Big Red Car here. Bit cloudy yesterday but today promises to be clear and hot. Oh boy! Just the right weather for a bit of top down driving, eh?
So we have been chatting about the C Level Employment Agreement, breaking it down into its constituent parts and we’ve been chatting about compensation.
So, compensation has been subdivided into salary, benefits, short term incentive compensation, long term incentive compensation and “something special”.
You can see our musings here at the C LEVEL EMPLOYMENT AGREEMENT Series. Go back and review to make sure you absorb things in a logical order. Or, don’t, it’s your shot to call, sayeth the Big Red Car. Haha, Big Red Car, get it together.
Long term incentive compensation rationale
The rationale for long term incentive compensation is to provide longevity and stability for the enterprise through committed leadership. This is the proverbial “golden handcuffs” from the perspective of the Board and the shareholders. Fail to do this correctly and you will eventually lose your CEO to another company who is a bit more enlightened.
The notion of handcuffing the CEO to the company through a well designed and generous compensation provision in an Employment Agreement is a critical responsibility for a Compensation Committee and Board of Directors. As fortunes change, it is equally important that the incentives are weighed and measured to ensure they still accomplish the same objective. Boards are forewarned to ensure they have a CEO and do not drive her into a suitor’s arms by failing to be attentive to this very important consideration.
From the CEO’s perspective this is a way to share in the growth of the company and to build wealth based on performance. A CEO should be able to earn 5-10% ownership in the enterprise over a period of time based on performance. If the company is wildly successful, the CEO should be able to make a bloody fortune.
My darling CEOs, you will pay for your groceries with your salary but you will buy a lake house with your long term incentive compensation. Get some and don’t work for folks who will not provide such an incentive. They will NOT get better with age. You will cut your best deal right up front while everyone is still “grinfucking” you. Trust me on this.
Mechanics of long term incentive compensation
Long term incentive compensation is what we used to exclusively call “stock options” but has now morphed into other products from restricted stock, to phantom stock, to profit participations and a myriad of other ideas. The death of stock options was announced but nobody showed up for the funeral and they are still being widely used. The draconian changes never really materialized.
We will focus on stock options as part of this discussion and if you are using something else, you will have to work through the intricacies of that approach.
Stock options are discussed in terms of:
1. The Stock Option Plan which created the stock options for the entire company;
2. Size of the grant (quantity);
3. Strike price (price at which they are exercised, the amount of money you have to pay to exercise them and get a share of stock in return);
4. The vesting period (the time period over which they become irrevocably yours — this is the Golden Handcuff, Old Sport); and,
5. The termination implications (if you leave the employ of the grantor, you will have certain restrictions) and expiration of the stock option grant.
You must get any grant of stock options in writing, Grasshopper. Nobody can “promise” you stock options, they have to be granted in writing. The IRS will not be happy if you suggest that you have some “oral options” and if you happen to be a conservative, they will likely sever a pinky.
Your stock options are likely to be “unqualified” — go talk to your lawyer and get an explanation of what that means.
Pro tip: In doing fundraising of any kind whatsoever, make damn sure you know the implications of the stock option pool as it relates to valuation and the cap table. These stock options will have an impact on valuation both before and after the funding. Know the impact before you sign anything.
Nature of long term incentive compensation
As a CEO, we have previously stated that you should look to earn 5-10% of the company’s stock through long term incentive compensation over a 5 year period.
This should be in writing in the Employment Agreement and the implications of termination — for cause, without cause, by the employer, by the CEO — should all be laid out carefully and clearly. Fully vesting of all stock options should be front and center in any severance package contained in an Employment Agreement.
Know what you have to do to earn that severance package. Pay particular attention to “change of control” provisions.
As to vesting, the Big Red Car has always favored vesting all the options at the end of the Employment Agreement term but the Big Red Car is a simpleton sometimes. If you are going to put on some Golden Handcuffs, put on some Golden Handcuffs. Don’t pussy foot around, ya’ll.
The Big Red Car says — be generous but let them wait. This is the true nature of Golden Handcuffs.
This “waiting until the end” vesting is called cliff vesting though the term is also bandied about a bit when there are intermediate cliffs. But waiting until the end of the Employment Agreement term is cliff vesting.
CEOs should negotiate to get the stock options vested over some period of time consistent with the Employment Agreement — such as equally per year over the term of the Employment Agreement. You negotiate a 3-year Employment Agreement, then stock options vest over a three year period on 31 December of each year.
Variations on this theme are countless. Just remember — you do not get what you deserve, you get what you negotiate. Remember to negotiate.
So, there you have it, Old Sport. Simple as pie. All American cherry pie.