Questions about an article? The founder of a temporary employment agency used this approach to attract and motivate key executives. They grant NSOs at a below-market exercise price that reflects the amount of salary deferred. Having a clear picture of your company will help guide you in choosing the chief executive that is right for your situation. For these and other reasons, companies usually issue NSOs as well as ISOs. From time to time I get questions about startup compensation. Without an entrenched personnel bureaucracy and long-standing compensation policies, it is easier to tailor salaries and benefits to individual needs. Email feedback@yec.co. Second, be thorough and systematic about analyzing the options. ISOs have other drawbacks. Startups often prefer ISOs since they give executives a timing advantage with respect to taxes. The lure of cashing out quickly was a great motivator for this company’s top executives. The founders devised a solution to meet the needs of the company and its prospective employees. 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. Your background and training have prepared you for the challenge. Looks really good. One service company in the startup stage adopted an insurance-backed salary plan for its key executives. In other words, these companies were all tremendously successful up to the point of going public, yet the CEO’s salary was still lower than that we’ve seen for some Series A startups, especially on the West Coast . Thanks. 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. Group medical is also essential, although there are many ways to limit its cost. 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. February 4, 2010. 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. YEC members represent nearly every industry, generate billions of dollars in revenue each year and have created tens of thousands of jobs. And these awards should take place only after the company has fully distributed stock to the founders. First, be realistic about the limitations. Tho two tables below tell the story for VPs of Engineering (VPE) and VPs of Product (VPP) across the US broadly and in the SF Bay Area. Opinions expressed are those of the author. 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 compensation of the founder-CEO should be benchmarked to the market after benchmarking the rest of the function heads to the market. Compensation data is highly situational. Executive Compensation Plans in a Startup’s Growth Stage. Does it make sense to grant key executives an equity interest? Founders rightly worry about diluting their control before obtaining venture funds. 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. 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. Many young companies underestimate the money and time it takes just to administer benefit programs, let alone fund them. It did not make sense for the company to raise venture capital to pay the engineers their market-value salaries. Some founders take the other extreme. One of the engineers was single and had few debts; he was happy to go cash-poor and bank on the company’s growth. Young Entrepreneur Council (YEC) is an invitation-only, fee-based organization comprised of the world's most successful entrepreneurs 45 and younger. © 2021 Forbes Media LLC. Roughly, for every additional $1 million raised, a startup CEO will take home between $4,000 and $5,000 more in annual salary. 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. Most options, whether ISOs or NSOs, involve a vesting schedule. Deciding on compensation policies for startup companies means making tough choices. Based on recent job postings on ZipRecruiter, the Startup CEO job market in both Chicago, IL and the surrounding area is very active. As with most things in life, managing compensation issues inside of a startup is all about balance. 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. 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. They decided to forgo cash compensation altogether for the first year. Factors to Consider When Vetting a Potential CEO. 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 … 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. Private companies estimate the market value of their stock.). 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. COO < CMO < CPO < CTO would be my guess in terms of equity, but the cash compensation is probably pretty similar. Other creative policies may not only cost less but they also may better suit the interests and needs of executive recruits. More and more startups are following the lead of larger companies by allowing executives to defer cash compensation with stock options. 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. Companies can choose among various book-value plans, under which they offer to buy back shares issued to employees according to a pricing formula. This new CEO will be responsible for overseeing every part of your business, so it's critical to know the overall status of your startup, from financial health all the way down to company culture. NSOs can be issued at a discount to current market value. 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% . In such cases, it may make sense to create an artificial market for stock. 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. 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. Expertise from Forbes Councils members, operated under license. Equity compensation is the practice of granting partial ownership in a company in exchange for work. Your business plan is based on sound strategy and thorough market research. If so, should the company use restricted stock, options, or some combination of both? The company gladly obliged. What are the tax implications? This dizzying array of choices notwithstanding, startup companies face three basic questions. Granting shares in a company that may never be sold or publicly traded is a bit like giving away play money. Also, don’t forget about the human aspect of compensation. 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. 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. They receive the financial benefits of owning stock without the risk of buying shares. Every startup situation varies. The choice of whether to issue actual or phantom shares should also be consistent with the company’s strategy. Companies must factor regional and industry trends into their compensation and benefits calculations. For every $1,000 in cash an engineer received over a base figure, he or she forfeited a fixed number of shares. Many executives value the option of deferring taxable income more than the security of immediate cash. 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. After some negotiation, they settled on a maximum of 2% for each of the five engineers. But never are the challenges more difficult—or the stakes higher—than when a company first takes shape. Selecting appropriate compensation and benefits policies is a critical challenge for companies of all sizes. Startups must strike a delicate balance. 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. Analysis of CEO Cash and Equity Compensation in 2016 . NSOs can also play a role in deferred compensation programs. Venture capitalists or other outside investors will demand a healthy share of equity in return for a capital infusion. executive compensation and option plans. Many executives prefer these programs to outright equity ownership because they don’t have to invest their own money. 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. 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. Is there any way to match the array of benefits—retirement plans, child-care assistance, savings programs—her current employer provides? 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. You may opt-out by. Here are a couple of examples showing how things can go wrong. How to proceed? He planned from the start to sell the business once it reached critical mass, and let his key executives know his game plan. A salary of $100k per year is going to half your runway when compared with a salary of $50k per year. Startup Board Compensation Board compensation will change over time as the company matures. Compensation and benefits plans can be expensive to design, install, administer, and terminate. Different compensation programs affect the income statement in very different ways. Properly crafted, an executive compensation plan can help attract top-notch talent, retain best performing executives, motivate the leadership team to succeed and align their activities to help ensure the company’s goals are being reached. Of course, if companies generate taxable income before their executives exercise their options, lack of a deduction is a definite negative. Let’s consider these questions one at a time. Critical to the company’s success were five software engineers who would write code for the first product. 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. Cafe Classic: It's a New Year and I Have an Urge -- Don't You? Research and development, facilities and equipment, and marketing costs all make priority claims on resources. 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. So management backed out of the program at the eleventh hour. 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… One small but growing high-tech company used a combination of stock techniques to achieve several compensation goals simultaneously. David Ehrenberg is the founder and CEO of, EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit — And Pushing For Change, Gender Bias: Trademark Act Never Contemplated A Woman Or Gay Male President, Cannabis Challenges Differ In Each State Where It’s Newly-Legal, 5 Unexpected Places To Find Your Next Great Business Idea. Attracting these executives is easier said than done. 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. 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. 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. Reporting rules for artificial stock plans are very restrictive and sometimes create substantial charges against earnings. 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 networked your way to just the marketing candidate you need: a vice president with the right industry experience and an aggressive business outlook. While it’s easy to understand cash salary, the equity portion can be difficult to assess, particularly for someone new to tech or startups. A keeper. So it set up writing boards in the cafeteria, provided all employees with daily lunches from various ethnic restaurants, and encouraged spirited noontime discussions. The executive otherwise enjoys all the rights of other shareholders, except for the right to sell any stock still subject to restriction. To set the table I wanted to share some national startup compensation data. As with phantom shares and SARs, book-value plans require a thorough accounting review. They can be issued to directors and consultants (who cannot receive ISOs) as well as to company employees. They consulted other software startups and documented that second-tier employees typically received 1% to 3% ownership stakes. Whatever the format, our top priority is … 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. Certain approaches, like setting aside assets to secure deferred compensation liabilities, require that executives declare the income immediately and the company deduct it as a current expense. Downloaded, abstracted, indexed, easily found again in the future, to be backup up. Copyright © 2020 Harvard Business School Publishing. Any compensation data out there is hard to come by. Equity is the great compensation equalizer in startup companies—the bridge between an executive’s market value and the company’s cash constraints. To spotlight how that applies to CEOs at venture-backed companies, we partnered with compensation data firm J.Thelander Consulting to break down the data by gender, the amount of capital the company has raised, and whether or not the CEO founded the company. 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. How do you structure a compensation package that will lure her away? At the same time, there are real advantages to being small. One thing to keep in mind, though, when considering how large of a slice the CEO gets is how much equity will remain in the option pool afterward for other key employees sought later. (This program allows employees to contribute pretax dollars into a savings fund that also grows tax-free. He also allowed them to buy shares at a discount. As a rule of thumb a non-founder CEO joining an early stage startup (that has been running less than a year) would receive 7-10% equity. The list of traditional employee benefits doesn’t have to stop here—but it probably should. Compensation at a startup company is largely made up of three components: salary, benefits, and equity. Since 2008, there has been a secular trend to increase cash compensation and decrease equity to startup management teams. You should resist these temptations. 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