In the previous installment of our executive compensation series, we covered the fundamentals of executive compensation and why it requires a different approach than employee compensation.
In this article, we’ll focus on the pitfalls and strategies that can make or break your executive comp plan. Understanding these things can help you attract and keep top leaders, protect your runway and equity, and support your long-term success. Here’s what you need to know.
Top 4 Executive Compensation Mistakes Startups Make
With more considerations and higher stakes than employee compensation, these executive comp missteps can be costly and hinder company growth.
Mistake #1: Giving away too much equity
A key component of executive compensation is equity, a percentage of ownership in a company, typically in the form of stocks or shares. It’s a key tool for recruitment and retention, especially for startups with a careful eye on their cash runways.
Awarding excessive equity is the most common misstep for early-stage companies, who often provide unnecessarily high equity levels to get someone to accept an offer. This practice dilutes the share value for existing shareholders and reduces the finite pool of equity. This depletion can make it challenging to offer competitive packages to future hires and can ultimately affect your company’s future growth and stability. Finding the right balance is key.
Mistake #2: Skipping comp benchmarking or using the wrong comp data
Don’t fall into the trap of using compensation data that isn’t relevant to your specific industry, funding stage, or company size. Using outdated, inaccurate, or irrelevant market data can lead to pay structures that are either too low or excessively high.
While it’s important to factor in a candidate’s experience and skills, starting with the right market data helps ensure your compensation packages are both competitive and right for your company’s stage and goals.
Mistake #3: Not aligning with your compensation philosophy
A compensation philosophy outlines how your company will pay and reward its employees relative to the market, reflecting its goals, mission, and values. For executive comp, a philosophy should include data sources and how you’ll cut or analyze it, target percentiles, and the pay elements you’ll offer.
These guidelines become reference points you’ll adjust as your company grows in size and valuation. When companies don’t have a comp philosophy, decision-making becomes random, leading to internal pay equity issues and pay structures that don’t align with company goals or adapt well as things change.
Mistake #4: Making too many exceptions
One of the easiest pitfalls for startups is making too many exceptions to their comp plan. Just like most things related to executive comp, exceptions are more significant than those for employees. One exception can easily snowball into two and beyond, straining runway and equity.
Frequent exceptions can also lead to costly turnover at the highest ranks, because in this era of pay transparency, more people are talking about comp, even execs. We witnessed this recently with one company that didn’t consider internal equity when hiring a CHRO. They quit within a month after learning they were being paid far less than a more junior executive.
Top 3 Best Practices for Executive Compensation
Now that we’ve reviewed what to avoid, here are things to do to ensure your executive comp plan hits the mark.
Best practice #1: Communicate the potential value of equity
Although executives are often savvier about equity than employees, don’t assume they understand everything about the equity component of your offer. Always provide specifics, including your company’s current valuation and growth potential, exit scenarios, risk factors, and tax implications.
Context and details are especially important when leaders come from a larger or more established company that has a different risk and reward profile for their equity grants. It’s also important for companies to understand this difference so they don’t try to match the large compensation packages of bigger companies at later funding stages.
Best practice #2: Regularly review and update your executive compensation plan
As startups grow and reach significant milestones, such as funding rounds, product launches, and revenue targets, priorities and business dynamics may shift. Review your executive comp plan at these milestones to make sure it aligns with your current goals and remains competitive in the market.
And even if you don’t hit a major inflection point, it’s a good idea to review your comp plan on a regular basis and adjust it as needed.
Best practice #3: Use external advisors
If you’re a new founder or it’s your first time building an executive team, it’s helpful to partner with an independent third party that can give you guidance and a different perspective.
They can also mediate between internal stakeholders, including the board, its compensation committee (if you have one set up), and your management team, who often have different perspectives and fiduciary duties to the company. For example, management teams focus on how to move the business forward and secure talent, while boards focus on doing what’s right for shareholders. Outside advisors bring market insights, objectivity, and expertise to help find common ground between parties.
Building a Strong Future with Executive Compensation
As you navigate the complexities of executive comp, keeping these common mistakes and best practices in mind can make a significant impact on your company’s success. By crafting thoughtful and strategic executive compensation packages, you’ll attract, motivate, and keep the leadership you need to grow and protect your company’s financial health.
Explore the rest of the series:
Executive Compensation 101: Fundamentals for Planning
Executive Compensation 101: Nailing Equity
Executive Compensation 101: Equity Refresh Grants
Navigate Executive Compensation with Confidence
Whether you’re starting from scratch, need to adjust your plan, or want help understanding the nuances of executive comp, Sequoia advisors are here to help companies you. Connect with an experienced Sequoia advisor.
