Q&A With Dee DiPietro on Startup Compensation

In a previous post I mentioned Dee DiPietro, CEO of , who is a seasoned startup compensation expert. Well, over the past couple of weeks, I’ve had the opportunity to have an email Q&A session that I put together here on the topic of equity compensation philosophy in startups.

FN: What philosophies have you seen work in terms of how to use equity to compensate employees?

DiPietro: Although compensating at the 75th percentile of equity is always a great practice, the key to a successful equity program is communication versus any one particular strategy. I have seen many lucrative programs that were marginally effective (read as employee discontent and turnover) due to a lack of communication to employees – resulting in a lack of belief about potential value or position against the market. In the absence of information, people tend to construct their own information which is typically not the same information as the company beliefs. A second key to a successful program is hiring the right people for the right stage of company development. Early stage employees that are comfortable with a larger equity stake and higher risk may not always be a long term fit for the later stage company. Conversely, more risk-adverse people do not typically value equity compensation as highly and opt for a later stage package with a larger cash component. This does not mean that salaries are significantly reduced in private companies as was typical prior to the late 1990s but rather positioning in the market and the size of cash bonus provided.

FN: What’s your view on option refreshes?  When do they work and when not? 

DiPietro: Option refreshes are now a critical part of an equity program due to changes in acceptable metrics for private companies to achieve before an [exit]. Up through 2000 when a typical path to an [exit] was about 4 years, a refresh program was not conventional in privately held, venture backed companies – although I personally found this practice a bit short-sighted for retention after an IPO or sale. Now that the models for development have changed to larger revenues with typical development times of 5 – 6 years, a four-year grant without refresh is not an effective retention tool. Most companies wait until vesting is at least 75% or three years complete before implementing a refresh program and this practice puts the company in a reactive versus proactive position. At this point, the early technical team is seriously considering diversification, especially in light of a lack of information about refresh practices. So, for each person who gets an offer from a public company, the thought process goes like this: I am valuable but not critical to success so they can replace me, the company will go on and my stock will be worth something. I will get a sign on bonus and have two weeks of vacation that will need to be paid so I have enough cash to exercise options the 80% of my options that are vested. I will get an increase in base salary of 10-15% and I will get an annual cash bonus of 20% so I will have paid options in a private company with potential upside and a cash package from a more stable public company. In successful schemes I have developed, companies do not wait as long to implement refresh programs but there were difficult choices to be made and communicated to the board. The primary factor in developing an effective compensation program which includes refresh is the competitive stance required for the labor market in which you are competing for your talent.

FN: Is there really a cash-equity tradeoff?

DiPietro: At the executive level where there is a larger amount of equity being given, most definitely. Data typically shows a 20-25% reduction in exec comp compared to small market cap companies. For a few early hires who get a larger equity stake, quite possibly more. But for most positions, no. A company is lucky to be able to use equity to offset bonus for some period of time.

FN: It seems that use of equity ebbs and flows, where is it now and what’s the outlook?

DiPietro: The changing practices in public companies will make use of equity for staff level positions more strategic and less prevalent as many have focused changes necessitated to address equity spend and dilution issues on the staff level grants versus executive. However, the use of cash has increased significantly to offset these changes. In response, privately held companies will need to determine the best use of their available compensation elements to compete effectively. In consideration, one might wonder what this will do to current investment models and the decisions boards will make when faced with increased cash spending resulting in a delay of liquidity versus increased option pools resulting in reduced investment return.