3 Reasons Equity Compensation is Experiencing Climate Change
Equity Compensation has been slowly going through its version of climate change. Much like our planet, the environment for equity compensation has changed for decades, and very few have adjusted or even noticed. Whether you agree with the causes of climate change, it is hard to deny that weather differs from even 50 years ago. Regardless of the driving forces, it is impossible not to recognize that equity compensation delivers different results than when it became the primary currency of tech startups in the 1980s and 1990s. The question at hand is if or how companies will address the issue.
Monolithic plan design is no longer effective.
When equity started, it was relatively easy. A company grants stock options, probably Incentive Stock Options (ISOs). They vested annually over four or five years, and only US employees received them. Big companies paid in cash and were not a challenge.
Over the past couple of decades, there have been changes to accounting rules, tax codes, dilution models, extended times to an exit, global workforces, and more. Through all these, most companies have continued using stock options, vesting schedules have changed slightly (most are now three or four years and vest multiple times a year). Companies use RSUs more frequently, but only when forced. Nearly every company, in just about any industry, uses equity. Things have changed, but I don't think we can argue they have kept up with the surrounding environment.
2. The long-term is increasingly short-term.
It wasn't uncommon to have grants with 25 year lives in the 1980s. The ISO rules restricted the tax benefits to a life of 10 years, and companies followed the path of least resistance for all grants. The original intent of vesting was to get the company and the participant to a potential exit event. Today it takes longer to reach and exit than in those heady early days. At the same time, executives and employees are increasingly less patient, and many consider three years to be a reasonable time to build value. In some cases, companies are exploring long-term awards designed to keep people for one year!
3. Funding rounds are more extensive, but equity percentages haven't changed.
IPOs are a funding round. Companies looked to an IPO as the primary funding round required to move them from a startup to a competitive business. They were the ultimate value creator and liquidity event.
Today the average pre-IPO company seems to be a "unicorn." Companies can be well-funded without tapping the public markets of IPOs, and IPOs can be an escape hatch, not a necessity. With so much money pre-IPO, very few companies have attempted to allow employee liquidity before an IPO.
I started this article with five reasons, which quickly morphed into eight and the makings of a whitepaper or e-book. Once we know the challenges we face, we can discuss why this is happening, enlist the aid of credible compensation consulting services. We can discuss why investors, boards, and founders have done so little to address the challenge. We can discuss long-term, lasting solutions and what they will take to become real. But, for now, we need first to recognize the changes around us and will not fix themselves.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources, including a resource dedicated to Performance-Based Equity Compensation. He has co-authored" Everything You Do In Compensation is Communication," "Equity Alternatives," and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.