NostraDANus Predicts the Future of Pay (3 yr hindsight edition)

Stickman 2013 3 5 10 yrAt the end of 2013, Dan Walter was asked to predict what compensation would look like over the next 10 years. The first year of his predictions, 2017, is happening right now. Amazingly the news about executive compensation today reflects his predictions from 3 years ago.

Regarding executive pay

“…more leverage will be put on internal metrics and external metrics” (rather than TSR).

Regarding broad-base pay

“…far more of the budget will be dedicated to strong performers. Weaker performers will, unfortunately, be left further and further behind.”

Dan also made predictions for 2019 and 2023. Take a look at the full post from 2013 to see the future.

Do you want to get ahead of the compensation trends? Are looking for better ways to be competitive in a tight job market filled with companies paying almost exactly the same way? Perhaps it’s time to contact Performensation and create an approach to compensation that is future-proof.

Dan is the President and CEO of Performensation, a total rewards consulting firm that is dedicated to aligning pay with corporate strategy and culture. For more than a decade Performensation has been helping companies be successful by beating their competition. Call us today to start planning your future.

 

Startup Equity: In Conclusion (Part 14 of a 14 part series)

Stickman Startup In ConclusionIt feels odd to be wrapping up this series on Startup Equity. I started the series almost six-months ago, and although I have written around 10,000 words, I still have nearly endless things that we can discuss.

My goal was to provide some insight into the variations, complexity, power and hurdles that come along with equity compensation focused specifically on startups and other private companies. The information available is often too unreliable, too high level and too inconsistent to be useful. I hope this series has given readers multiple different perspectives and can provide the start for better conversations, better plan designs, and more successful companies. I am going to follow through on the suggestions from readers and colleagues that I turn the series into an ebook. If you are interested in getting a copy of the ebook, please shoot me an email (dwalter@performensation.com).

  1. You should know that determining grant size can be a challenge and that traditional techniques used for cash compensation do not translate well to the more variable nature of equity compensation. Using more refined methods can create much better results. 1
  2. You should know that NO ONE agrees on the value of equity compensation. Not ever. But, that’s OK as long as each party communicates the reasoning for their valuation. 2
  3. I hope you a have better understanding of the concerns of Venture Capital firms and similar early investors. Also, that you can better explain your case for equity and how it can drive their goals as well as yours. 3
  4. You should have a better understanding of how to use equity as your currency. You must also be willing to embrace your equity uniqueness, and why you shouldn’t put too much focus on comparisons to other companies (especially publicly traded) 4
  5. You may be able to evaluate better when you can accomplish your equity compensation goals with only a synthetic instrument. Sometimes polyester can outperform silk. Knowing when and how is the key. 5
  6. You should have a better grasp of when it makes sense to give additional equity grants and when it may be a recipe for failure. Most importantly, you should be clear that other companies’, entrepreneurs’, or thought-leaders’ formulaic methods or proven processes are unlikely to work perfectly for your company.6
  7. You should be fully aware of the MOST COMMON MISTAKE startups make when using equity compensation. 7
  8. You should be confident that your employees don’t understand their equity compensation any better than politicians understand the Internet. 8
  9. You should know that the variables that have the most impact at startups are Vesting, Termination Rules and Change in Control provisions. If you get these right for your goals and timeline, you are more than halfway to success. 9
  10. Performance-based equity shouldn’t be that scary to you. Yes, there is more to it than time-based equity, but it can be far more effective at getting you to your destination. 10
  11. Staying private and using equity compensation in a world obsessed with IPOs should no longer seem crazy. Equity compensation is very a useful tool and can even offer significant design advantages if you are willing to explore the possibilities. 11
  12. Hopefully, you know more about the evolution of cash pay and equity compensation levels over the past decade or two. Equity may no longer give you the savings that it once did, but that can offset by its long-term competitiveness. 12
  13. You may better understand more technical issues like Rights of First Refusal, Tag Along Rights and Drag Along Rights. Not everyone goes public, and not everyone stays at your company forever. Proper planning and documentation can lead to less stress and angst. 13

You will notice that I have touched on some of the more commonly covered topics like accounting and taxation issues. I have barely talked about things like ISOs and NonQuals. And, I haven’t gotten into the final 12-18 months in the run-up to IPO. There are at least one hundred other topics that tend to only come up in very specific conversations, but I think the foundation has been laid and hope that you will share any other specific topics that you may want me to cover in the future. Thanks, and I hope you will come back and read my future articles whether or not they cover startup issues.

Startup Equity: You’re Coming With Me, or maybe NOT (Part 13 in an n part series)

Stickman Startup Drag Along Tag AlongWe’ve covered a lot of ground in this series, but there is always more when it comes to equity compensation. Sharing ownership can be messy and participating in a liquidity event can be even messier. Companies, majority shareholders, and minority shareholders have defined tools to help avoid some of this messiness. Three of the most important provisions to consider in a startup equity plan are 1) Rights of first refusal, 2) Tag along rights and 3) Drag along rights. Often these are defined in your lawyer’s boilerplate document and never addressed during the design and approval phases of your plan.

1) Rights of First Refusal:

These are designed to protect the company from unwanted shareholders. They can be the bane of, or boon to, employees and other equity plan participants. The most basic form allows the company to buy shares from a potential seller for the same terms and conditions offered by a third party prospective purchaser. If someone wants to cash out, finds someone willing to buy their shares, and is not otherwise prohibited from selling their shares, they must first offer the shares to the company for purchase. If the company decides not to buy, the third-party can become a shareholder.

Rights of first refusal can be designed to allow the company to buy back shares at the most recent valuation price instead of the price offered by the third-party. This can ensure that the company is not “held over a barrel” by a seller who has found someone who passionately wants to become and owner and is willing to pay top dollar. This can be upsetting to a seller who has not read their agreement. This is especially true when the “investor value” far exceeds the value the company currently deems reasonable pursuant to a valid valuation.

Very few companies WANT a shareholder they do not know or with whom they are not on friendly terms. Most companies will exercise their right. But, what if they can’t? Not every company has the cash to buy back shares on a whim. Savvy equity holders can use this to their advantage by timing their potential sale to occur when the company is cash poor. It is critical that a company consider every possibility before simply signing off on a basic equity compensation plan.

2) Tag Along Rights

These are designed to protect minority shareholders. Imagine a majority shareholder decides to sell their shares. Imagine also that you are employee #5 and have purchased and held your shares for a while. When the majority shareholder sells, a tag along right ensures that the minority shareholder(s) can sell an equal percentage of their shares at the same price. If you are the minority shareholder, this can be huge. It helps ensure that the control and value of the company isn’t sold out from underneath you, especially if the purchaser is someone with whom you may disagree.

3) Drag Along Rights

These are designed to give additional power to majority shareholders. In many cases, a potential acquirer will balk at having to negotiate individual terms with minority shareholders. A well-designed, “drag along right” allows the majority shareholder to require minority shareholders (often equity compensation plan participants) to sell a pro rata portion of their shares to the acquirer for the same price, terms, and conditions as agreed to by the majority shareholder. This can be especially powerful if someone is looking to acquire 100% of a company. Negotiating with only the majority holder while guaranteeing the participation of every shareholder can smooth the process considerably. It also gives the majority shareholder significantly more negotiating power.

Lacking control of future transactions makes everyone a bit uneasy. Everyone should know whether they can leave the party, join the party or be forced to shut down the party. Building your equity compensation program to reflect your potential future transactions is a way to ensure all parties are treated in a way that can be both expected and relatively conflict-free. Most companies and plan participants do not pay attention to these details until the conflict has already started.

Startup Equity: But Can’t I Pay Less Cash? (Part 12 in an n part series)

Stickman Startup Cash ValueThis series of articles has covered a lot of ground, but this particular article touches on a critical component that we have not really discussed. When equity first began to be used in Silicon Valley, prior to the boom of the late-1980’s, the goal was getting senior players to have some skin in the game. This is still a major objective of equity.

As the stock market took off in the late 1980’s and flew through the 1990’s, equity became a cheap replacement for cash. The accounting rules ensured equity barely touched companies’ books. The stock market ensured that equity delivered far more, far faster that any form cash compensation. These high growth companies were able to keep cash pay low. This allowed the to easily compete for talent against large mature companies. This is no longer the case.

Many things have changed since the 1990’s. When it comes to equity compensation, the biggest change is that you only see lower cash pay at the earliest of startups. Far more Angel and Venture Capital money is being spent on staff than in the past. This means that less is going to research and development, or larger investments are required to build companies with no better potential than those in the past.

Remember that the accepted “value” of startups is based on recent investment rounds. Very few consider that a far great percentage of these investment rounds is being spent on staff than ever before. In fact, below the very top roles, we see very little differentiation in pay between public and private companies. The startup discount no longer exists for most industries.

What does this mean if you are an executive, HR leader of compensation professional? First, you need to budget the essentially the same base pay, and perhaps cash short-term incentives regardless of whether you have just finished your B-Round or your IPO. Second it means you need to be far better at using equity intelligently and efficiently. You can no longer throw a basic equity plan out there and expect to also get away with sub-par salaries.

Add to all of this the rapidly changing workplace and experience. Companies are spreading out more quickly. Employees at all levels are looking for more workplace (and time) flexibility. Housing prices are skyrocketing in nearly every location where equity compensation is a strong component of total rewards. The fundamental equation has changed and companies, and their leaders, must learn and adapt. They must understand that the bargain garage-based startup is far different when a garage now costs $1 Million.

So, in answer to the question: “How much less can I may my employees if I also give them reasonable equity?” If you are a typical startup, equity will not give you any direct cash savings. Of course, if you are in any industry where equity is uncommon it may still have some capability to reduce cash pay, but those industries are becoming increasingly rare.

The next pieces of this series will touch upon some of the most technical equity issues that are often not included in terms of compensation. These include: Call and Put Rights, Drag Along and Tag Along Rights and Rights of First Refusal. Let me know what else interests you in the space as I am wrapping up this series in the not so distant future.

Startup Equity: Staying Private in a Public World (Part 11 in an n part series)

Stickman Startup Private CoIt is readily accepted that an IPO is Nirvana to a startup. Of course, a fantabulous acquisition will also work in a pinch. Most startups design their equity plans around one or both of these possibilities. The events increasingly trigger vesting events, earn-out periods, house purchases and early retirements. But, what if you want to build something far longer-term? What if you only want to grow, make money and accomplish some important goal? Do equity plans even work for these companies?

The short answer is, they can. The better answer is they ABSOLUTELY can, as long as you and the person designing your plan know what they are doing. A surprising number of companies with no intention of trading publicly have successful equity compensation programs. We’ll stay away from the wonky technical details in this post and focus on some of the things that can help make your program successful.

Privately held companies vary in size far more than publicly held companies. How you should handle the issues varies widely depending on your company’s size, profitability and growth expectations. Many of the issues I have discussed in earlier posts (1, 2, 3, 4, 5, 6, 7, 8, 9, 10) and will discuss in future posts, apply whether or not you intend to eventually have an IPO or get acquired by a publicly traded company. Feel free to go back and read some of those articles to get reacquainted.

Common Types of Private Companies and Considerations for Equity

  1. Mega-Super-Giant Company

These are technically not startups, so I will keep this brief. These are the companies that often dwarf publicly traded companies. They can be found in almost any industry. They may have tens of thousands of employees or more. Sometimes they even have to file reports with the SEC due to having so many shareholders.

These companies may use equity plans in a manner similar to public companies. The biggest difference is that there isn’t a broad group of outside investors who can fund future employee transactions. This means that these companies may make a market in their stock, offer equity that settled only in cash, or more recently, offer programs that are funded through pre-approved private investors.

  1. Profitable High-Growth Companies

These companies are in the enviable position of making money. They don’t need money from investors to thrive. They are in many “old school” industries, but they can also be found in tech, biotech and other industries that typically look to VC or PE money to grow.

A surprising number of startups are profitable. These companies have very little reason to tap into other people’s money, whether private or public investors. Because of this, they have far more freedom to design their plans to meet their specific needs. They don’t worry about how the “next round” will dilute people. They seldom worry about getting the approval for new share allocations. They have a broad range of options.

But, they do not have outside investors to fund transactions. They must still compete for talent with companies with more traditional plans. Success drives their growth but also is throttled by current and future needs for investment. In short, they can’t simply rollout a typical plan and hope it will work.

They do, however, have interesting opportunities in plan design. Some may offer a regular or occasional dividend or dividend equivalent payments to their equity plan participants. This allows people to extract some value, without needing to wait for an “event.” They may settle all awards in cash or add in performance metrics that would otherwise be difficult with outside investors looking over your shoulder. They often have vesting schedules that are far shorter or longer than their less profitable or more typical competitors.

The main ingredient in their successful equity plans is playing to their unique key strength. Real money. Their profitability drives their valuations. The profitability provides funding for employee transactions. Their profitability allows employees to feel there is less risk in equity. But, in a world of unicorns, it requires a LOT of money to compete for the absolute best talent.

  1. Family-Owned, Professional Services, etc.

These companies have often been around for decades. They know how to operate in their space. Growth is always an objective, but often not the most important goal. They have well-established company cultures and often focus on excellence before innovation.

Historically it’s has been unusual for these companies to broadly share real equity. It is more common for real equity to be reserved for a relative few at the top of the company and offer synthetic equity or no equity to the lower ranks. This paradigm is starting to shift. Professional services firms are offering more techy-style products and solutions. Family businesses are being taken over by a new generation of leaders dealing with a new type of worker. These companies are looking at things as if they are a startup with a brand new lease on life. They are exploring equity because it has become a ubiquitous element in current total reward programs.

Outside of these three types of private companies is a wild kingdom of others. There are as many potential solutions as there are business models. The point is this: Equity isn’t only for tech startups and an IPO is not the perfect goal for every company. Staying private is a path that can allow companies to compete for talent in unexpected ways. Don’t limit yourself to the rules that must be followed by companies who require outside funding.

Startup Equity: Three Crucial Variables (Part 9 of an n part series)

stickman startup three crucial thingsStartup equity has approximately a gazillion moving parts. But three of these variables are far more important than all of the others. These three components are what make your plan uniquely yours. They are the things that require real thought. They are also the elements that are most commonly viewed as “plug-and-play” in the world of startups.

  1. Vesting Schedule

Stock options are grants with four-year vesting schedules. Everyone knows this. RSUs have a three-year schedule. Everyone knows this as well. However, while these are the most common vesting schedules, they are not as “standard” or as scientific as you may think.

The truth about vesting is a bit more complex. Vesting should align with expected employment cycles and potential company objectives (time and performance.) If four years fit this bill, then great! If not, you should consider something(s) different. Two years may be right or maybe seven years makes sense. You may even need more than one vesting schedule depending on the level of participant and the goals for that job. Your vesting schedule is a key competitive differentiator. Doing the same thing as everyone else puts you at a disadvantage unless you are the absolute best in your industry.

  1. Termination Rules

If you die, you get one year to exercise. If you leave while still in good standing, you get 30 days or three months. Unvested options and RSUs expire immediately. Again, this is common knowledge but it is not based on facts.

A small number of companies have started granting equity that does not expire. While this is a generous offer, the likelihood that it will result in running out of grantable shares is far too high for most companies. But, you may want to look at longer periods for key positions, or termination rules that align with the tenure of an individual. If someone has been with you for eight years, they may deserve more leeway than a new hire. There is no easy answer that works, only easy answers that don’t.

  1. Change-in-Control and Related Liquidity

Things are less standard in this area. Should vesting accelerate? What should expire? What the heck qualifies as a “change-in-control?” Accelerating vesting sounds great, but it may limit a company’s ability to show value. If critical positions have no “stickiness” then acquirers may offer less in return for the risk of losing key players. Acceleration of RSUs may result in income and taxes at times when participants cannot afford it. On the other hand, acceleration may be a great negotiation tool for participants in key positions.

All of this may lead you to “inspire” people to stick around after the transaction via continued vesting or earn-out periods. This can be effective, but may backfire if the time to transaction has already been extensive. One solution may be to build in performance criteria that trigger acceleration only if the value of the company exceeds a certain level. Properly designed and communicated, this can provide targeted motivation that drives those most responsible for achieving this value.

The emerging fourth member of the big three is performance conditions. Ten years ago these were seldom seen at startups. Now they are still uncommon, but commonly requested. We will cover this topic in an up coming post.

Take a look at your plan and agreements. How “vanilla” are your vesting, termination and change-in-control provisions? More importantly, why? Don’t sell your company short on such a big component of your pay and motivation package. Minor differences in these three areas can have a major impact on your ability to hire, motivate and keep your best talent.

Startup Equity: The Most Common Mistake (Part 7 of an n part series)

untitledHere is my 2017 gift to you. I truly believe that equity compensation helped build the technology industry, and therefore the world as we know it. But, an unfortunate number of startups make the same error when using this complex and powerful tool that drive corporate success.

If you browse the internet, ask entrepreneurs or receive guidance from someone at a VC firm, you will get similar answers when asking about equity awards for the first twenty, or so, employees. This information, while accurate at a generic level, is likely to be incorrect for your specific circumstances.

The answer looks a bit like this. Outside of the founders, the C-level hires should each get Continue reading

Startup Equity: Isn’t It Refreshing? (maybe not) – (Part 6 of an n part series)

untitledThe historically long periods between the startup and “big event” for companies has given rise to many issues that were never considered when stock options and other equity tools first became the preferred startup incentive tool. Among these unplanned issues are things like:

  • Wealth inequality between the first 20 employees and employee 5,000 or 12,000 or more
  • Grants expire when the company has not yet made its move to IPO
  • 409A Valuations
  • Dilution and burn rate issues long before IPO
  • Grants becoming stale
  • Downward movement in stock prices
  • (Ugh, this list can take the maximum 800 words allowed for this post)

This post we will discuss the controversial issue of “refreshing” grants for long-term employees. To clarify, these are not grants for promotions or company-wide performance. These are equity compensation awards that are given simply because Continue reading

Startup Equity: Synthetic Equity or Sharing Without Sharing (Part 5 of an n part series)

untitled4When you hear “equity compensation” and startups, you immediately think of stock options. More recently RSUs (restricted stock units that settle in company stock) have also been popular. But, what if you aren’t the “sharing” type? Or what if your company doesn’t have stock? LLCs are a good example. How does your business compete when it doesn’t have access to the same tools? Synthetic equity is becoming an increasingly popular answer.

Synthetic equity refers to any type of incentive plan where the value delivered to participants fluctuates based on the value of the enterprise. For corporations, the most common tools are Continue reading

Startup Equity: Comparing Your “Currency” to a Competitor’s (Part 4 of an n part series)

untitledComparing base bay is relatively easy, equity not so much. A dollar is a dollar. And, if a dollar isn’t a dollar (let’s say it’s a Franc), there are published exchange rates to help convert values. But, with equity compensation, the base currency is your stock, and its value is not easily translated (or even agreed upon). This fundamental disconnect is one of the most challenging issues faced by anyone dealing with equity compensation at a start-up.

Let’s start with the oversimplified example above. There are exchange rates from dollars to francs, but they are not as consistent as the prices available for Continue reading