How to Build an Compelling Executive Equity Package
Due to our work with private equity and venture capital backed startup operations, we are often asked to advise about creating an attractive compensation package for an executive, which often includes equity.
What is Equity Compensation?
Equity compensation is a strategy leveraged by many fast-growth startups to provide an ownership stake in the company to an executive once they meet certain vesting requirements. Equity compensation can consist of stock options, stock grants, and other components.
Crafting a Solid Equity Compensation Package
Crafting a compelling equity package requires a lot of careful consideration and weighing of various options. In this article, we want to demystify the major components of this important task.
Step 1: Research Industry Benchmarks for Compensation and Equity
Crafting a compelling equity package always starts with understand benchmarks in your industry for compensation and the trends in where compensation is weighted.
During this stage, you’ll want to use research, intelligence gathered from similar companies, and your network to develop a sense of what will be considered attractive to your executive candidate.
Step 2: Outline the specifics including vesting schedule, equity type and grant
Creating your equity compensation package must carefully consider the following specifics:
- Vesting schedule: A vesting schedule is a timeline outlining when the executive will gain ownership of the equity. A typical vesting schedule spans over four years, with a one-year cliff (meaning no equity is vested until after the first year). After the first year, equity typically vests on a monthly or quarterly basis.
- Equity type: There are various types of equity that can be included in an executive’s package. These may include stock options, restricted stock units (RSUs), or actual shares of stock. Each has its own tax implications and benefits, so consider the specific needs and preferences of the executive and the company.
- Size of the equity grant: Determine the percentage of the company’s ownership to be granted as equity to the executive. Consider factors such as the executive’s role, experience, and the stage of the company. The grant size should strike a balance between being attractive to the executive and not diluting existing shareholders too much.
Step 3: Set performance-based incentives
Linking equity to performance goals serves as a powerful motivator to the executive who will be working towards the company’s objectives. Consider outlining the following factors:
- Performance metrics, such as revenue targets, profitability, or other key performance indicators (KPIs), and tie a portion of the equity to the achievement of these goals.
- Equity “refreshers”: these are performance-based incentives, usually smaller than the initial grant, that are offered annually or based on specific milestones.
Step 4: Establish an exit strategy
Now that you have drawn up the specifics of the equity package, you’ll want to do some final due diligence to make sure your legal and financial bases are covered.
- Legal Check: Consult legal experts to ensure compliance with relevant laws and regulations
- Tax check: ensure the package is structured in a tax-efficient manner.
- Exit contingencies: Outline the terms and conditions for the executive’s equity in the event of a company sale, merger, or acquisition. This can help protect the interests of the executive and the company during such events.
Step 5: Communicate (and negotiate)
Clearly communicate the equity package to the executive, explaining the vesting schedule, performance goals, and any other relevant terms. Transparency and open communication can help ensure the executive understands and values the equity package.
Step 6: Monitor and adjust
Regularly review the equity package to ensure it remains competitive and continues to align with the company’s goals and objectives. Be open to adjusting the package as needed to reflect changes in the market or the executive’s performance.