Compensation Trends and the Impact on Private Technology Companies

by DEE DIPIETRO

DEE DIPIETRO

Dee is a pioneer in the compensation space for private companies. She is a mainstay of Silicon Valley and is renowned for her depth of knowledge in private company compensation. With over two decades of compensation consulting experience, she credits each grey hair with adding to her knowledge. Dee founded Advanced-HR in 1997 and produced the first online compensation survey specific to private companies. Dee has worked with many private companies on their way to IPO, including several now household names being clients along the way. In 2014, Dee's consulting services were in such high demand, she decided to embed her knowledge into a platform that empowers companies to create and manage their own compensation plans. While not creating technology to replace herself, Dee enjoys driving trucks and tractors at her avocado ranch in San Diego.

Webinar Transcript

Man: In founding Advanced HR Incorporated in April 1997 Dee DiPietro became a recognized pioneer in survey data and produced the first systematic survey of compensation and equity for privately held venture backed companies. In January 2000 she led the company to launch Option Impact, a world first in the delivery of online compensation benchmarking that is still the only single source solution for all compensation and equity data needed in privately held venture backed companies. With more than 20 years experience in business management, Ms. DiPietro's accomplishments are extensive.

She has developed and managed, a highly successful human resources consulting practice for a small fast pace firm, served in senior human resources management positions in life sciences and information sciences industries, and held senior staff management positions in the manage health care industry. Prior to entering the business management field, miss DiPietro conducted medical research in immunology at the University of California, San Diego. She holds a Bachelor of Science degree in microbiology and biochemistry. Please welcome to elevate 2015, Dee DiPietro.

Dee: Hi, I'm Dee DiPietro. Today I'll talk a little bit about compensation trends and the impact that they have on private technology companies. So on the first slide we're going to talk a little bit about private company development. Development parameters for private companies have dramatically changed over the last 15 years. If we looked at it in terms of what was going on in the industry at any particular time during kind of what we call Web 1.0 or the .com era 1998, 1999 before the .com bust in 2000 companies typically went private in about four years.

The average size of the company was about 40 employees, they typically raise about 22 million in capital, and the median annual revenue at IPO was about 35 million. By the time Web 2.0 came along in the social era driven a lot by Facebook, LinkedIn things like that development time had doubled to about eight to ten years. The reason being that the public markets were demanding a lot more from private technology companies. They had to kind of prove themselves a little bit more.

So the average size of the company increased 75 to 80 employees, companies were raising more money, average was about 52 million and the median annual revenue at IPO was a $111 million. Today we have the mobile era, web 3.0. Development time is still eight to ten years but we have larger companies, there are 90 to a 100 employees. Companies are raising a lot more money, 78 million is the median and the average annual revenue at IPO is 82 million.

On this next slide, I'll go through a little bit about the compensation trend and tell you a little bit how private company compensation is impacted by labor market trends in the broader industry competition. Essentially in the .com era, free IPO bonus plans began to appear.

The first time that we had really seen this in the private company market. We saw cash in this instance significantly increase. Prior to this, you'd always take a 20% to 30% discount on the public company market and that's what you find in a private company. But we saw public company practices starting to drive down into the pre-IPO world at this point. Options were great. It's just that people weren't sure what the options were. So it was kind of like the gold rush, we want stock options but people really weren't sure.

Then in 2002 to 2003 after the .com buzz, people thought that salaries were going to go down, and actually that's not what happened. Companies laid people off and actually for their critical skills they really focused on those people, they didn't necessarily pay them more money... I'm sorry. They had to pay them more money because at some point options were perceived to be worthless. So that cash became king during that period. Social era, Facebook starting to use restricted stock, all of a sudden restricted stock becomes a big concern in private companies.

And it really focused the shift over to the number of shares versus the typical way we look at stock in a private company as percentage of the company. Cash again was increasing due to the competitive neighbor of the labor market, and options were perceived to have some lesser value than restricted stock. In essence, they do but the fact of the matter is that the potential growth on an option is typically much more than the potential growth on restricted stock. In 2008, 2009 again we saw a downturn in the market, fueled by the economy.

Companies again are laying off people but again the salary reductions are minimal, and the talent... what we saw is talent taking a lower job. So people weren't necessarily taking cuts in pay but they were taking a lower level job just to get their bills paid. Again options became not as important as cash at that point. From 2010 to 2011 Google increased their salaries by 10%, cash was king the labor markets were still sluggish, sluggish and options were nice to have but they weren't considered to be of value again.

Today the stock market actively [SP] visibly drives the option potential worth. We see people again making lots of money off stock options. Cash and equity are important and the options are still somewhat allusive as people try and equate stock options to RSUs. On the next slide, I'll tell you a little bit about how this impacted actual compensation, and what we're going to look at is we're going to look at compensation for a mid level engineer. And you can see what happens over the course of each of these eras that we've looked at. We have compensation from a base salary of 70,000 to 80,000 a year in 1998, 1999. Being a 135,000 to a 145,000 a year now, and with total target pair bonus going up about 20K higher than that.

On the next slide what we'll do is we'll take a look at how this equates to the labor market. So a lot of times when people look at market data, they look at anything being less than the 50th percentile as being less the competitive. And what happens is private companies typically compensate between the 25th and the 50th percentile. And so when they're looking at market data or when they're looking at ranges setup at the 50th percentile of market sometimes they feel these aren't competitive because the people that are driving the labor market and the people that they're trying to recruit other companies...other talent from are paying significantly different in the labor market.

So you see kind of two to three years ago before a lot of the people started paying technical on product roll, at the 75th percentile we saw Apple, Facebook, and Amazon really driving the target at the 75th percentile and over on the right side you can see the relative pay that resulted at that. Google at that point in time stopped participating in salary surveys and said they would pay between the 95th and the 150th percentile. So you see them over on the far right and you see that realistically these people can pay 60,000 a year more than a private company that's paying up to 25th to 50th percentile, because they have the cash, okay?

Executive trends on the next slide. Using market data especially at the executive level is really key to developing an executive pay strategies. We in the private company sector, we've seen proliferation of C roles over the last couple of years. So companies have added their chief product officer, their chief people officer, their chief customer officer, their chief sales officer.

And with increasing competition in the critical staff positions, we've seen that there's an overlap between what the directors and senior directors, and architects are getting paid in cash compared to what the executives are getting paid because the executives are taking a much larger discount and essentially using that equity offset because they're taking a bigger risk, and there's potentially going to be a bigger reward.

We also find that founders cash typically lags the non-founder cash into a later stage. So if you're working with private venture backed companies, you should always know that when you're working with a founder position they typically have less in cash, more in equity. And when you're using bench marks you definitely want to segue the data, so that you're looking at either founder cash or non-founder cash in equity. We've seen total cash medians significantly increase over various stages of company development. So that we're seeing bonus play a much larger role earlier in company development than we've ever seen before.

I'd like to switch roles a little better, switch gears a little bit here and talk about balancing cash and equity on the next slide. Balancing cash and equity is really important in private companies because the role of each starts to change significantly and private companies really need to be aware of this and make the best use of their resources. Typically what I see is companies trying to rely too heavily on their stock and not put enough cash into their programs earlier on.

So when we see early stage companies it's very common to see lower base salaries. There's a much higher emphasis on equity and these companies typically are trying to make their round stretches quickly as possible. The mid stage companies kind of post B[SP] companies, we see an increase in cash. We see some use of bonus and we still see a higher use of equity but at this point the company is starting to scale back and starting to change that mix of cash and equity. So by the time they are a later stage company, they're focusing, they're still taking a small discount on the cash. Typically this is in the bonus area not so much in the base salary specially at the staff levels.

The cash is offsetting the equity a little bit because these companies can't give out as much equity, and they're typically starting to position more to become a public company, where they're going to put in much more cash and take out equity. So there's still some advantage to that later stage company but definitely not the potential reward that we would see from a mid or an earlier stage company.

On the next slide, I'd like to talk a little bit about risk and reward. So within private companies the risk reward ratio is a little difficult to understand and communicate, but if we put it into an analysis we can understand how an employee would look at this from a perspective. And essentially what we want to do in this risk reward analysis is look at the package that a private company provides with the same four year investment filter that an employee would look at coming into the company. So the employee is thinking I have a package, where at my current job I have my cash, I have my bonus, I have my potential RSUs.

And I'm going to go to this private company and I'm going to trade off my bonus and not have RSUs, I'm going to have the stock options, and I'm going to have this base salary that might even be a little bit lower. And I need to understand over the course of four years, what my investment is going to be and what my potential return is going to be. And so as a private company, companies should take the time to look at their option packages and look at the offers that they're giving out with the same guides of what does a four year investment do for this person.

So here we've provided for you a four year investment plan and you can see that this person on an annual basis is trading off 82% of their "given package" that the public company for 0.08% of equity, and that's a 38% risk and is that 0.08% equity going to return the type of value that is going to make this employment with the company worthwhile from an employee's perspective.

So on the next slide we can show you the challenge of risk reward, so not all options are created equal. And many mid to senior level staff people when we run this analysis, they've made a highly risky investment in their employment because private companies have traditionally lagged on cash, they haven't put in a bonus plan. They're trying to cut their options too much or they may not have their options strategically structured. When we run this analysis we find that there is maybe a 3% return and is a 3% potential upside a realistic for the $327,000 investment that the person made. So again in this particular instance it wasn't. If it's a high value company some of the Unicorns that we hear about in .0.08% is returning significantly more income than kind of the company that we've modeled out right here, then yes, it would.

So it just goes back to saying that not all options are created equal, and it really is incumbent upon the company to understand what they're offering in the market and does that investment make sense for somebody going to join their company. On the next slide the solution to risk reward, I've gone over this a little bit already but realistically look at the value of the compensation packages. You should look at competitive labor markets, it really may demand that you pay higher cash earlier on, and from a company perspective you need to be able to do an analysis on this and convince your management that from a labor market confrontation [SP] perspective this is really what it takes.

Staff level grants, really what we find is the general role of them is your staff level grants really only provide as much upside as possible to eliminate your bonus plan into a mid stage. When you're mid stage you really have to look at that mix of cash and equity, and decide when you should put a bonus plan in or when you should move your base salary guidelines to the 75th percentile, what makes sense for the particular labor market that you're competing against.

In the San Francisco Bay area, where we're relocated we find that there's so many market drivers that drive to the 75th percentile for the technical product design ranges that if companies don't move to that 75th percentile, they're having a very hard time recruiting. And what we've seen in the data over the last couple of years is that the distance between the 75th and the 50th percentile has grown very small. So we've got our 25th percentile down here, maybe it would be this way if I'm trying to do it backwards for the camera, and we find it go up and then down. So that again we have the 50th and 75th, not a lot of delta between those two points.

The other thing that is really incumbent upon companies that we find is not as straightforward is that they really look at their retention in their performance programs when allocating equity. And we'll talk a little bit about this on the next slide but what we find is that when companies have hit their three of four year mark, they look at their talent and they go, oh my gosh! The person is highly invested. And they really need to look at allocating equity for performance grants earlier versus later.

We've developed a very simple one, two, three star rating so that if a person is at the key of what they're doing maybe there are a one star person, and that typically is making up 10% to 20% of your population, you really want to go all out to retain those people. They are absolutely mission critical to your company. So we'll talk a little bit about a refresh program for them in a moment. The two star people, they are really good, they're infinitely harder to replace than the three star people. The three star people, we love you, we want to keep you, but we really need when we're allocating additional equity, we really want to look at our one and two star people on how are we going to retain these critical people, because it's much more painful if they leave.

So you do need to cost out different strategies when you're doing this to afford... to test the affordability, and I do know from consulting experience that when companies wait until they're in their third or fourth year to try and implement a package, it's very expensive because they haven't been doing it all along and they have to play catch up in one year. But essentially what you're trying to do in doing this, is you're trying to create a vesting horizon for your critical assets. So that they can look and see that they always have two or three or four years of unvested equity in front of them.

I'll explain how on the next slide. We've talked a little bit about how to vest [SP] this but there's a couple of additional ways to do it. You want to get the right stock to the right people at the right time, and there's been in 2007 the laws in California changed, which California for better or worse drives a lot of the practices across the United States. And what it said is that stock level positions don't minimally have to vest [SP] 20% a year, and so what happened is this ability to move forward and to create a unique vesting pattern helped private companies.

So that if you want to give a grant to somebody and they're vesting at 25% in year of their new hire grant, the last thing you want to do is vest options over the top of that new hire grant. It creates a big spike and then it drops down the other side. So what we'd like to see is we'd like to see our critical asset getting grants after even one year but at least two years, and we want to see those grants tagging on the back and the vesting on the back end of their new hire grant. So that they're vesting a new hire grant and then they're vesting the short little grants every year. The advantage of doing that is it locks in earlier strike prices for them.

So on the next slide, I have a little schedule to show you how potentially your performance grant, your retention grant program can kind of safeguard this retention of your key people. And it shows the initial hire grant and then it shows when you're granting these little grants and that there's a two or three year delay, and then the grant will vest over one year and essentially what you're doing that way is creating a vesting horizon for these people.

This is pretty much... we've hit some high points. Number one high point is make sure that you understand the value proposition that your company can provide to its employees. Make sure you're putting cash into the programs you understand your competitive labor market. Make sure your retention correctly. What I'd like to do on moving to the next slide right now is just a quick pitch on what our solutions are to risk and reward. We have two, we have option driver our new platform where private companies can completely design out their stock and pay plan.

You put your information into the system from your HRES in your equity administration system, you put your new hires in. We pipe in all the competitive data you need, you can analyze it, you can model out different plans, you can see what's affordable within your plan. The other thing is if you just want market data we have what we call collaborative data, any private company that enters data into our system in path of QA can get an advantage of our private company data source at no costs. Basically you give us your data, we'll give you your data or vice versa. You give us your data, we'll give you our data. Thanks very much.