Note: This article is part of an ongoing series on Board Directors. To learn more about their roles and responsibilities, download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.
You’ve started a new company, you’ve successfully recruited great Board Directors, but how do you navigate the tricky road of compensation? This post provides insight into what you should be thinking about when creating your policy.
Attributes of a Great Compensation Policy:
- Linked to Evaluation – changes in director comp can coincide with evaluation
- Equity-Based – Conserves valuable cash and aligns long term interests
- Reasonable – Over-paying directors can be a source of liability
- Well-Documented – Spell out key issues like contingent vesting to avoid confusion
Attributes of a Poor Compensation Policy:
- Excessive – Cannot be supported by objective benchmarks
- Informal – Not well documented, or based on promises of future actions
- Cash-Based – Growth company investors will generally not tolerate use of cash beyond repayment of reasonable expenses
Most directors of early stage companies are highly professional and accomplished people with a great deal of valuable expertise. Some will not make the significant commitment of time necessary to serve on a board without being compensated for that time (a contrasting and minority view holds that because the board seat was negotiated for, it is unfair to ask for compensation as well). A value-added director is generally well-worth the equity spent on them. However, in either case, board service to early-stage companies is generally not a salaried position. Compensation for board service should be based on the reasonable use of company equity to align the board’s interests with those of the shareholders. Board observers are generally not compensated unless their role is such that they are actively engaged in helping the company on a regular basis, and even then payment may or may not be offered.
Compensation decisions can be improved by being accompanied by evaluation: Boards must be able to defend the reasonableness and appropriateness of their compensation decisions and should not be in a position of paying directors who are not effective contributors. Before an annual grant occurs is a good time to look at any changes to board composition.
Based on Common Stock and Vesting: Directors should be paid in the form of stock options to purchase stock (typically common, or similar derivatives such as restricted common stock shares) which vest over a period of time (typically two to four years).
Reasonable in Amount: Early-stage directors are often paid in common stock (typically via options or restricted stock grants) in an amount equal to somewhere between 0.25% and 1.0% of total shares outstanding on a fully diluted basis. Board chairs or extremely active directors with specific industry contacts and introductions may be at the higher end of the prevailing range. Executive directors and special advisors are special cases and may fall outside of the range, though it is the responsibility of the board to ensure the appropriateness of all compensation paid by the company.
Conducive to Board Evolution: When selecting the amount of stock and the length of vesting, keep in mind that a startup's needs evolve over time and it may be desirable to rotate directors, including the independent director, off the board. For that reason it makes sense to give less stock but slightly faster vesting. Long vesting terms can make it more difficult to move a director off the board. Using less stock with shorter vesting is also less dilutive. For example, you might offer a director who wants 0.50% of total shares outstanding and vesting over four years, 0.25% vesting over two years instead.
Well-Documented: The policy on director compensation should be written down and should specify what happens to the vesting of stock options upon resignation, should specify single-trigger acceleration upon change of control (to ensure that the directors will not vote against an acquisition in the best interests of the shareholders), and should set out guidelines for incurring and reimbursement of reasonable, actual expenses in connection with board service. It can also be desirable to record that directors shall have the right to purchase stock on the terms of the company’s most recent financing if room remains, or a right to participate in future financings.
- Director compensation can benefit from being accompanied by evaluation.
- The compensation policy should be well documented.
- Director comp must be reasonable, benchmarked and defensible.
Want to learn more about the roles and responsibilities of Directors? Download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.