Folks, I am not sure if this has been discussed before. If so, can you pls direct me to the relevant posting?
I would like to know about the standard practices to decide compensation for early stage employees. Consider this example: I am planning to hire a person at the CxO level. My company is about 15-20 people. Of these say 4-5 ppl are the Sr Mgmt. The Sr Mgmt have equity stake and the remaining employees as low level guys hired at market salary. Now if I have to add another person at the CXO level, are there any thumb rules for compensation? Say mkt salary for this guy is over 20L. How can I estimate a fair salary/stock package? Pls let me know in both cases – 1. the company has a valuation 2. The company has never been valued.
regards,
Vamsi.
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Its amazing how many people grapple with this question, I have also recently been asked this…I think the different answer show you one thing, there is no correct answer. But I am going to have a go here.
Assume there are no stocks or shares, then you would simply look at his CV , what the market pays and negotiate the best deal for you and him (most likely slightly better for you) . BUT you will have a upper limit in mind, if market says 20 lacs, you will possibly push to 25 lacs, if he disagrees you will then say Bye to him. And this is the crucial point when doing the stock thing you need to have a upper limit also, the problem with stocks is that you dont feel the pinch, since its not hard cash. And that is why we have all this confusion.
Okay now back to your point stock + shares, you need to decide
a) how important is this guy, will he take it to the next level, AND how quick
b) How will this impact the rest of the people
I for one never say you should pay under market salary unless you are a founder, simple reason is that you wish to have the person focus on your business, or focusssing on other jobs, or wondering how he will pay the bills this month.
Just as to you the stock does not hurt you and hence you find it hard to value, so does the person on the other side of the table, he cant pay the bills with it. Always pay a fair market salary. The stocks are a carrot, a sweetner, when you come to negotiate.
There is a another scenario where you are cash strapped, hence you must sell the stock to him, in order to do this you must know what they are worth today, and tomorrow, of course you being the founder you will always feel that they are worth billions, but unless you have done a billion dollar exit before you will never sell it to him. Its like selling a unknown car to someone you don’t know, try telling them its worth 1 Cr.
Soooo you need some justification, which is you business plan, other comparables in the market.
now assuming you have all this, its just down to numbers, also some people like to give each management level 0.5 of what the level above got in ter,s of options.
I know I havent given any numbers, but the number means nothing, having said that psychologically, 5% sounds way to small, 15-20% is always better.
Now to options, these mean nothing unless you know how many shares it equates to, hence when discuss you need to say the max pool of options will only equate to x% of the company, from there he can work out what its worth.
Shares also mean nothing, you can have 50%, and get diluted down to 0.5% by the time the IPO happens, hence if you can ensure that he will have x% by IPO/exit it has more value that just a number.
So in summation
1. Pay market salary, dont give shares if you do not need to, get him to justify why he should get them,
2. If shares are your only option, then give
a) shares – initial thankyou
b) options – keep him there
These need to have a value, based on some criteria, be open tell him how would he value it, but say you have a overall limit of 10% which you will give to all employees, set the barrier
3. Make sure you have a clear exit lined up, and he can see it, most startups dont, and hence shares/options etc mean nothing
Of course if you are the employee, there are different ways to negotiate a better deal…but thats for another day 🙂
Iqbal
Krish: If you knew the contribution you wouldn’t have a problem with how much percentage you should give him (or make a deal based on milestones etc.). The vast majority of exec hires come with a very fuzzy contribution estimate upfront (IMHO).
Vamsi: If you can easily define b) then a) does not matter. If you are aware of the contribution that the exec is bringing you, you shouldn’t care about the risk he takes. If he’s bringing in a value of 2 crores to you, you can’t give him anything more than 2 crores. So funda is: if you can use b) (defined contribution) use it, otherwise you have to go half way. I don’t think there’s a way to define how to weight each component, but i’d be curious to know if there’s a fits-all formula.
That’s purely a matter of consensus, Vamsi. There will be some trade-offs on either side, (founder getting some early economies and the CxO looking forward to handsome payoffs later) but that shouldn’t be a problem if you would put your heads together and storm it off.
Guys, thanks a lot for the gyan. I think that compensation (stock + salary) has to be a function of
(a) multiple of lost opportunity costs to the cxo
(b) value add that the cxo brings to the table.
While (b) is what actually matters to the start-up, (a) also needs to be considered because this will be foremost in the incoming cxo’s thoughts. Does the following make sense?
1. Both the start-up and the cxo agree on the current valuation (whatever mechanism is used to arrive at that) and future 3yr-5yr business plan (and hence valuation).
2. Say the current valuation is 10cr and 4r expected valuation is 200cr. If the current market salary of the cxo is 20L, assuming that the cxo takes a salary of 10L for the next 4 yrs, its 40L in lost opportunity costs. So if we take a 10X multiple on that it comes to 4cr – which is 2% of the 4yr expected valuation.
Now how do we determine (b)? I believe that can be tied to specific milestones like sales numbers or product releases etc right?
The big question is how should (a), (b) weighted to arrive at the final number?
Vamsi.
Deepak,
You say – “I would say that a senior execs contribution is just about as imaginary as the projections on an excel sheet.”
Then why is he being hired at all…? 🙂