A\u00a0compensation philosophy serves as the foundation for all compensation\u00a0decision-making including:<\/p>\n
- \n
- Objectives of the compensation program<\/li>\n
- Total pay mix (i.e., short-term vs. long-term;\u00a0performance vs. retention\/attraction)<\/li>\n
- Desired competitive market position (e.g., peer\u00a0group median)<\/li>\n
- Pay-for-performance approach<\/li>\n
- Use, type and amount of equity<\/li>\n
- Approach to benefits and perquisites<\/li>\n<\/ul>\n
Although\u00a0still not common among public company practices, the Board of Directors should\u00a0also discuss their preferred approach\u00a0to the design and amount of Board pay\u00a0through a philosophy statement.<\/p>\n
\n![\"2020](\"https:\/\/chiefexecutive.net\/wp-content\/uploads\/2019\/10\/2019-20-Comp-Report-280x220.gif\")
<\/a>Just Released: Chief Executive’s 2019-20 CEO & Senior Executive Compensation Report for Private Companies.<\/em><\/a> With data from over 1,600 private companies, i<\/strong>t is the most authoritative resource in the U.S. for private company executive pay. Know more, pay smarter. Learn more.<\/a><\/em><\/strong><\/h4>\n
\nDisclosing\u00a0executive compensation practices and decisions and managing to a compensation\u00a0philosophy is important since the\u00a0approach a company takes must be disclosed in\u00a0the Compensation Discussion & Analysis (CD&A) section of the public\u00a0company\u2019s proxy statement. \u00a0As a public company, the compensation\u00a0philosophy disclosure does not need to be detailed, but it\u00a0needs to accurately\u00a0reflect how the Compensation Committee manages executive pay.<\/p>\n
2.\u00a0Develop a Public Company Peer Group<\/strong><\/h3>\n
It\u00a0is not unusual for a private company to prepare competitive pay analyses on an\u00a0as-needed basis to address current issues and\u00a0understand market\u00a0practices. \u00a0These analyses are generally not prepared annually and may not\u00a0be based on public company\u00a0practices. \u00a0Most public companies, in contrast,\u00a0review the total pay levels of their senior leadership team annually with\u00a0direct\u00a0comparisons to public company practices driven by CD&A disclosure\u00a0needs and Say-on-Pay votes. \u00a0The approach to constructing\u00a0a public company\u00a0peer group is an important step in ensuring the Compensation Committee\u00a0understands public company\u00a0practices and should follow these generally accepted\u00a0practices:<\/p>\n
- \n
- Use revenues, market cap, assets, industrial\u00a0classification or other characteristics to select companies of similar\u00a0size.<\/li>\n
- Review business models to ensure peers have the same\u00a0or similar businesses. \u00a0(This is particularly important if a\u00a0company\u2019s long-term incentive plan\u00a0uses<\/li>\n<\/ul>\n
relative performance\u00a0metrics. \u00a0If the majority of peers do not have similar business\u00a0models then performance comparisons will be distorted.)<\/p>\n
Developing\u00a0a public company peer group was once thought of as a simple exercise but peer\u00a0group construction is one of the most\u00a0important steps in establishing an\u00a0executive compensation program. \u00a0Poorly constructed peer groups have been\u00a0blamed for\u00a0excessive compensation levels as they are often one of the\u00a0foundation stones that go into the construction and design of\u00a0executive pay\u00a0programs.<\/p>\n
Further,\u00a0with the increased use of relative performance measures, it is critical that\u00a0the business models and cycles of the peers\u00a0are aligned with the company.\u00a0\u00a0Without this alignment, performance comparisons and awards paid under incentive\u00a0plans may not\u00a0truly reflect a company\u2019s relative performance, resulting in\u00a0incentive awards to executives that are either too small or too\u00a0generous.\u00a0\u00a0For example, if the majority of peers have business models that are not as\u00a0profitable as the subject company, then\u00a0awards based on a relative comparison\u00a0of profitability will result in inflated incentive awards.<\/p>\n
3.\u00a0Understand Equity Usage<\/strong><\/h3>\n
Many\u00a0private companies that are managing to an exit event set aside 8% to 15% of\u00a0shares for management. \u00a0Most of these\u00a0shares are typically granted to the\u00a0management team in a single equity grant, while the remaining shares are set\u00a0aside for future\u00a0grants to existing and new hires. \u00a0In many cases, members\u00a0of the management team may not receive a subsequent equity grant\u00a0until the IPO.\u00a0\u00a0Assuming the cash compensation levels (salary plus bonus) are\u00a0competitive, Compensation Committees have been\u00a0comfortable that setting aside\u00a08% to 15% of equity for management will result in fully competitive total pay\u00a0levels, especially\u00a0given the expectations of high equity returns upon a\u00a0successful IPO exit.<\/p>\n
In\u00a0the past, it was not unusual for a private company to expect to have an exit\u00a0event in a three-to-four-year time frame. \u00a0In\u00a0today\u2019s economy,\u00a0particularly since the financial crisis of 2008, it is not unusual for a\u00a0private company to have an exit event in\u00a0eight or more years. \u00a0The amount\u00a0of time currently needed for an IPO event results in private companies using\u00a0substantially less\u00a0equity than a public company over a similar time period.<\/p>\n
The\u00a0following table illustrates this concept. \u00a0Assume a private company issues\u00a012% of outstanding shares to management.\u00a0\u00a0Contrast this to the amount of\u00a0shares that could be granted to management of public companies. \u00a0For\u00a0purposes of this\u00a0illustration, we show the mean and maximum amount of shares\u00a0that could be granted to employees and Directors of public\u00a0companies based on\u00a0current Institutional Shareholder Services (ISS) guidelines. \u00a0We also\u00a0selected three industries for this\u00a0comparison. \u00a0These industries run the\u00a0spectrum of low, medium and high users of equity.<\/p>\n
We are showing a pre-IPO company that uses 12% of outstanding shares under all\u00a0scenarios. \u00a0The chart shows that over a four\u00a0year period, the private\u00a0company equity practices are reasonably competitive with public company\u00a0practices but over an eight\u00a0year period, private company equity practices\u00a0become uncompetitive even when compared to industries that are traditionally\u00a0modest users of equity. \u00a0Under the latter result, a private company may\u00a0experience attraction and retention issues as other\u00a0opportunities may become\u00a0more attractive.<\/p>\n
4.\u00a0Assess Executive Compensation Competitiveness & Design<\/strong><\/h3>\n
The\u00a0type of equity granted at private companies differs from public company\u00a0practices as well. \u00a0Private companies rely heavily on\u00a0time-vested\u00a0restricted stock and stock options and, in many cases, performance-vested\u00a0options. \u00a0This type of program is much\u00a0different from public company\u00a0practices where the vast majority of equity programs include two to three\u00a0equity vehicles and\u00a0where performance-vested stock options are highly\u00a0uncommon.<\/p>\n
The\u00a0design of the long-term incentive (LTI) plan is one element of the executive\u00a0compensation program that will need immediate\u00a0study for a few reasons:<\/p>\n
- \n
- A program that is heavily weighted with time-vested\u00a0restricted stock or a program that only has time-vested restricted stock\u00a0and stock options will be\u00a0criticized by proxy advisory firms. \u00a0These\u00a0designs are not considered performance-based equity programs under some\u00a0proxy advisory policies.<\/li>\n
- Performance-vested stock options are very rare since\u00a0two hurdles need to be met before they gain any value: the stock price\u00a0must rise and the\u00a0performance condition must be met. \u00a0Management\u00a0teams universally deride these programs as being unmotivational since the\u00a0likelihood of realizing value\u00a0under this design can be substantially more\u00a0difficult than more typical programs. \u00a0Also, most Compensation\u00a0Committees agree that other equity designs\u00a0can be far more effective with\u00a0motivating and rewarding executives for creating value.<\/li>\n<\/ul>\n
There\u00a0is abundant market data on long-term incentive plan prevalence and practices,\u00a0best practice perspectives and summaries\u00a0of proxy advisory policies on\u00a0long-term incentive designs. \u00a0The Committee and management team have\u00a0access to the information\u00a0needed to design a long-term incentive plan that will\u00a0align with public company practices, be motivational and support\u00a0shareholder\u00a0growth objectives.<\/p>\n
5.\u00a0Investigate Board Pay<\/strong><\/h3>\n
The\u00a0Board of Director pay practices of a privately-held company differ\u00a0substantially from public company practices in several\u00a0ways. \u00a0In general,\u00a0venture-backed private company Boards typically include individuals who are\u00a0employees of the major investors\u00a0and they may or may not be paid as a Board\u00a0member. \u00a0The Board may also include executives with substantial operating\u00a0experience, financial expertise or other high-level management skills needed at\u00a0the Board level. \u00a0These are always paid\u00a0positions.<\/p>\n
For\u00a0private companies, the Board pay mix will be heavily weighted with equity while\u00a0cash compensation will be modest when\u00a0compared to public company\u00a0practices. \u00a0The chart below illustrates the differences. \u00a0This chart\u00a0compares median Board pay at\u00a0private companies with $25M to $50M in revenue to\u00a0public companies with revenues ranging between $50M to $500M. \u00a0The\u00a0public\u00a0company data includes larger companies to illustrate how Board pay will need to\u00a0change over time once a company\u00a0becomes public and grows.<\/p>\n
This\u00a0data shows how varied Board pay practices can be in private companies vs.\u00a0public companies. \u00a0At private companies, cash\u00a0compensation may be less\u00a0than half of public company practices. \u00a0However, the value of equity may\u00a0be many times more\u00a0valuable. \u00a0In addition, private companies typically do\u00a0not grant equity each year which is a common practice at public companies.<\/p>\n
Board\u00a0pay is a topic that should be reviewed before a company goes public, especially\u00a0as Board members, who represent the\u00a0major institutional investors, rotate off\u00a0the Board. \u00a0The company will need to maintain a Board pay program that is\u00a0attractive to\u00a0new Directors and it will need to be fully competitive as\u00a0companies vie for talent in this arena.<\/p>\n
6.\u00a0Study Proxy Advisory, Compliance & Disclosure<\/strong><\/h3>\n
Private\u00a0company Compensation Committees have much less concern than do public companies\u00a0about proxy advisory firm policies\u00a0on compensation. \u00a0Additionally, public\u00a0company pay practices may simply not be important to private company\u00a0Compensation\u00a0Committees. \u00a0Therefore, it is likely a private company will\u00a0have pay practices that are not common in public company practices\u00a0and\/or may\u00a0not be aligned with proxy advisory policies. \u00a0Because of the influence of\u00a0advisory firms, it is always important to audit\u00a0a private company\u2019s executive\u00a0compensation program to understand how it differs from public company practices\u00a0and to\u00a0understand if any changes need to be made over time. \u00a0For example:<\/p>\n
- \n
- Private companies favor the use of stock options and\u00a0restricted stock while public companies are more likely to include\u00a0performance-vested equity in their\u00a0long-term incentive programs especially\u00a0given proxy advisory policies covering equity practices. \u00a0Proxy\u00a0advisory firms want to see a significant part of the\u00a0long-term incentive\u00a0grant made with performance-vested vehicles and often do not consider\u00a0either restricted stock or stock options to be performance-based.\u00a0\u00a0Understanding if the design needs to be modified and the future timing of\u00a0any change is important as the exit event takes shape.<\/li>\n
- Many public companies have Section 162m umbrella\u00a0plans that allow them to minimize or eliminate the lost tax deduction for\u00a0non-performance based pay.\u00a0\u00a0This law does not apply to private\u00a0companies and it is another aspect of executive compensation that should\u00a0be understood and addressed in the plan\u00a0design.<\/li>\n
- Public companies need to prepare an annual CD&A as a part of the proxy statement. The CD&A needs to discuss, among many items, how pay decisions were made including disclosing in some detail incentive plan goals and performance against goals. \u00a0If discretion is used in assessing performance, the CD&A needs to state the discretionary factors taken into account in determining award levels. \u00a0Private companies have no similar disclosure obligation and can liberally use internal judgment on pay decisions without having to outline goals, performance attainment against goals and how discretion was used.<\/li>\n<\/ul>\n
In\u00a0Summary<\/strong><\/h3>\n
Many\u00a0aspects of executive and Board compensation differ when contrasting public and\u00a0private company practices. \u00a0As private\u00a0companies near an IPO, they should consider\u00a0conducting an audit of all elements of their pay practices to understand what\u00a0has to\u00a0change, what may need to change, and over what period of time. \u00a0It\u00a0is important for Compensation Committees to understand\u00a0that pay programs can\u00a0evolve over a two- to three-year period post-IPO, which gives the Committee\u00a0enough time, with careful\u00a0planning, to seamlessly evolve the program from\u00a0private company practices to the best practices of public companies.<\/p>\n
<\/p>\n","protected":false},"excerpt":{"rendered":"
Venture-backed private companies maintain executive compensation programs that are significantly different than public company programs. \u00a0This does not mean a venture-backed private company that is planning an initial public offering needs to immediately make drastic changes to its programs to conform to public company practices, proxy advisory concerns and regulatory issues.\u00a0\u00a0However, Compensation Committees of these […]<\/p>\n","protected":false},"author":3905,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_oasis_is_in_workflow":0,"_oasis_original":0,"_relevanssi_hide_post":"","_relevanssi_hide_content":"","_relevanssi_pin_for_all":"","_relevanssi_pin_keywords":"","_relevanssi_unpin_keywords":"","_relevanssi_related_keywords":"","_relevanssi_related_include_ids":"","_relevanssi_related_exclude_ids":"","_relevanssi_related_no_append":"","_relevanssi_related_not_related":"","_relevanssi_related_posts":"","_relevanssi_noindex_reason":"","footnotes":"","_links_to":"","_links_to_target":""},"categories":[867,2199,2130],"tags":[],"class_list":["post-71898","post","type-post","status-publish","format-standard","hentry","category-ceo-compensation-boards","category-compensation","category-talentmanagement"],"acf":[],"yoast_head":"\n
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