Equity Compensation, Unprecedented Times Require Unprecedented Actions, Step 4

Building a Foundation of Trust and Understanding

Step 4: Can You Reallocate Executive Compensation?

You won’t be the first company to do it. One of the most common questions from CEOs when it comes to compensation is, “What are our peers doing?” When faced with a genuinely unforeseen event, many do not want to hear the answer to this question.

A historically strong bull market has buoyed many executive pay packages for more than a decade. The same compensation plans that have built their wealth may provide part of the answer to getting through turbulent times. Now might be a good time for executives to "donate" some of their equity, or its value, to a broader group of employees. Many executives have already started the process of reducing their pay. 

For most companies, compensation is the single largest expense. This means that in difficult times the easiest way to reduce costs is to reduce staff. The math is not intuitive, but it’s actually simple. 300 Engineers with an average total cash compensation of $150,000 (they are cheap engineers) equals $45 Million. For a company with 1,000 employees, this is likely a reasonable multiple of the cash compensation for the entire C-Suite. Laying off even half of these engineers can save close to $2 Million every month.

So, no reallocation or reduction of executive pay is going to make the company whole. If you are in an industry that has been critically impacted by a market downturn, there are very few ways to avoid any type of staff reduction. Even a few hundred people making $30,000-$40,000 a year will cost a company about $1 Million each month. If your business is shut down or otherwise unable to produce revenue, these costs savings may ensure your survival until things turn positive.

But even the most dramatically impacted companies cannot shut down entirely. Systems need maintenance. Customers need support. Essential functions and bills need to continue. The people doing these jobs may be working harder and have a greater responsibility than ever before. This does not even consider the individuals who may be facing actual risk to their health or existence. For the people left to “keep the lights on,” there are some interesting and tested examples of incentive plans.

The Start-up Model

Start-ups are legendary for running lean and keeping costs low. They often have no profits, and may not even have any revenue. Their approach is to focus things on the long-term. The majority of these companies have no annual cash incentive plan. Most set Base Pay at market rates and augment that with strong equity compensation programs. The goal is a multi-year event horizon triggered by a Change in Control or Initial Public Offering. Shareholders begrudgingly accept dilution in return for future returns. This model is very effective when stock prices have fallen precipitously. 

A key component of this approach being successful is working with your investors to make sure they are along for the ride. Another critical element may be evaluating the size of your management team to see if a leaner team may be what you need. This may create some headroom to offer additional equity to the critical staff you need to keep. The focus here is on long-term recovery with outsized potential payouts for success.

The Bankruptcy Model

This model concentrates on keeping a small group of the best people possible and focusing on a relatively short-term event horizon. These incentive programs are seldom designed to last for even a year. Since the stock has little or no growth potential, it is a poor pay element in these programs. Instead, cash is the tool of choice, and values are driven by the ability to execute to a plan and often the ability to support the purchase of pieces or the entirety of the company. 

A key component of this program is having the ability to set aside or plan for the cash you will need to pay the incentives when goals are met. For companies facing 3-6 months of incredibly difficult times and expecting to bounce back strongly after some reorganization and recovery, this can be an effective incentive. The total values will be less than a longer-term equity model, but the cash obligation will be more significant in the short-term.

In both the models above, executives may be able to “lend a hand” by forgoing some of their cash compensation or voluntarily forfeiting some of their equity compensation. Often the equity forfeiture isn’t much of an ask since the awards may be underwater. The cash component is often more difficult. Note, many CEOs have already done this without any prompting. Neither approach may be realistic or helpful for your company, but in unusual times it is best to explore every possible solution.

For bespoke strategic planning seminars that are made only for your business and even help with better compensation consulting approaches, contact FutureSense at info@futuresense.com.