stickman private company dataDuring the month of November I’m going to focus on my equity compensation roots. With both the IPO and M&A markets once again starting to gain attention, we can start by discussing a recent survey on equity compensation at private companies.

The National Center for Employee Ownership, (www.nceo.org) just released their 2011 Private Company Equity Compensation Survey. This survey is unique because it focuses exclusively on data from more than 200 privately held companies. Given the focus of the compensation industry on market data, this unique data set gives us a rare glimpse into companies that provide very little in the way of public disclosure.

The participant companies were fairly well dispersed in multiple industries. 42% were from biotech, software and other technology sectors; 16% were professional services firms; 12% in manufacturing and the remaining 30% spread among a variety of industries. More than 80% of the responding companies have been in business more than five years.

Given the direct impact that exit strategy has on equity compensation design, it is interesting to note that only 10% of companies expect to go public, while 56% are planning on being sold to another firm. A surprising 27% currently have no exit strategy. 47% of firms have VC investors, 29% have family investors and 25% have Angel funding.

More than three-quarters (77%) of these companies give all of their C-level officers some form of equity compensation. 56% of respondents give equity to at least some hourly/technical employees. While these numbers show a broad application of equity, the amounts awarded tell a slightly different story. 56% of equity is awarded to C-level officers, while only 4% goes to hourly/non-supervisory employees.

The mix of equity instruments used is also telling. 66% of companies use stock options for some or all of their participants. 29% use restricted stock shares. Just 10% use one or more of phantom stock, stock appreciation rights (SARs) and restricted stock units (RSUs.) Non-founders held a mean of 15%, while founders owned a mean of 38% of the outstanding equity at responding companies.

So, what does this all mean?

First, accounting practices seem to be driving equity design more than management concerns about creating new shareholders. Restricted stock has a fixed accounting expense and avoids the need for 409A valuation. Stock options require 409A valuation, but have a fixed, predictable expense. Phantom Stock and SARs usually pay out in cash and result in a need for both a 409A valuation and regular adjustments to the compensation expense on a company’s books. While the accounting issues are important, plan design should first focus on the big-picture goals of the company. Many companies can benefit from the addition of synthetic equity to their programs.

Second, private companies are not being impacted by the current push for performance-based equity seen at public companies. This is likely due to the generally unpredictable nature of both company valuations and predictions on future performance. While many management teams would like to have more robust and defined performance hurdles, plans have not yet caught up with aspirations. Between 75% and 90% of public companies in the US now use performance criteria for some or all of executive equity awards. The number of private companies in this survey using performance equity did not even register in the final data.

Third, more than a quarter of companies have put equity plans in place with no clear idea of how those plans will have value to the participants.  With 27% responding that they currently have no exit strategy, it is likely that most of these firms have not been able to clearly communicate a realistic potential value, or event horizon, to their employees. Without this communication these companies lose much of the value of equity as both a motivation and retention tool.

Finally, companies are not simply using equity as a spark to obtain the holy grail of an IPO. In fact, only one out of ten companies considers an IPO in their future. Equity has become a fairly ubiquitous compensation tool that is being used regardless of the potential future of the company. Participants and employers see a value in equity even when they cannot express how that value will be obtained. It is important that companies continue to communicate the processes, potentials and values of equity awards as they evolve. As I have said in the past, in the absence of information, people will use their imagination.

The survey is available from the NCEO for $150 to members and $250 to non-members. NCEO introductory memberships are available for $90.