A REVIEW OF EXECUTIVE COMPENSATION SURVEYS: PART II

Private companies face unique challenges and opportunities when it comes to designing and implementing executive compensation plans. Unlike public companies, which are subject to extensive disclosure and regulatory requirements, private companies have more flexibility and discretion in determining how to reward and retain their key talent.  Private companies must balance a variety of interests as well, including those of owners and other investors as well as employees and customers.  Compensation practices should align with strategic goals and market realities. In this post, we review some trends and insights gleaned from executive compensation surveys that focus on private companies, especially startups, and discuss some implications and best practices for our private company clients.

The surveys reviewed are the 2023 Private Company Executive Compensation Survey Insights Report by BDO (the “BDO Report”) and the State of Startup Compensation, H1 2023 by Carta (the “Carta Report”).  These surveys provide valuable data and analysis on compensation levels, structures, and practices of private companies across various industries, sizes, and stages of development.

Key findings & observations

Public company pay is higher on average than private company pay, largely because public companies grant significantly more equity compensation. The BDO Report notes that public tech company CEOs earn 6.93 times more than their private company counterparts, with the largest disparity due to equity grants to public CEOs.  The non-equity cash compensation of public real estate company CEOs is 4.28 times as much as private real estate company CEOs.

Private company pay varies with industry and revenue. The BDO Report breaks down median compensation of public company CEOs as a percentage of private company CEOs by industry. Technology, retail and hospitality, and banking are among industries with the highest pay ratios, while life sciences and healthcare, manufacturing, and non-banking financial services are among the lowest.  The BDO Report also notes that CEOs of larger private companies, with revenue between $50 million and $100 million, earn 1.78 times the CEO pay of smaller private companies with revenue under $25 million.

Private companies have a variety of ownership structures, which may affect compensation practices. Companies with employee stock ownership plans (“ESOPs”) accounted for 41% of the private companies surveyed in the BDO Report. Compensation for CEOs of companies with ESOPs did not differ much compared to non-employee-owned companies. In some instances, pay to CEOs of employee-owned companies was slightly less, but the BDO Report notes that it is not consistent over time.  

Carta found that the median ESOP is between 13-20% of company equity.  Companies with lower post-money valuations allocated smaller percentages of equity to ESOPs.  For example, companies valued at $10 million to $25 million had a median ESOP allocation of 13.7%, while companies valued at $500 million to $1 billion had a median ESOP allocation of 17.2%.

Startup employee compensation was adversely affected by the decline in startup capital fundraising in 2023. According to the Carta Report, the average percentage change in fully diluted equity granted as compensation to eligible employees decreased 26% compared to November 2022.  Carta notes that grants of equity for C-level executives have not changed much, declining 2.7% year-over-year. In contrast, entry level employees have seen equity grants decrease 25.4% and manager-level employees’ equity grants have taken the biggest hit, declining 41.8%.

Startup employees face challenges and risks in exercising their equity options. The Carta Report notes that of the startup employees that received incentive stock options (“ISOs”), only 28% of vested equity grants were exercised before expiring in August 2023.  Additionally, employees with ISOs generally have 90 days in which to exercise vested options after leaving a company. According to Carta, extended exercise windows continue to be uncommon, with the first quarter of 2023 seeing 21% of terminated options with post-termination windows of over 90 days and second quarter seeing 17%.

Startup board members and advisors receive relatively stable equity grants. The Carta Report notes that startup company board members’ equity grants have remained stable. The median percentage of fully diluted shares granted to a pre-seed company independent board member was 0.52% in 2023, while seed-stage company independent board members received 0.50%, and Series A independent board members received 0.40%.   The initial equity grant to early employees rose year-over-year. For example, for the first hires of companies, the median percentage of fully diluted shares granted was 1% in 2023, compared to 0.96% in 2022.  For advisors, the median percent of fully diluted shares granted ranged from 0.24% for pre-seed stage companies, 0.10% of seed stage companies, and 0.07% for Series A companies. 

Considerations for executives, directors and shareholders

These trends and insights have valuable implications and takeaways for our private company clients, especially for their executives and boards of directors. Some of the key points to consider are:

  • Executives. Private company executives should benchmark their compensation against relevant peers and market data, factoring in their industry, size, ownership structure, and stage of development. They should also understand the value and risks of their equity compensation, and negotiate for fair and reasonable terms and conditions, such as vesting schedules, exercise prices, and post-termination windows. They should also seek professional advice on the tax implications and strategies of their compensation plans, especially for ISOs and ESOPs.
  • Directors. Private company boards of directors should design and oversee executive compensation plans that align with the company’s strategic objectives, performance metrics, and shareholder expectations. They should also ensure that the compensation plans comply with applicable laws and regulations, and that they are transparent and well-communicated to the executives. They should also monitor and evaluate the effectiveness and outcomes of the compensation plans, and adjust as needed to reflect changing market conditions and company needs.
  • Shareholders. Private company owners and investors should support and incentivize their executives and employees with competitive and fair compensation plans that reflect a company’s value and potential. They should balance their own interests and rights with those of the executives and employees, and foster a culture of trust and collaboration. They should also be aware of the tax and legal implications of their ownership structure and equity arrangements, and seek professional advice as needed.

Executive compensation is a critical and complex issue for private companies, especially startups, that requires careful planning, analysis, and communication. By staying informed of the latest trends and best practices, and by working with experienced and trusted advisors, our private company clients can optimize their compensation plans and achieve their business goals.


Surveys Referenced


Authors

Lawrence Cunningham

Carlos E. Juarez
Villanova University Charles Widger School of Law