Archive for the ‘Compensation’ Category

Board Member / Advisory Member Compensation

How much should you pay board members and advisors to your company? If your board members are VC investors, the answer is simple: nothing. They are on your board to help maximize the value of your company and their investment. If you have a VC that wants to invest and wants to be paid (in either cash or equity) for his / her board service, then find another VC; these folks aren’t legit.

One caveat to this: Venture Partners. If you read our post on different roles and titles in the VC world, you know that Venture Partners can have a range of compensation packages depending on how the VC firm they are a part of is set up. There are some firms that, in exchange for funding, want the company to issue their venture partner on the deal some piece of equity. This is simply because the venture partner doesn’t have a piece of the fund carry and therefore they want him to have some skin in the game. This is rare, but not unheard of.

As for outside board members, generally you don’t see cash comp given in startups, but you do see equity grants. A normal range for a good outside board member is an option grant worth 0.25-1.0% of the company, normally vested over 2 to 4 years depending on desired length of service.

When looking at Advisory board compensation, it ranges from nothing to small grants (usually less than 0.1% of the company.) Cash comp is not appropriate.

In all cases you should be willing to cover reasonable expenses for board member and advisors to come to your meetings if they have to travel. They key word is reasonable – you get to define this. For example, I once sat on a board where the CEO insisted that she choose the hotel we stay at and book the reservation (fortunately she had frugal but good taste.)

If you really want to drill down into the bowels of board compensation, check out Brad’s prior posts on the subject:

Compensation of Board Members 

Compensation of Outside Board Members

How Many Stock Options Should I Give To An Advisor?

Do Venture Capitalist Like To Change Pre-existing Employment Contracts?

Q: You’ve spoken at length about vesting for founders and key employees in your term sheet series. I was interested on your take concerning pre-existing employment contracts in which vesting terms and stock ownership has already been agreed upon by the Corporation and Employees including founders?

A: (Jason).  What VCs really want is to make sure that founders and key employees are properly incentivized to make the business a success.  For instance, if the stock awards were already vested, it’s probably that a VC investing in the company would want to reset or impose vesting restrictions on the prior awards.  Perhaps, the VC would want to award additional grants subject to vesting, etc.. to achieve the same result.  It all depends on the cap table dynamics.

Another set of terms that a VC may want to change at the time of investment are overly-generous severance provisions and make clear that all employment is at-will.

Other than that (assuming that cash compensation is not out of line), VC’s normally respect prior agreements.

What are typical compensation numbers?

About now you are probably saying, “Okay, you’ve written some helpful posts (at least we hope you think they have been helpful) on compensation, but show me the money!  What are some real life compensation numbers?” 

We hate compensation surveys. We hate average compensations ranges.  We hate industry data.  But
we know you want it (since 42 of you have asked us for it.)  Just be careful how you use it. These are our opinions and experience backed up by some industry data that we track.  Every case is different.  Your mileage will vary.  Tax, title, licence, and delivery charge not included.

Much of the cash comp will depend on how large the company is and where it is along the revenue and profitability curve.  Geography matters and while these numbers are for the U.S, there will also be major differences within different parts of the country.  Also, note that each round of financing will dilute ownership.  We’ve done our best here to spread these numbers out from early stage and more mature startups.  One thing that seems fairly consistent:  companies with less rounds of funding have lower paid executives and founders make less cash, but have more equity than non-founders.  Think of the non-founders as “hired guns” who are professional company managers, whereas the founders may not be, but given the risk of founding the company, generally hold higher equity stakes. 

Title

Cash Comp

Cash Median

Bonus

% Co Equity

% Co. Median

CEO
Founder

100k-250k

200k

0-100k

5-20%

9.0%

CEO
Non-Founder

180k-260k

225k

0-150k

3-7%

5.0%

President / COO
Founder

100k-200k

175k

0-50k

3-8%

5.0%

President / COO
Non-Founder

150k-230k

200k

0-75k

1-3%

1.5%

CFO
Founder

100k-170k

150k

0-20k

1-5%

2.5%

CFO
Non-Founder

100k-200k

160k

0-50k

0.5-1.5%

1.0%

CTO
Founder

120k-200k

160k

0-30k

2-10%

4.0%

CTO
Non-Founder

125k-200k

160k

0-50k

0.5-2%

1.0%

VP Engineering
Founder

150k-185k

160k

0-30k

1.5-5%

2.5%

VP Engineering
Non-Founder

150k-200k

175k

0-50k

0.7-1.5%

1.0%

VP Sales
Founder

175k-200k

175k

0-60k

1.2-5%

3.5%

VP Sales
Non-Founder

160k-200k

175k

20-150k

0.7-1.3%

1.0%

VP Business Dev
Founder

150k-180k

170k

0-35k

1.5-5%

3.0%

VP Business Development
Non-Founder

150k-190k

175k

0-70k

0.5-1.3%

0.75%

VP Marketing
Founder

140k-180k

160k

0-30k

1.3-7%

3.0%

VP Marketing
Non-Founder

160k-190k

175k

0-50k

0.5-1.2%

0.8%

Trends in Compensation Packages in Venture-Backed Companies

As we continue our series on Compensation, let’s look at some recent compensation trends. In general, while compensation is on the rise, the rate of increase slowed between 2005 and 2006. Founder compensation (in whatever role they play) is rising faster than non-founder compensation. There are some theories on this including (a) founders are becoming more savvy about their compensation packages and (b) there is increased competition between VCs for good deals and one way to win deals and keep founders happy is to pay them more (as Brad’s 18 year old niece likes to say – “well duh!”).

Non-founder CEO compensation has been fairly consistent for the past three years while founder CEO comp is up. As companies mature, these numbers tend to converge, although in general non-founder CEO’s make more cash comp – usually because they have significantly less equity – than founder CEO’s.

Comp for financial executives – both founder and non-founder – is on the rise. Double digit increases in cash and equity compensation for the past three years is not irregular.

Engineering and technical executives have seen a small rise in cash comp over the past couple of years, but equity has remained relatively stable.

Sales executive compensation has remained relatively flat. That being said, our experience is that they are making more incentive and commission compensation which follows the general macro economic uptick the U.S. has seen the past couple of years.

Marketing and business development executives have seen a steady increase in compensation over the past couple of years. Cash comp is up in the low double digits and equity about the same. With companies generally performing better than in past years, they are spending more on marketing and business development functions, as opposed to fulfilling these roles with a combination of the CEO and sales.

One other trend is the apperance of the “management carve out.” Given the recent past of tough times for start ups and dilutive / recap financings, many companies were left in a position whereby the management and employees did not own sufficient equity in the company to keep them motivated. In some cases, they owned plenty of equity, but due to large amounts of capital raised and the VC’s liquidation preferences, their equity was out of the money in any reasonable liquidation scenario. To solve this issue, investors and management developed the concept of “management carve outs” whereby the employees would receive a certain percentage of proceeds on a liquidation event (usually 5-10%) on top of anything they would receive for their equity. In essence, these employees were receiving a liquidation preference that sat along the liquidation preferences held by investors. As general economic conditions improve, these are becoming less common, but are still a valuable tool to keep management and employees incentivized.

Equity Compensation Terms

As part of your offer, there will likely be an equity component (if there isn’t, your first question after receiving the offer should be “so – what equity are you offering me as part of this package?”) The equity component will either be a grant of stock options or restricted stock – both with some sort of vesting component. If you’ve been employed by a startup before, you are probably aware of the concept of vesting; if not, take a look at our description of vesting in our Term Sheet series.

The standard vesting terms for a venture-backed company are typically a four-year vest with a one year cliff. For example, let’s assume you are granted an option for 10,000 shares of stock as part of your compensation package. A standard vesting plan would have you vest 25% of your options (2,500 shares) after one year (“the cliff”) and the other 7,500 monthly over the next 36 months (or 208 shares / month.) The vesting increment is usually either monthly or quarterly after the cliff period ends.

Note that “restricted stock,” while different, essentially works the same way. With restricted stock, the holder actually owns the stock, but the company has a right to repurchase should they no longer work at the company. The terms around this repurchase right “expires over time” – you can think of it as the same as vesting.

People ask about what types of acceleration we see in vesting arrangements. There are several common ones:

1. Acceleration based on prior performance: Many times a VC invests in a company whereby the founders own stock outright that prior to the VC financing is not subject to vesting. It is a pretty standard practice that the VCs will want to subject these equity holdings to a vesting schedule to incentivize the founders to stay around post financing. Normally, however a founder who has worked hard for a year to get the business off the ground will usually get a year of vesting credit. The actual amount varies – don’t expect to necessarily get vesting credit back to the day you originally thought of the idea while working at BigCo.

2. Acceleration based on termination: Often, founders and non-founder executives will negotiate a clause into their employment agreements that if they are fired without cause, their option vesting accelerates a year or so.

3. Acceleration based on an acquisition and termination: Commonly called “double trigger acceleration” this acceleration takes places when a company is bought and post acquisition, the acquirer terminates the employee within some period of time (usually within one year of the acquisition). The first “trigger” is the acquisition; the second “trigger” is the termination. It’s pretty standard practice that double trigger acceleration exists in company-wide stock option plans. Therefore, all employees at the company who are fired after an acquisition and within some time period enjoy the benefit of their options accelerating. The amount of the acceleration ranges broadly from a year to full acceleration.

4. Acceleration based on non-assumption of plan: One of common term in equity plans is the clause that accelerates all options under the plan if an acquirer doesn’t assume the option plan upon buying the company.

The other major term one see recently is the concept of a “drag along.” This is a relatively new term that’s come about in the past five years. It subjects stock holdings to a drag along, or voting proxy, whereby if the holder is no longer with the company, their shares are automatically voted (drug along, essentially) by the majority of the shareholders that are still with the company. This term became popular to ward off disgruntled shareholders who were no longer with the company.

Deferred Cash Compensation

Along the lines of our last compensation post, cash is at an extreme premium in pre-VC funded companies. In that vein, you might be presented with a situation where you “defer some of your salary” until after the first institutional financing. This means that you are theoretically earning this portion of your salary and once the financing happens, you will get it paid out in one lump sum.

Be careful about expectation setting here – while some VCs will respect this arrangement, if this deferred compensation number starts to grow, as a condition of the financing the VCs will often require some or all of the deferred comp to be converted into equity. This isn’t a horrible situation unless of course you’ve already spent your deferred comp on a new car. (Note to self – don’t by a new car until after the company is successful and you get a windfall from the sale of the business.)

Compensation in Venture-Backed Companies Before They Raise Money

You’ve started your own business and you hope to one day get funded by a reputable VC (yes – there are a few of them.) You’ve got a great idea, your business plan is almost drafted, and you’ve self funded the company along with another co-founder out of savings and credit cards. You think you’ll build out a small team, create a prototype over the next six months, and then go out and raise venture capital.

In the meantime, how much do you pay yourself? Will any of this affect your ability to raise money? By now you should know the answer is “it depends” but what decisions you make here can affect your ability to raise money, so let’s look at factors that one should consider.

First of all, don’t be greedy on cash compensation. There is nothing that turns off a VC more than seeing a pre-revenue, pre-funded company where the employees are making market salaries. You might think that you are setting a compensation floor prior to a VC financing, but more likely you are just sending a confusing message about the relative importance of short term cash compensation. Since you are funding the company yourself, it also isn’t very tax-efficient as you end up paying ordinary income tax on money you have invested in the business (which you presumably already paid taxes on once before.)

Often we see founders and early CEOs not take any cash compensation until the company achieves a funding event. Remember, your previous level of compensation at your last job is not really relevant when you are just starting out a company. Theoretically – in the pre-funding stage – you are providing “sweat equity” (anyone out there remember when that phrase was fashionable) – generally VCs respect the macho entrepreneur who says “current cash comp isn’t nearly as important to me as owning more of the company.” This usually goes a lot further than “but at my last job I was earning $200,000 a year.”

What about the first few employees? Many early team members can’t afford to not get paid anything – the reality of families and mortgages exist for many startup entrepreneurs and early employees. Our experience is that the pre-funding salaries usually settle into a discount of 25% to 50% from post funding salaries (so an engineer making $100k should be willing to work for a period of time for $50k to $75k in exchange for additional equity. Of course, this presumes that the company can afford to pay anything, which is only possible if the founders are providing startup capital or an angel round has been raised. If you are really pre-funding (e.g. pre-angel round), the salary number is often a lot lower (and often approximates $0.)

After an angel round, salaries often increase, but our experience is that the best entrepreneurs keep their comp as low as possible and allocate the incremental cash to adding a few additional people to the team. Everything above applies after the angel financing and before the venture round – especially the signal that you are sending to your future investors.

Compensation Packages in Venture-Backed Companies

You’ve been offered a job at a startup. The folding tables look romantic, the smell from the Chinese restaurant next door isn’t too annoying (yet), and there is a plunger in the one bathroom. The founders tell you that cash is tight but they are having lots of meetings with VCs and a financing is just around the corner. What should you expect regarding compensation?

Of all the questions that we’ve gotten, the most popular have been surrounding compensation. It runs the gamut from “how much do you pay X” or “how do VCs feel about deferred comp” or “what are standard compensation terms.” Given all of the interest in what cash and equity compensation is, we’ve decided to create a series of blog posts to address the issue. This series isn’t just for employees, but also founders. If you’ve been a regular reader of Brad’s blog, then you’ll know we’ve partnered before in discussing such topics such as Term Sheets, Letters of Intent and 409A.

As with all of our series, but probably even more so here, please take our opinions as just that – our opinions. There aren’t “right” or “wrong” answers here, every case is special, your mileage may vary, etc. There are many factors that go into determining compensation packages – it would be inappropriate to simply print this blog series, take to your next board meeting and demand a raise (especially if you work for a company we are an investor in.)

Over time we will publish individual posts on particular topics concerning compensation, including such scintillating missives as “compensation by job title” and “advice for paying outside board members and advisors.” If at any time you’d like to read or print the entire series as one post, check out the “Download Our Content” feature on the upper right of this frame.

We hope you enjoy this series and welcome your comments. If there are areas that you think deserve their very own series (say – like “Angel Investing” which we are currently working on) please suggest them to us.

- Jason and Brad

Why Don’t Companies Issue Non-Voting Stock To Employees / Investors?

Question: A founder who plans to take several rounds of dilution (Seed, Series A, etc.) and to have a decent sized employee option pool has to plan carefully if he/she also wants to retain control. But equity and control are not the same thing. They can be separated by issuing non-voting shares to employees and perhaps to early friends/family and even seed investors. This seems like a sensible option. It doesn’t divest control to those who are less likely interested in it, and makes it possible for the founder to be far more generous in allocating equity/upside. Why is this not more common? Did the Google founders do something along these lines?

Our Take: Few companies do this. To my knowledge, neither did Google. There are a number of reasons why companies don’t issue non-voting stock. First, despite the small amount of equity in each employee’s hands, it’s well accepted that employees like voting stock. Why, you ask if their vote isn’t material in the grand scheme of things? Probably because everyone else they know has voting stock and therefore they want the same. In short, it’s the regular practice and people like to have what others have. An employee offered non-voting stock is basically being told “we don’t trust you.”

Second, Investors are going to want to have a voice in company decisions and therefore are going to want to have voting stock. I don’t know anyone willing to write a check that doesn’t want some control over the company and this usually comes in different forms, from board rights to voting stock, to preferential stock rights, etc.

Third, if I was dealing with a founder who was really caught up in keeping control and only offering non-voting stock, I’d at least pause and wonder what was going on. The fact is few founders have greater than 50% of the equity at the time a company is sold or goes public and I’d want to explore exactly what that founder had in mind. It would strike me as a “red flag.”

Lastly, keep in mind that some founders don’t stay with a company indefinitely. Let’s take the case of a company with 3 founders who only issue non-voting stock to angel investors and employees. Let’s assume that the founders each own 20%, the angels 20% and a 20% employee pool is created. Each founder has 33% of the voting control since none of the angel stock or employee stock can vote. If two founders leave, the remaining founder, the angels and the employees are stakeholders in a company that they have no control over. If everyone had voting stock, there would be 60% of the capital stock in the hands of folks still with the company (assuming the option pool is granted). Worst case, there would be a 40% stalemate. What might seem like a good idea day one, can have some perverse effects later down the road.

How To Incentivize Employees in a LLC context?

Question:  How would you financially incentivize key employees during the startup stage of a company? We’re an LLC so it’s hard to give units (but possible). The alternative is similar to “phantom shares”, but it’s expensive to setup.

Our Take:  First, I realize that “incentivize” isn’t a word (At least MS Word says it isn’t), but I can’t find a better substitute, so hold your grammar hammer comments. Your question is a tough one. While LLCs provide some tangible tax and operation benefits to a young company, the issues of employee equity ownership usually pull entrepreneurs to change their company to a corporate structure. (As an aside, most VCs can’t invest in LLCs per their fund documents – FYI).

Creating a phantom plan is an expensive pain. The two best ways are either granting / selling / giving units or setting up a “liquidation preference” for employees. One great thing about a well-setup LLC that it can be a very flexible document and one can normally amend the unit allocation table simply by amending that page and getting signatures from current unit holders. In other words, one doesn’t have to completely amend the document. The bad news is that you can’t very well impose vesting, so you end up amending the page often. The other bad news is that you are giving direct ownership of the company away.

One other technique that we’ve used is to not issue units, but in the allocation section of the LLC agreement, specifically say “in the event of a sale of the company, the payout will be X.” “X” can be most anything that you want. Perhaps it’s 50% to the founder, 30% to other co-founders and 20% to Jack, Jill and Mary, the company’s employees. Note that this “liquidation preference” is completely independent of unit ownership. If you want to get really creative, you could have the employee part of the allocation pay to an employee plan and then the plan pay out to the employees, so you only need to amend the plan and never mess with the LLC or feel the need to disclose this document to employees.

Bottom line, it’s a bit trickier than running a standard C-corp. Consult your attorney on this one.