I am often asked – what starting salary, what bonus, what equity amount should I seek in my CEO or C-level executive compensation package? There are companies that do executive compensation surveys and recruiters often have access to those statistics. But what if you are in a custom situation or you have special attributes that make irrelevant the normal metrics a Gartner or Mercer survey may suggest for your compensation package?
In these circumstances, I have developed my own approach to modeling executive compensation that may address your needs in just such a custom situation.
In this article, I first describe three special circumstances that may justify a custom executive compensation package. Then, I move on to discuss what you, as an executive, are giving up and would need to see compensated if you are to move to one of these new opportunities. Then, I share my techniques and strategy to develop a custom compensation package. I discuss the key equity components of the package and the approach to determining the right amount of equity to seek. Finally, my article suggests three separate strategies to get corporate buy-in, that is, “selling” the custom package to the company to provide the needed explanations for how the unconventional package suggested can work to meet the legitimate needs of the company as well as the executive.
Circumstances that Justify a Custom Executive Compensation Package
There are three major circumstances that call for a custom CEO or C-level executive compensation package.
- Start-up and early stage company CEOs – often if these companies are undercapitalized, they cannot support the proper CEO or C-level executive compensation, so a custom package may well be appropriate to complete the recruitment for the benefit of both parties.
- Turnaround CEO situation – if a company has performed poorly, has been in a downward spiral and might even be on such shaky ground its very survival is unclear, and in any case very much needs the right CEO or C-level executive to right the ship, then the risks the CEO or C-level executive takes in assuming such a position merit a custom package.
- Special needs executive recruitment – if a CEO or C-level executive has special attributes that fill a critical need for the company, especially if executives with those special attributes are in short supply, that too would justify a custom package. Such special attributes can certainly vary. It could be special skills, experience, reputation, contacts – whatever the key attributes the company needs at that time and has had difficulty securing elsewhere.
Designing a Custom Executive Compensation Package
In designing the package, the first thing I look for is what you, as an executive, need to make this move.
And the suitor, the company that wants to hire you must not only make up for your loss of pay and benefits to leave but also make up for three more things.
- Loss of comfort. Presumably, you are doing well in your career. You are well established and already a rising star with your current employer. Going to a new company, you will need to prove yourself again. You will also be leaving your current stakeholders and champions behind. You cannot be sure that the office suite you move to will be as hospitable.
- Loss of platform. As for your platform, your prominence in your field is known where you are. The phone is ringing. Recruiters are seeking you out. It could be that if you make this move, you will be going to a less visible platform where your skills are not so well showcased in your field or industry.
- Loss of opportunities. This may be a very good opportunity, but who’s to say what other new opportunities might be offered to you over the next two or three years. If you commit to this offer, you will be off the market for new opportunities for at least this period. So this must not only be a great opportunity but it should be one where you are so valued by the company that a reasonable custom offer is made to you.
What Should Be in Your Executive Compensation Package?
Certainly, you want your executive package to at least match your current package in salary and benefits. To the extent benefits cannot be matched, there are a number of companies that provide services to match your benefits to those offered at your prior firm. And to the extent salary is not matched, the contract can provide for “springing” salary that more than makes up for what you’ve given up as success is achieved.
The main area of the custom executive compensation package would be your equity position.
If the company is an early stage company or turnaround situation, it may well be less than $50 million in gross assets. If that is the case, you would want the company to be structured as a C corporation and be issued Qualified Small Business Stock (QSBS). My recent CEOWorld article on QSBS discusses how, with the issuance of this stock, the first $10 million of capital gain can be excluded so that there is no Federal taxation and all further gain above that would be at lower capital gains rates.
Where the stock has significant value, the issuance of QSBS can still be achieved by the purchase of shares using a promissory note meeting the conditions set by Treasury regulations and rulings.
Where the company is an LLC and that cannot be changed, then you would seek incentive units, where the threshold is clearly stated and reflective of the current low value of the enterprise. As with QSBS, you would make the Section 83(b) election. Though you would not get the $10 million or 10X tax exclusion of QSBS, you would get capital gains treatment on sale of your units.
Where the company is a family business or other business that won’t issue actual equity, then you would want a customized package centered on phantom stock. My earlier CEO World article discusses the phantom stock package you should seek.
With each of these approaches, you would want a tie between the package and terms of employment, so there is requisite vesting if you are terminated without cause or quit for good reason, or further acceleration on change of control of the company. You also want needed protections against dilution and for liquidity in case the owners choose to keep the company a private “life-style” company.
How Much Equity Compensation Should You Ask For?
The last section spoke about your equity piece, the critical piece of your custom executive compensation package, in terms of what you want in your package – the character of your equity, but not the quantity.
In terms of quantity, if the company is not public, which is generally the case with startup and emerging companies and many turnarounds as well, then it is most helpful for you to approach the issue of quantity in terms of your percentage of the fully diluted equity of the company. Often companies will try to get you focused on number of shares – but it is best to start with percentage and then have the company represent to you that the shares are equal to the agreed upon percentage.
So what quantity should you ask for? What percentage?
Here the company may try to pigeonhole you into a Gartner or Mercer survey. The recruiter might say “CEOs in our industry get 4% for early stage companies.”
But here, we are in the world of custom executive compensation. So the survey does not control. Instead the decision on quantity – your percentage interest should be guided by two different factors.
First, what will it take to get you to make a move? In a recent representation, my executive client was receiving on average $2 million per year in equity awards in a rising and comfortable situation in his established life science company. So, my position was that if he was going to make a move to commit perhaps 4 years to another life science startup company, he needed to get equity awards, where he had a realistic chance of making $20 million, since in 4 years he’d have $8 million with his current company. So, we held out for that level of equity and arranged for the QSBS structure with an 83(b) election so that if he succeeded, $10 million of his gain would be excluded from taxation.
Second, what is your presence worth to the company? In another recent representation, the company had made a very successful launch, one even recognized by national business magazines. The key thing needed was “scale up.” My client was well known to the company founders and had a strong record of leading other tech companies in successful scale-ups. This knowledge and experience as well as my client executive’s credibility in the field were of critical value to the company. It was those factors that enabled us to hold out for the size of equity stake that was sufficient to get him to leave his already comfortable, stable and quite lucrative position.
Getting Buy-in: “Selling” Your Custom Compensation Package to the Company
To sell the company that the executive should get 6% or 8% or even 10% when the Gartner metric says 3% or that the executive should get options rather than QSBS, I try to pound away on three things. (References to “you” are to the company with whom we are negotiating.)
- You want an “A” team player. My client is the best or one of the best in his or her field. The cost to you, the company, of not securing an “A” player could make the difference between success and failure and could have a further multiplying effect on your ability to attract other “A” players, your ability to attract capital investment, and your ability to enlist other stakeholders.
- You want alignment. Give my executive what he or she seeks and he or she has a compelling equity interest in the company that fully aligns him or her with the company’s growth goals and will assure his or her long term commitment.
- Success for my executive means even greater success for you. Even where my executive retains a 6% equity position through to the IPO, that means the other stockholders hold a 94% position. If my client executive achieves his or her goal to achieve a $20 million gain on the stock that justifies committing 4 years to this venture, the other stockholders would make a $313 million gain on their stock position. And my client’s superb leadership as CEO or Chief Scaleup Officer had almost a 50% share in the success achieved, paying him or her 6% and letting him or her realize $20 million was a damn good price to pay for the other shareholders whose passive investment netted $313 million.
Those would be my three key closing arguments to try to move the company into providing this kind of custom compensation package to recruit a highly prized CEO or C-level executive. Your executive compensation attorney should deploy similar arguments to try to achieve those results as I have done for my clients in the past. Clearly in these matters, it is important for you to have in your corner an executive employment attorney, skilled in tax law as well as corporate, securities and contract law to achieve the desired results.