CHAPTER THIRTY-EIGHT
WORKING WITH THE BOARD ON YOUR COMPENSATION AND REVIEW
In Corporate America and certainly in the land of startups, the board’s biggest, weightiest, and most important responsibility is probably hiring, firing or compensating the CEO. In this chapter, I’ll focus on compensation, which really means performance management and compensation.
THE CEO'S PERFORMANCE REVIEW
As I mentioned in Chapter 11, some kind of formal performance management process on you as the CEO is critical. It will help you understand the impact you're having on your organization, your strengths, your weaknesses, and your road map to being a better CEO.
You're not the only customer for your performance review. The board is an equally important customer. How can they properly figure out your compensation and guide you as your boss if they're not contributing to and reviewing your performance appraisal each year?
The three most important things about your performance appraisal are that you:
- Have one. This is where 90 percent of CEOs fall down. Even though your board, as your boss, should do this, you are the leader of your board—regardless of whether you are chairman. Lead them in this process as you would anything else
- Publicly acknowledge the results of your appraisal. This is Step 1 toward internalizing the feedback and making public commitments about acting on it, which leads to Step 3.
- Act on it! Feedback is a waste of everyone's time if you don't learn from it and drive self-improvement, whatever your mechanism is for that (see Part Five on self-management for more on this topic).
There are many ways you could run this process. You could run an open 360 process with your staff and your board together with a professional facilitator, as I described earlier on. You could run a closed and anonymous survey that is administered by your human resources head or by an appointed board member. Alternatively, you could do something in between with a facilitator (preferably your coach) and an open discussion among board members with no staff present. Again: how you structure this is less important than making sure that you do it.
YOUR COMPENSATION
I talked extensively about compensation earlier, so I'll focus here on your interactions with your board about compensation, both yours and others.
The three components of CEO pay are the same as the three components of executive pay: base pay, incentive compensation and equity. While it can be awkward to talk about your own compensation and while CEOs who are young and single sometimes like to ignore cash compensation, it's critical to spend real time on compensation for yourself and your executive team each year so that everyone on the team, including you, is compensated fairly. You need to guide your board meticulously and dispassionately through this process at least once a year. Ideally, you have a compensation committee to do this work with you. If you don't, you should!
I bring all three elements of compensation together in a single document once each year. (You can find the template we use at Return Path on www.startuprev.com.) Base pay is simple: award raises or redline pay based on individual performance, company performance and benchmarking against previous years.
Incentive pay and equity are more complex.
Incentive Pay
In terms of plan design, you and your team need to be thoughtful about incentive compensations plans and payout every year. You need to pitch; the compensation committee needs to catch. Build your proposed plan based on what you think the most important objectives are for the company to build shareholder value each year. Answer this question for yourself: “If we did all of this, would we be totally excited at the end of the year?” If the answer is yes, you have a good plan, regardless of the specific metrics. It could be entirely based on revenue or revenue growth. It could be entirely based on EBITDA, operating profit, a combination of the two, or neither. Whatever you do, make the plan as simple and quantitative as possible (even if it's a series of black-and-white qualitative goals, each worth a percentage of the overall plan).
Another guidepost could be uncapped, which, particularly when your metrics are revenue and profit, makes a lot of sense. If you achieve revenue or profit metrics that clearly build a ton of shareholder value beyond plan, you should participate in that success.
Payout is much easier, particularly if the plan is simple and quantitative. At the end of the year, you report back to the Compensation Committee what the percentage attainment was. If you want to have a conversation about increasing the number or decreasing it based on other factors, you can do that but you should have a very good reason. You should 100 percent make sure that you accrue the bonus payments on your monthly income statements over the course of the year (based on a reasonable projection of the year's likely outcome from each point in time).
As a side note, for the past several years, we have had 30 to 40 members of the company's leadership team participate in exactly the same incentive compensation plan (with sales leaders participating at 50 percent of their target, with the other 50 percent as commission against their territory). This can be a key part of driving alignment on your leadership team. Per the prior paragraph, you can always request that your Compensation Committee give you some discretionary powers over individual bonuses if you feel that a few individuals deserve more than base plan attainment based on their individual work during the year.
Equity
I've heard of very, very few examples of startup or even growth-stage companies where CEOs have less than a 5 percent stake in the business and are earning less than 0.25 percent per year—and those are usually more mature companies with crowded cap tables and a more certain financial outcome.
Early in the company's life, the optimal form of equity for you (i.e., before the IRS determines it's valuable) will likely be Restricted Stock, which doesn't cost much of anything to buy and will certainly leave you with optimal tax treatment of any gains. You can make something called an 83B election with the IRS when you get the stock. This is much less common to give to other employees, though I've never been sure why.
In addition to working with you to determine your own equity stake, every board expects to set up an option pool. Experienced venture capitalists and outside directors will have a general sense of what's reasonable and fair. Your option pool will have to be resized or refreshed regularly, especially if you're adding lots of staff in rapid succession and raising multiple rounds of financing. After making high-level decisions about the size of your option pool, your board should give you quite a bit of discretion in distributing equity to your employees.
EXPENSES
Although not nearly as important as performance management or compensation, your expenses are also a point of relevance for your board. For about nine years, no one approved my expenses. About four years ago, I decided it would be a good idea for our CFO to start approving them. Then there was some scandal at some big company that caught my eye in the Wall Street Journal about a CEO abusing his expenses. I decided it was time to ratchet up the CEO expense policy.
For the past couple of years, my executive assistant, Andrea and I have aggregated all of my expenses for the full year. And I mean all of them. Everything that goes through a regular expense report and everything that doesn't, like car services that are directly billed or things that get billed to the corporate card. We pull out things that aren't personal, like Pizza Friday for the office or extra fans during the heat wave. Then we categorize all expense items, analyze them on a per-night or per-trip or per-person basis as appropriate, footnote extraordinary items and compare them to the prior year's number for the same line item. The template I use for this can be found at www.startuprev.com. Then we send them to the board, cc'ing my CFO, controller and our outside auditor in case anyone on the board has any questions. We also ask our auditor to comment specifically during the annual audit as to whether my expenses are appropriate and in the range of what they would expect based on what they see at other companies.
As usual, transparency rules. If you have nothing to hide, share it all. As more CEO scandals erupt, you might as well get ahead of the curve with your board.