Executive Compensation for Private Companies (sic)

Fred WhittleseyEffective Equity: The Equity Compensation Blog, Pay and Performance: The Compensation Blog


Wikipedia says that:

The Latin adverb sic (“thus”; “just as”; in full: sic erat scriptum, “thus was it written”) inserted after a quoted word or passage, indicates that the quoted matter has been transcribed exactly as found in the source text, complete with any erroneous or archaic spelling, surprising assertion, faulty reasoning, or other matter that might otherwise be taken as an error of transcription.

I won’t cite where this title came from.  Let’s just talk about faulty reasoning.

Years ago, there was a sharp distinction between public and private company practices in executive compensation.  Public companies had the clear advantage of liquid equity to use as compensation in the form of stock options, restricted stock, and more recently performance shares.  The combination of market multiples and noncash compensation vehicles gave public companies a great advantage in delivering cost-effective compensation.

Private companies without a path to or intent for a liquidity event were limited to “synthetic” forms of equity-like alternatives:  phantom stock, stock appreciation rights, cash long-term incentives, or no multi-year compensation program at all.

Companies in the middle – private, but actively planning for an IPO or sale – had confidence in using actual equity-based compensation, knowing that the exit event would likely occur (generally) in a comparable timeframe to the equity vesting schedules.

Then, several things changed:

  • The time-to-exit lengthened significantly.  Even the fastest-growing most profitable pre-IPO companies found the timetable stretched from 4 to 5 years out to 8 or 10 years, or more.
  • Employees grew increasingly impatient with these extended timeframes, and wanted liquidity opportunities sooner than that, sometimes before investors realized liquidity for their positions.
  • The corporate governance environment for public companies became increasingly unattractive with waves of increasing regulation – Sarbanes-Oxley, Dodd-Frank, et al.
  • The investor base broadened from the choice between venture capital (VC) and private equity (PE) to wealthy individuals, both at the smaller-scale “angel” level and including the growing population of billionaires.
  • Other sources of capital entered the game – foreign sovereign wealth funds, mutual fund firms, hedge funds – all wanting to share in the wealth creation of the successful startups. These “newer” investors have much longer timeframes for an exit – so-called “slower money”.
  • Some companies discovered sources of liquidity that do not require a sale or public offering, providing interim liquidity to both early investors and employees.
  • Markets for private company shares were created, allowing erstwhile “private” companies a liquidity option and opening the door to using equity compensation the way that public companies do.

Now the decision process for private companies wanting to emulate public companies’ long-term incentive programs has become much more complex yet full of new opportunities.

The label “private company” has become blurred and can lead to limiting creative thinking.  “Private companies do this and don’t do that.” “Only public companies do that.”

A topic for another day is that “executive compensation” has become an increasingly meaningless term, aside from the media that love to cite the “overpaid CEO” and related “excessive pay” themes.

When we narrow the topic with outdated terms, we limit the realm of creative possibilities.

Instead:  “Compensation for Workers” then:

  • What is the current form of organization and ownership structure of the company?
  • What is the projected form and structure over the next three to ten years?
  • What is the diversity of investors in terms of investment horizon, liquidity needs, and risk orientation
  • Given all of that, how should we pay our workers, and should it be any different for the so-called “executives”?

That is a set of questions that will lead to much better compensation solutions.