Your Complete Guide to CEO Compensation: How Much Equity Does a CEO Get?
In designing executive compensation plans, it is critical to incentivize executives to achieve business objectives. A variety of well-established methods are available to organizations to reward executive performance, like an equity compensation plan, with the executive and the company often benefiting from a significant tax advantage.
Pay practices and philosophies should be closely tied to the organization's goals to ensure an effective executive compensation program. There are a lot of opportunities and innovations available in the start-up market. Most start-ups fail, but those that succeed are worth it.
Cash flow problems are one of the reasons most start-ups fail. As a start-up is always cash-strapped from the beginning, how well it manages its finances has a significant impact on its success. This situation emphasizes the importance of equity compensation.
Basics of Equity Compensation
Business owners use equity compensation to improve their cash flow. The difference is that employees receive a portion of the company's stock rather than a salary. As part of the equity compensation package, employees do not earn any income first.
Entry-level employees are not suitable for start-ups. At the low point of their financial stability, companies need to hire the best talent in their field, but professionals in these positions already earn high salaries.
For a new company to find the right executive, it has to compete with companies that have been around longer and can offer better salaries, benefits, and compensation packages.
Strategic board members, consultants, and business advisors are often offered equity. Awards, non-qualified stock options (NSOs), incentive stock options ( ISOs ) that helps in retention, restricted stock units (RSUs), and performance shares are the most common forms of equity granted to employees.
Risks exist for an employee, however. Unlike salaries, employees never know if equity awards will fully pay off, so they know what they'll get and when.
Is equity Paid Out in What Way?
Equity is paid out differently by each company. These are through vested equity and granted stock. The payments for vested equity are spread out over a set amount of time. Upon entering into a contract, the granted stock will be provided.
Employees assume the risk of accepting equity as an alternative to, or in addition to, salary, regardless of the equity offer.
You must understand how the deal is structured and what kind of equity is proposed. There are times when employees find out the company doesn't offer equity but rather options to buy it through an employee stock purchase plan (ESPP).
Also, sometimes these options are in a completely different class of equity than the founders.
How to Determine Executive Equity Compensation?
Providing value to the organization is the idea behind the CEO's performance. Through compensation contracts, executives' actions are aligned with company success. Most companies emphasize pay for performance in an explanation of their compensation programs.
When looking at a company's compensation program, make sure that executives have a stake in making money for investors. Paying for performance is widely accepted, but CEOs assume risk. As a company's market value fluctuates, a CEO's wealth should also fluctuate.
A company's funding and financial instruments will determine how much it needs. If a company is completely owned by its founders and has never taken outside financing, it is likely to be 100% owned by that founder. Conversely, a company's founder who has raised several investments may only hold a small ownership of company stock.
As a result of equity dilution, shares should be more valuable than before because the amount of equity given should increase. If the executives want 50% of the shares, the original shareholders should own half of the value of the company. This means that the value of the company should be at least doubled.
By giving 50% equity, the founders would take on all the financial and failure risks and provide the CEO with the entire potential growth. Consequently, it is reasonable to value the risk at least half as much as the growth that the executive contributed to. So 25%, a potential doubling of the company's value, would be the initial point of negotiation.
Let FutureSense Help You Plan for Equity Compensation
Equity compensation is quite complex. Due to its legal implications, managing equity manually in more complex situations becomes more difficult and risky. Initial management might be simple for start-ups. Your business can benefit from our expertise and knowledge in developing a solution.
If you are interested in discussing our equity compensation assistance, contact us at info@futuresense.com today!
About FutureSense
FutureSense is a management consulting firm that provides integrated solutions to build and sustain human capital capacity. The firm can work with you by offering support and guidance to manage your workforce. To learn more about FutureSense, please visit FutureSense.com.