Compensation Committee
The Board will often want to form a committee to oversee the key decisions related to team compensation. This would include establishing a fair structure for salaries (often by level of role), formulas for variable compensation for sales and other related roles, company-wide incentive plans and of course, stock options in their various forms. The challenge for the CEO is to prepare thoughtful recommendations in all these areas or the compensation committee will appear to be taking out of the hands of the management team a key instrument to recruit and build a strong and loyal team.
Differences in compensation strategies often divides a team. Everyone wants to maximize what they take to the bank but everyone should also realize the need to be gentle on the bank balance, especially in the early stages of a Company. Stock options often play a key role acting as an offset against hard cash earned, but over time even the use of Company shares becomes difficult for the Company stakeholders.
Setting the Standard as CEO
The CEO should set the standard for compensation strategies early on. The CEO should have a personal belief system that defines the style of compensation every team member should enjoy. The CEO should consider what goals to head for in terms of long term Company value so as to be able to position the use of stock options properly in the overall compensation equation.
Some key points to consider:
- If the CEO does not take a leadership stance on compensation structure, someone else on the team will -- typically a Board member and usually one focused on saving the Company money. This can make it harder to attract 'A' caliber resources if compensation becomes teeth pulling.
- Most employees will not understand how to appreciate the receipt of stock options. This should not stop you from using them as an overall compensation element. If a success occurs for the business, you want to be able to say everyone was treated fairly and equitably based on their contribution, role and time with the Company. Make a decision about how stock options are to be used (if at all) and stick to it. You may want to review the policy each year, but avoid creating inequities as they generally become known and problematic over time. A common policy is to grant all employees some form of stock options and then reduce the number of employees eligible in subsequent years using role and/or level as one key qualifier.
Given stock options should be treated as finite, you want to avoid 'running out' so the need to dilute existing shareholders is avoided.
- Variable compensation -- especially for sales roles, tends to relate to financial success. If financial goals are met, people earn their variable compensation, if financial goals are not met, they should not earn variable pay. This aspect of compensation can become black-and-white as the Company grows but is certainly shades of gray when just starting out (see below for more on this). If a team member achieves a financial target, you should be happy to pay them even if the total pay received seems large -- it should be a win for the Company to have someone achieve a financial target. If it is not, you should review how targets are set and make sure you know more about your business the next time (it's a shame on you moment, not the employee receiving the pay)..
The CEO should prepare a compensation table that outlines the overall structure for each major role and level in the Company (e.g. job title/level, base salary range, variable salary range, stock options, bonus, etc). The table should contain enough entries to cover the hiring plan for the next 24 months (sometimes you hire out of order from the plan as quality candidates emerge). The table should be presented to the Compensation committee (or Board as a whole if a committee is not formalized) for approval. Once approved, the CEO earns the necessary degrees of freedom to hire to plan with little required apriori Board involvement.
Keep in mind that the Compensation committee will want to make sure the proposed compensation plan is fair and equitable and perhaps equally important, it properly structured for the relevant markets the team members will work in. They may ask the CEO to produce the industry salary data reports as backup -- these are often available for major markets and define common salary ranges for common roles.
Variable Compensation
Setting variable compensation is tricky at best and is more fully described in Sales Compensation. What is important is to make sure it strikes the right combination of incentive and fairness. When the business is young, it is hard to set revenue targets with any degree of accuracy so having variable plans based on revenue is problematic. You may want to present to the Compensation committee a 'startup' plan for the first year that pays incentives for the achievement of strategic objectives which are often not all revenue based. Once the startup objectives are met, variable compensation can start shifting to revenue targets.
One of the biggest mistakes made when just starting out is to define a compensation target on some invented revenue goal (typically from the business plan presented to investors). If the goal is not met (a common situation for a startup), the first sales person is at risk given they are not making target salary. It's not uncommon for the Board members to say too-bad so-sad, those were the targets set -- a reminder of the need to think through the getting started issues well so you do not get stuck with too many internal issues to manage of higher priority than external ones.
CEO Compensation
The Compensation committee is also responsible for setting the compensation plan of the CEO. This should happen with the same priority and vigor as the whole team, but often is done well into the operating year. It is worth getting done right and up-front so there is no end of year arguing.
If needed, the CEO can propose a compensation plan to the committee for approval versus waiting for the committee to draft one. A typical structure would include rewards based on achievement of the strategic objectives for the year in combination with how well the company is poised to succeed in the following year. Some common compensation points include:
- validating value proposition of the company (translates into securing N customers in the first year)
- hiring leadership team members
- securing a strategic partnership
- completing a fund raising round
- staying on budget
The compensation points should not include pie in the sky goals used to attract interest in the Company -- it's time to be honest with everyone and set goals grounded in actual activities.