Driving Company Value through the Compensation Committee
Attracting and retaining top talent are among the most challenging and critical CEO responsibilities. In addition to cultivating a positive culture, compelling compensation and benefit programs provide the quantitative rationale for prospective employees to join and remain at a company. In a market with well-funded competitors, companies need to compete with terrific culture, a mission that motivates prospective employees, and yes, a competitive compensation package.
At the growth stage, our portfolio companies are rapidly scaling teams, adding experienced leadership, and rethinking organizational design. We want to provide our CEOs with effective compensation committees that can provide advice, guidance and oversight around compensation and benefit programs. Often, companies have not formally established committees by the time Catalyst invests – instituting a committee to review compensation (and particularly bonus plans) may feel like a luxury during the start-up phase. As companies scale to $8 million to $10 million of revenue and 50+ employees, they need to be able to recruit large numbers of employees and managers who weren’t part of the founding team. Those hires expect market salaries, understandable bonus plans, stock options and competitive benefit plans. The CEO benefits from putting some of the responsibility and oversight in the hands of a compensation committee that can tie the structure of the plans to long term value creation while grounding them in the realities of the competitive market.
A compensation committee is typically comprised of a subgroup of the board, and often the management team will make recommendations to the committee for review. Ideally, the committee will include independent board members who can provide neutral input. Below are a few suggested guidelines to optimize compensation committee efforts.
Step 1: Align Compensation with Business Strategy – and Keep it Simple
Best practice is to set compensation bands for expected salary, bonus and equity for each title in the organization, however, sometimes plans are set based on ad hoc formulas or decisions made as early employees were hired. Many of our companies undertake a compensation analysis at the onset of working with the committee, and they often identify opportunities to standardize bands by level, which makes hiring managers more efficient and prevents bias from impacting comp decisions.
The committee also seeks to ensure that annual bonus incentive plans align with the company’s strategy and long-term goals. The key question is: what behaviors are you trying to incentivize, and do they align with the key business initiatives? These initiatives may include revenue growth, gross margin improvement, churn reduction, capital efficiency, EBITDA expansion, etc.
It is important to establish straightforward objectives and associated compensation triggers. We have seen instances of complex bonus formulas based on a dozen variables – with so many objectives, it is difficult for employees to decipher where they should be spending their time. A simple and easy to understand comp plan with 2 or 3 core metrics works best and communicating how those metrics drive value enables employees to feel like they are contributing to the ultimate outcome.
We often weight KPIs based on importance. For example, if a company is focused on growth, 50% of the management team’s bonus may be based on hitting growth targets and then maybe 20% on the EBITDA target and 30% for individual performance based on personal MBOs.
The compensation committee often considers individual objectives for the management team member and a pooled bonus plan for the broader organization. Members of the sales and customer success teams are often compensated based on commissions paid for achieving quotas, so they may be ineligible for additional bonuses.
Step 2: Benchmark salaries and bonus percentages
When developing a compensation plan for an organization or structuring an offer for a new executive hire, take a step back to make sure the proposal is in line with market expectations. We use several compensation benchmark reports to ensure our companies are offering compensation that prospective hires or existing employees would find compelling based on other opportunities in the market. When we consider benchmarks, we take into account a company’s stage and traction, amount of capital raised, geography, and sector. For example, a $2 million revenue startup in Detroit should have different compensation benchmarks than a $50 million revenue company that has raised several venture rounds in Silicon Valley.
Benchmarks can also provide guidance on the appropriate ratio of base and bonus to total compensation. We’ve seen a 60:40 base to bonus ratio be very effective with top C-level execs of high-growth software companies looking to incentivize their team to hit key milestones.
Step 3: Use equity wisely
Lastly, and possibly the most valuable and important retention tool for senior teams, is the equity portion. Typical management option pools at the growth stage range from 10% to 20% of the fully diluted ownership, with annual grants ranging from 2% to 4%, depending on the hiring pace. We have seen companies succeed in recruiting and retaining terrific entry- and mid-level talent by granting equity. Many times, growth companies have limited funds available for salaries and bonuses, but they can offer equity that allows employees to share in value creation.
When we make an investment, we typically increase the option pool to make sure we have enough equity to attract the key hires needed to help the company scale. We also consider vesting schedules to make sure employees still have significant value remaining in their unvested option value and to decide if an equity refresh is necessary. On average we want to make sure each senior team member has at least three times their base salaries of unvested option value.
Overall, be creative. Try to figure out what your executives value most. Whether it’s work-from-home policies, extra vacation days, or relocation bonuses over base pay, try to understand what’s important to them when making or creating a compensation package. Some atypical benefits may make an offer extremely compelling. For example, one of our companies offers a year’s worth of diapers for new parents and has an attractive parental leave policy. In a time when the unemployment rate is at a 50-year low, all of these factors can contribute to a compelling culture, which further attracts and retains employees and allows a company to successfully scale.