What are average compensation packages for executive positions in start-ups?
This article comes from Peter Kennedy of WTR Consulting Group
First of all, there is no traditional average for the amount of stock given to a new
executive in a very small Internet start-up. If you knew what was given to every new
executive in every new start-up, you would have every imaginable amount from 50% or more
to a small fraction of the company equity. The key question to answer is: how much are you
willing to give up, and in fact risk, now, and how much might you give up later? Your
answer depends on a lot of factors, including the following:
- What are the chances of future success (with and without a key player)?
- How many other key executives may I need to recruit later?
- How widely do I want to share ownership and under what circumstances? (The faster you
grow, the less you need to retain as a percentage of the total equity).
- How much risk is the new executive willing to take on? (The more risk, the greater
should be the potential reward).
- When do you plan to go public and under what circumstances?
Secondly, there are some good general rules of thumb to follow in structuring an
executive compensation plan. The best thing to keep in mind up front is that the interests
of the owner and the interests of the hired executive tend to diverge on a number of
fronts, including the following:
- The amount of risk assumed,
- The time horizon for a return on investment, and
- The ability to re-deploy assets.
The owner/entrepreneur is usually willing to take a great deal of risk while the
executive/manager is generally much more risk averse. The owner is going for all or
nothing, while the executive is less willing to make a wild bet.
The owner usually has a fairly long time horizon and is willing to be patient about
eventual success. The executive is generally working with an annual time horizon is much
more impatient for success. Compensation can not wait for several years, since the
executive is investing human capital, and has entered into a contract to exchange services
The owner may ultimately exit out of an investment and re-deploy assets in another
venture. The executive's investment of human capital is more difficult to re-deploy. The
executive is trying to build a career, and must seek another opportunity that seeks the
kind of experience and qualifications gained from the last venture. This can take time.
With that in mind, an executive compensation plan that is able to cause the interests
of the owner and the executive to converge is generally more successful than one that
tends to reinforce these different interests. In general, that means some meaningful
ownership interest, contingent on performance, ought to be a part of the executive's
compensation package. How much? In general, some now, and perhaps more later, all tied to
One way to approach this is to have a better understanding of the marketplace for the
executive's qualifications and experience. What are other's willing to pay for the skill
set, the reputation, the experience, the track record, the education, etc? Put another
way, where would your ideally qualified executive most likely be working? And where would
this executive go after working for you?
Starting with an amount of money that represents the estimated present value of total
direct and indirect compensation over a fixed period of time (say five years), the
question becomes how to allocate that compensation in two ways:
1. Over time
2. Over different elements of compensation
Thinking about a 5-year time horizon initially, does it make the most sense to allocate
the compensation as equal amounts over the time period, as declining amounts, or as
increasing amounts? I would suggest the latter.
As to different elements of compensation (described further below), the basic question
is how much to allocate to fixed compensation, and how much to allocate to variable
compensation. Base salary and most benefits are fixed compensation, annual and longer term
incentives, including stock options, are variable compensation. Again, the answer for
start ups should be obvious: put as much as possible into variable compensation initially.
The following examples should illustrate the ideal principle, which can only serve as a
starting point for negotiation, but which at least gives the owner a philosophical and
financial basis for an opening offer.
The numbers are not necessarily representative, although they shouldn't be too far off
for a small start up. Please note the following in the example:
- Base salary only goes up about 2% a year.
- Bonus represents 30% of base salary in year 1, rising to 70% in year 5
- Stock represents 20% of base salary in year 1, rising to 100% in year 5
- Variable pay amounts assume outstanding year to year performance; high growth and high
- Benefits and perquisite costs remain relatively flat over time
- Variable pay represents an increasing share of total compensation over time.
- Total compensation increases substantially over time.
As background for this example, a definition of the different elements of executive
The typical executive compensation program is structured to include the following
- Base salary,
- Short term (annual) incentive payments,
- Long term (2-5 years) incentive payments,
- Stock options (10 year option term),
- Supplemental benefit plans, and
Base salary is the amount that an executive receives generally irrespective of the
performance of the company at any particular point in time. In most cases, executive base
salaries are more closely related to the size and scope of a company's operations, to type
of company ownership, and to industry, than to considerations having to do with recent
company or individual performance. Base salary is generally increased from year to year at
a relatively steady pace that corresponds closely to average increases for all employees
for that year (typically 4%-7%). This excludes promotional increases, competitive
adjustments, or incentive payments. There is some relationship with general inflationary
trends, although only over longer periods of time.
Annual incentive payments are typically based on tactical objectives measured on a year
to year basis. The objectives can relate to company or individual performance. As a
company moves into a more competitive environment, the variability of annual incentive
payment amounts is likely to increase.
The characteristics described for short term incentives would also generally apply to
long term incentives, except long term incentives are often based on goals identified as
"strategic." Ostensibly, the intention is to focus the executive's attention on
long term planning and results. Because long term incentive payments incorporate longer
periods of performance measurement, their variability is likely to be greater than short
Stock options are granted to executives from time to time as a reward for performance
or as a means of aligning executive and shareholder interests. Where company cash flow and
capital resources are limited, typically in an early stage of growth, stock options are
often used as a substitute for higher cash compensation. The amount of options provided is
rarely based on the meeting of specific performance objectives, although this practice is
increasing. The value of the options relates only to the growth in the value of company
stock and not to any specific performance by the executive. The value of stock options is
not currently accounted for on the income statement, representing only a dilution of
shareholder equity, instead of a direct expense that reduces net income for accounting
purposes. However, FASB Statement 123, "Accounting for Stock-Based
Compensation," which was adopted in October of 1995, encourages companies to adopt a
new method of accounting which would reflect the estimated fair value based on a selected
option pricing model and would have the effect of reducing net income and earnings per
share, either directly in the financial statements where the approach is adopted, or in
the very least, in pro forma disclosures in the footnotes to financial statements, where
companies continue to rely on APB Opinion 25 for stock option accounting.
Supplemental benefits are those benefits provided to executives that are in addition to
the benefits provided for rank and file employees of the company. These are typically
provided in the retirement area to make up for limitations imposed by the Internal Revenue
Service on highly compensated employees on the benefits that are otherwise available to
all employees under the general retirement plan benefit formula.
Perquisites have traditionally been available to executives to assist them with the
performance of their job duties and to convey the rank and status of their office,
particularly with respect to the outside contacts the executive must cultivate. In recent
years, where perquisites do not have a strong business rationale, they have often been
[Peter Kennedy, WTR Consulting, firstname.lastname@example.org]
Q2 What are good resources for determining compensation for both technical and
executive positions? [Ariel Glassman, email@example.com]
In general compensation strategies get very complicated very quickly, so be prepared
for some real head scratching. There are no easy answers. Another thing to keep in mind is
the impact on your personal exit strategy: if you plan on selling the company, you don't
want to have given most of it away early on. [Hans Tallis,
Hans_Tallis@ers.com]. Depending on the type of salary information you are looking
for, check out the following resources:
General Salary Information:
- The Bureau of Labor Statistics, http://stats.bls.gov/
has lots of information on salary statistics. You can find the average/high/low for System
Analysts in a particular region. Do a search on the position name and the city/state you
want. Information is in PDF and ASCII. [Miles Fawcett, firstname.lastname@example.org]
- The Software Publishers Association (based in DC) publishes annual salary surveys that
include technical and managerial positions. [Neil Harris, email@example.com]
- Some statistics from a 1997 executive compensation survey (for California): http://www.hronline.org/research/hiex.HTM
- Order form for 1997 National Executive Compensation Study, http://maea.org/survey.htm
- For a services business with approx. $1 million in revenues, you can expect to pay a CTO
about $120-150K salary, plus options on 2-5% of the company, plus an eventual bonus of
20-40% of salary. A COO would cost approximately $140-180K, plus options of 5-10% of the
company, or more, plus a bonus of 20-50%. [A VC investor]
- Don't commit too much of an ownership interest up front, before you really know how well
a newcomer would do. Leverage your offer of a somewhat lower base salary with a high
target bonus tied to the results you are expecting, so that the individual can earn
significantly more in cash compensation if performance expectations are met. Allow for a
range of possible bonus payments tied to a range of possible growth and net income
results. [A compensation consultant]
- Stick with 3% equity if that's what you're comfortable with, and offer a warrant or
other options to purchase more shares at a good price based on the person's meeting
performance goals. Have that person then take 24-48 hours to define the goals he/she will
meet. Put a deadline on getting a response to you. Make sure he/she provides summary
estimates for what it will cost in time and money (aside from salary) to meet the goals.
Take at least 24 hours after you get the response to reshape it to your liking. If his/her
goals are too far off the mark, go back and redefine the goals. Then, meet in person to
make the final offer. Frame it in terms of goals, not money. Stick to the 3% plus options
format. Finally, have one more person on your side of the table than your
"target" does when you make the offer, and if possible, have one of your
investors as the extra person on your side. The rest is easy. Hire if the person says
"yes", or walk if the person says "no" or nothing, and don't look
back. [Cliff Brody, Kidz Own America]
- The following attorneys may be able to make some suggestions:
- A book called "Graphic Artists Guild Handbook: Pricing and Ethical Guidelines"
(ISBN:0-932102-08-5) is an excellent resource for design staff and general cost
guidelines. There latest edition covers web development professionals. [Miles Fawcett,
- The Hay Group http://www.haygroup.com/ (in
Philadelphia) is a world leader in compensation consulting. They have a pretty good book
out, "People, Performance & Pay" (Free Press). It emphasizes that for a
compensation scheme to achieve effects you need to regularly advertise, monitor and
encourage it. They also run seminars and do consulting.
- Type "compensation consult" into your favorite web search tool to find other
Q3 What kind of exit strategy compensation do I need to consider? [Pam
Don't worry about someone's exit strategy. I heard a very interesting story the other
day: a very hot new company had found the perfect CFO, and struck the perfect deal,
including a package laden with options. However, at the final negotiation the prospect
asked for a severance package. "We don't do those," the company said. That was
it. Keep in mind, unlike some area companies, this one had set the reward return high to
compensate for the risk involved. [Esther Smith, firstname.lastname@example.org]