A Small Problem for Compensation Professionals

6a0134836082f8970c01bb090d7e4a970d-200wiThis is not the article I intended to post today. I had something else ready to go, but realized this was more important. I am sitting in my hotel room in San Diego, California getting ready to head over for the second day of the annual WorldatWork Total Rewards Conference. Total Rewards is a BIG category.  In three days it is not possible to dive into every type and flavor of “reward”. But one important family of compensation, equity, is almost completely missing from this year’s event.

Don’t get me wrong. There are some Continue reading

11 Reasons Your Equity Compensation Survey Data is Wrong

6a0134836082f8970c01b7c8191c03970b-200wiPart 3 of my ongoing “Stock Options on the Precipice” series.

How much equity should I give (or get)?

It’s probably the most common question I get asked. The answer, as I am sure you know, is “It depends”. And, with equity compensation the final answer is even squishier than other types of compensation. Data seems to be all over the place. Trends appear to vary based on who is providing them. It often feels like survey data is pulling companies in specific directions, when it should be reflecting directions that have already been taken. What in the heck is going on?

You haven’t lost your mind. Equity compensation really is Continue reading

Equity Compensation Triage Assessment (Stock Options on Precipice Part 2)

6a0134836082f8970c01b7c8140d49970b-200wiThe first article in this “Stock Options on the Precipice” series covered some of the main issues that are currently impacting employee stock options (check it out here). This article will discuss some of the paths you might take if you are having stock option concerns. For many executives, human resources and compensation professionals, this may be the first time to experience the trials and tribulations of stock options. For others, the questions below and the assessment process may be a new way of addressing this issue.

Luckily, Continue reading

Do Worker’s Want Shares or Cash? as quoted in the WSJ

equity graphicDan Walter, President and CEO of Performensation was quoted in this article on the topic of more broad-based use of equity compensation during the current hot market.

“Staking more employees in the company breeds loyalty and builds wealth in a way that salaries alone cannot, managers say.”

Article: Do Workers Want Shares or Cash, Wall Street Journal, Rachel Fientzeig

Dan adds the following thoughts to the article:

“Since the 1980’s equity compensation usage has grown in alignment with the growth of company values and the stock market. Take a look at our Equity Compensation Golden Decade graphic to learn a bit more about this. Designing and using equity compensation to be effective in both strong and weak markets requires the expertise and experience Performensation offers. Our focus on aligning these programs with company strategy and culture results in programs that work now and into the future.”

Let’s Get Rid of ISOs, ESPPs and Voting for President

untitledIncentive Stock Options, or ISOs, have been the foundation of tech company stock option programs for the past three decades. ISOs are supported by IRS rules that are designed to promote longer-term employee ownership by offering a tax advantage. ESPPs are governed by many of the same rules as ISOs. Most participants forego the potential tax advantage and treat their ISOs like any other stock option and their ESPP like a cash machine.

Since these plans are harder to administer, harder to communicate and most importantly, only a small percentage of people Continue reading

Combatting Self Interest in Pay

untitledProfessor Dylan Selterman (@SelterMosby) is a psychology lecturer at the University of Maryland. Earlier this summer he gave his students an extra credit question that made them select between direct self-interest or indirect self-interest. The question is below:

“Here you have the opportunity to earn some extra credit on your final paper grade. Select whether you want 2 points or 6 points added to your final paper grade. But, there’s a small catch. If more than 10% of the class selects 6 points, then no one gets any points. Your responses will be anonymous to the rest of the class, only I will see the responses.”

Essentially students were asked many questions in this portion of the test. First and foremost, was it in your own best interest? Second, do you think the other students believe it is in their own best interest? Third, how confident are you in getting a good grade on this paper?

People ask me why I believe so passionately that equity compensation can be a great tool for company success. The Continue reading

How have you seen Stock Options or Performance Rights grants change for employees from Pre-IPO to Post-IPO?

Question (Orig. on Quora):

How have you seen Stock Options or Performance Rights grants change for employees from Pre-IPO to Post-IPO? What are the triggers and how have the amounts differed? Building out our long term comp strategy. Thanks!

Answer (by Dan Walter):

First, it must be clarified that this answer refers to “pre-IPO” as companies with a realistic chance of an IPO, not simply any company (tech or not) that is not currently publicly traded.  This distinction is important since it plays directly into many of the design goals and trends for equity compensation. I can cover non-pre-IPO companies in a separate post)

Second, the difference between pre-IPO companies and so-called “unicorn” (>$1B) pre-IPO companies is also a significant differentiator in equity plan design and use.

Stock Options:
For most pre-IPO companies these are fairly basic. MOST TYPICAL… They may be ISO or NQSO. They are granted with a strike price equal to the IRC 409A) compliant Fair Market Value of the companies common stock.  They vest over time. Usually over 4 years. Sometimes 25% each year, sometimes 25% at the end of the first year and monthly for 36 months after that. We are also seeing more grants with a secondary event-based goal that has to be met before final vesting takes place (typically Change in Control). Leaving the service of the company usually ends up with the individual losing all unvested options and having a limited period to exercise vested options (usually 3 months for termination in good standing, 0 for cause, 1 year for death or disability). Grant size is generally determined as a % of outstanding shares for early employees and some formulaic number of shares for later employees. Exercises, if allowed before the IPO, usually require cash paid directly by the optionee to the company. The optionee is no longer an employee the cash payment may also include taxes due (since withholding may be difficult or impossible).  In a small percentage of companies still optionees are allowed to exercise unvested optionees and hold the remaining shares until they are vested.

So what is different for post-IPO options?
Often not much. The grant price becomes driven by the stock price traded on the open market (usually closing price on the date of grant). Vesting is generally the same schedule as pre-IPO (although many companies do away with allowing exercise of unvested options). Vesting for post-IPO seldom requires any trigger other than time. Leaving the service still ends up with the option losing unvested options and having a limited time to exercise vested options. GRANT SIZE: once a company is public grant size is most commonly driven at least partially by the black scholes value of the options at the time of grant. Values are less likely to be based on percentages or fixed formals and more likely to be based on compensation dollar values. Exercises become much easier with the addition of same-day sales and net settlement methods for payment. But, with public trading comes insider trading policies, black-out windows and, for some officers, SEC filings for nearly every transaction.

Back to pre-IPO companies
But, companies that stay private for a long time AND have a lot of employees AND grant a lot of equity may find themselves running out of stock options to grant.  This is one of the two biggest drivers for the pre-IPO move to Restricted Stock Units (RSUs). The other major driver is the fact that most options allow for a voluntary exercise transaction. These transactions create shareholders.  Too many shareholders means the company must file information with the SEC that may be available to competitors.  So, companies move to RSUs and restrict the vesting event to occur only after a period of time (usually at least 3 years) AND after the company choose to file publicly.  This can simplify the process for the company, but removes a lot of flexibility and leverage for the individual.  But, it still beats giving no equity at all.

More recently companies have been granting RSUs with performance-based vesting (most often also requiring a period of time to pass as well, typically at least a year).  Performance criteria for these pre-IPO performance-based RSUs are usually focused on internal financial and operational metrics.  Companies love metrics like EBITDA, but we recommend metrics that are more closely aligned with the jobs people do and decisions they make, rather than something like EBITDA that is a result of many things, but may not be understood or feel like it can be personally impacted by individuals.

Performance equity is still relatively uncommon in pre-IPO companies, except officers, but it is a growing trend.

So what about Public companies?
Public companies who moved to RSUs pre-IPO usually stick with them after the IPO.  Most of these companies also add and ESPP (Employee Stock Purchase Plan) that is focused on the rank and file.

At the time of IPO most companies create entirely new plans that are built to conform with public companies rules and best practices.  These plans also can include an “evergreen provision that automatically increases the pool of shares available to grant on an annual basis. Evergreen provisions usually expire before the start of the 4th fiscal year after IPO (shareholders and the advisors kind of hate them).

It should also be noted that overhang changes pre and post-IPO.  This is partly due to the different ways overhang is calculated pre and post-IPO.  But it is also due to the fact that once a company goes public people start exercising options and RSUs start vesting.  Every exercise of options or release of vested RSUs moves equity from one side of the overhang calculation (outstanding equity) to the other (outstanding shares). SO, the impact of exercises and releases is double that of equity cancelled for a terminated employee which only impact the outstanding equity side of the equation.  The quick movement in transaction during the first year after IPO reduces overhang quickly at many companies, giving them more room for new grants (as long as they have new shares coming through something like an evergreen provision.)

Now if you have gotten this far you are probably taking this seriously.  So you should know a little secret.  While all of the above is true it doesn’t mean that it is right.

The most common methods of using equity compensation are often not supported by any evidence of effectiveness. They are follow-the-leader approaches that many lawyers and compensation consultants throw out to companies to create average solutions (and great consulting fees).

The real process to determine a long-term compensation strategy requires a true understanding of your company culture and strategy. It requires know how and why each equity instrument works and it requires a communication program that ensures that your employees perceive the value of equity in a manner similar to your intent for that equity. The end result is a program that is unique to your specific facts, circumstances and goals.

I can go on (I have co-authored books on this topic), but I will wait for any follow-up questions first.

8 Things You’ve Gotta Know about Equity Compensation

untitledpEquity compensation continues to be a confusing topic for compensation professionals and with good reason. Equity compensation is not just variable compensation. It’s variable, variable, variable, variable compensation. There’s the variable of stock price. There are variable numbers of shares, units, options or rights. There are variable types of awards, variable vesting timing, variable (for international participants) currency rates and for many recent awards, there are variable performance conditions. So, it’s not just four variables I mentioned earlier, but six or more variables that come into play. This can be tough to grasp in the compensation world where everyone would really like some level of expected consistency.

In addition to all of the variables, there are Continue reading

ESPPs are a Dessert Topping and a Floor Wax

Stickman ESPP Dessert Topping floorwaxEmployee Stock Purchase Plans (ESPPs) get a bad rap although they should be lauded in wonderment. The proof is in the number of different areas that claim full, or no, responsibility for these underutilized instruments. ESPPs are much like the old Saturday Night Live “commercial” for Shimmer (“It’s a Dessert Topping AND a Floor Wax”). Unlike Shimmer, the mythical SNL product, ESPPs are actually delicious, effective and available on your compensation store shelves today. If your company does not have an Continue reading