New Year and I Have an Urge -- Don't You? In terms of actual percentage ownership in the company, 5% to 10% is a ballpark area to consider offering your potential CEO. Since we are on the topic of the CEO’s annual rhythm, let’s talk about senior management compensation. Despite this awkward tension (the desperate need to attract first-rate talent without having the cash to pay them market rates), marshaling resources for pressing business needs must remain paramount. Deciding on compensation policies for startup companies means making tough choices. Startup Board Compensation Board compensation will change over time as the company matures. In its ideal form, equity compensation aligns the interests of individual employees with the goals of the company they work for, which can yield dramatic results in … The five prospects had unreasonably high expectations about how much stock they should receive. When it comes to issuing stock, startups should always be careful not to sell the store before they fill the shelves. As the startup gets bigger and the equity opportunity gets smaller, cash comp goes up to 300k+ and 500k+ for public companies. But the wisest approach is to go slowly, to make enhancements incrementally, and to be aware at all times of the cash flow, taxation, and accounting implications of the choices you face. The goal should not be to come as close to what IBM offers without going broke, but to devise low-cost, innovative programs that meet the needs of a small employee corps. So management backed out of the program at the eleventh hour. Using this percentage range keeps you competitive when searching for quality CEO candidates, while also leaving room for incremental improvement once the executive is on board. And the resale restrictions created golden handcuffs without forcing executives to wait to buy their shares. But any program has costs—and costs of any kind are a critical worry for a new company trying to move from the red into the black. Harvard Business Publishing is an affiliate of Harvard Business School. One of his colleagues, however, had a wife and young child at home and needed the security of a sizable paycheck. All Rights Reserved, This is a BETA experience. Other C-level execs would receive 1-5% equity that vests over time (usually 4 years). Startup compensation basics Your typical startup compensation package consists of a combination of salary and equity. Early-stage will be higher stock and no cash, later stage the percentage of the stock grant will go down and cash will become a factor. It is also true, however, that the executives most attracted to startup opportunities may be people for whom standard benefit packages are relatively unimportant. Research and development, facilities and equipment, and marketing costs all make priority claims on resources. If not, does it make sense to reward executives based on the company’s appreciating share value or to devise formulas based on different criteria? The plan provided the company with tax deductions on any options exercised in the future (assuming the fair market value at exercise exceeded the stock’s fair market value when the company granted the options) and avoided any charges to book earnings in the process. Factors to Consider When Vetting a Potential CEO. Setting higher-than-average deductibles lowers employer premiums (the deductibles can be adjusted downward as financial stability improves). They consulted other software startups and documented that second-tier employees typically received 1% to 3% ownership stakes. Attracting these executives is easier said than done. ISOs have other drawbacks. The activity and success seen in the venture-backed biotech space has trickled down to the compensation of the executive teams and scientists running these companies. They had sufficient personal resources to contribute assets and cash to the new company in exchange for founders’ stock. He planned from the start to sell the business once it reached critical mass, and let his key executives know his game plan. The founder of a temporary employment agency used this approach to attract and motivate key executives. Now you must assemble the quality management team that venture investors demand. Companies must factor regional and industry trends into their compensation and benefits calculations. A startup's funding impacts the CEO's salary, the report found. Startups must strike a delicate balance. Investors and shareholders must decide how much dilution of equity they are willing to accept to provide an appropriate equity pool for the management team. It was prepared to offer an attractive—and costly—401(k) program until a survey disclosed that employees preferred a much different benefit: employer-paid membership at a local health club. The average pay range for a Startup CEO varies greatly (by as much as $113,000), which suggests there may be many opportunities for advancement and increased pay based on skill level, location and years of experience. Group medical is also essential, although there are many ways to limit its cost. But never are the challenges more difficult—or the stakes higher—than when a company first takes shape. But she makes $100,000 a year in a secure job at a large company. In short, what kind of compensation and benefits program will attract, motivate, and retain this marketing vice president and other key executives while not jeopardizing the fragile finances of your startup business? Such plans establish a measurement mechanism based on company performance—like book value, earnings, return on assets or equity—that determines the company’s per-share value. The table below shows 2016 median cash and equity compensation for six developmental cuts of survey data. As with most things in life, managing compensation issues inside of a startup is all about balance. And with good reason. Margaret O'Hanlon has some Classic tips for making career headway in the New Year. Whatever the format, our top priority is … The best performing companies use incentive-based compensation to achieve their goals. What an employee receives in equity, cash, and benefits depends on the role they’re filling, the sector they work in, where they and the company are located, and the possible value that specific individual may bring to the company. Typically, equity — a percentage of ownership in the company — is the anchor of a solid compensation package for a potential chief executive, so let's dive a little deeper into the details of what this may look like. © 2021 Forbes Media LLC. Moreover, the exercise price of an ISO cannot be lower than the fair market value of the stock on the date the option is granted. ISOs, however, give the company no tax deductions—which is not a major drawback for startups that don’t expect to earn big profits for several years. If the goal is to realize the “big payoff” within three to five years through an initial public offering or outright sale of the company, then stock may be the best route. You’ve decided to start a company. And these awards should take place only after the company has fully distributed stock to the founders. How much cash is reasonable? COO < CMO < CPO < CTO would be my guess in terms of equity, but the cash compensation is probably pretty similar. How to proceed? Selecting appropriate compensation and benefits policies is a critical challenge for companies of all sizes. What is the accounting impact? Analysis of CEO Cash and Equity Compensation in 2016 . Then they agreed on a formula by which these employees could trade cash for stock during their first three years. No shares actually trade hands; the company compensates its executives to reflect the appreciation of its stock. Executives with excess cash could exercise all their options right away; executives with less cash, or who wanted to wait for signs of the company’s progress, could wait months or years to exercise. Does it make sense to grant key executives an equity interest? Executive Compensation Plans in a Startup’s Growth Stage. And there are endless variations on the equity theme: restricted shares, incentive stock options, nonqualified options, stock appreciation rights (SARs), phantom stock, and the list goes on. Without an entrenched personnel bureaucracy and long-standing compensation policies, it is easier to tailor salaries and benefits to individual needs. If an executive leaves the company, he or she loses the unexercised options. The firm quickly discovered that it could not attract top candidates without the plan; it had become a staple of the profession in that geographic market. So unless you raise millions and millions of dollars right from launch, it’s difficult to justify a high startup CEO salary. Many executives prefer these programs to outright equity ownership because they don’t have to invest their own money. Each demanded 5% to 10% of the company, which, if granted, would have meant transferring excessive ownership to them. With the help of strong financial projections to determine what each point is likely to be worth as well as up-to-date balance sheets on where things stand now, a generous and enduring structure can be created that is balanced, yet worthy. And they have different tax consequences for the issuing company, which can deduct the spread between the exercise price and the market price of the shares when the options are exercised. In addition to an actual percentage, consider also vesting timetables tied to goals. Many young companies underestimate the money and time it takes just to administer benefit programs, let alone fund them. The company’s business plan, a competent leadership team and the right compensation package can each reduce the risk of working for a startup. YEC members represent nearly every industry, generate billions of dollars in revenue each year and have created tens of thousands of jobs. Thanks. Worthless paper can actually be a demotivator for employees. After working with startups for over a decade, I have dealt with many founders who are presented with the tough decision of handing off the role of CEO to an outsider. Also, don’t forget about the human aspect of compensation. Employee benefits do not run on automatic pilot. One newly established law firm decided not to offer new associates a 401(k) plan. Compensation and benefits choices have major tax consequences for a startup company and its executives; startups can use the tax code to maximum advantage in compensation decisions. Unlike standard deferral plans, where cash is paid out on some unalterable future date (thus triggering automatic tax liabilities), the option approach gives executives control over when and how they will be taxed on their deferred salary. As your company heads toward maturity, so can your compensation and benefits programs. Use the previously mentioned factors to choose which end of that range makes more sense. Survival is the first order of business for a new company. You can motivate employees to work hard and build the company’s value since they can readily envision big personal rewards down the road. (Shares need not be publicly traded for them to have a fair market value. From time to time I get questions about startup compensation. Executive Compensation 01/08/2021. Learn more at yec.co. EXECUTIVE SCIENTIST/ARCHITECT 92 51% 49% VP QUALITY 15 7% 93% GENERAL MANAGER 130 12% 88% VP CONSULTING 40 5% 95% C-LEVEL OTHER 56 57% 43% OTHER VP 122 12% 88% . Private companies estimate the market value of their stock.). What should independent directors expect in the way of compensation for serving on a startup’s board of directors? Alternatives in this situation include SARs and phantom shares—programs that allow key employees to benefit from the company’s increasing value without transferring voting power to them. This is tough to answer without knowing your background and without knowing how much the current company might be worth. Restricted shares most often require that an executive remain with the company for a specified time period or forfeit the equity, thus creating “golden handcuffs” to promote long-term service. Many executives value the option of deferring taxable income more than the security of immediate cash. Granting shares in a company that may never be sold or publicly traded is a bit like giving away play money. Startup companies have special opportunities for creativity and customization with employee benefits. Certainly, Thai food is no substitute for a generous pension. Having a clear picture of your company will help guide you in choosing the chief executive that is right for your situation. But benefits that promote a creative and energetic office environment may matter more to employees than savings plans whose impact may not be felt for decades. How do they affect cash flow? The company’s three founders had worked together at a previous employer. Finally, the company placed restrictions on the resale of stock purchased with options. Equity compensation is the practice of granting partial ownership in a company in exchange for work. Unrealistically high levels of cash compensation can turn off potential investors and, in extreme cases, threaten the solvency of the business. This is a difficult reality for many founders to accept, especially those who have broken from larger companies with generous benefit programs. The company gladly obliged. Some founders take the other extreme. Startups should evaluate compensation and benefits alternatives from four distinct perspectives. If you do decide it's time to look outside for leadership, it's important to know what it takes to lure a proven executive into a startup. Under Section 409A of the federal income tax law, if a “nonqualified deferred compensation plan” doesn’t meet the requirements of Section 409A, then the employee has to include all the deferred compensation in taxable income, plus pay a 20% penalty and interest. To 10 % of the toughest questions a startup executive compensation 's funding impacts the CEO ’ s go to! Insurance-Backed salary plan for its key executives and second-tier employees in a startup founder ask... An equity interest they fill the shelves much the current company might be.... 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