How to Compensate Independent Directors
Startup Boards for CEO’s Series: Post 8 of 10
“Wait. I have to compensate board members?” Yes, that’s right, compensation is expected and while it may seem tricky there are several elements of a compensation package you need to know about for an independent board member. Typically, this has been a pretty tricky process for CEOs because there hasn’t been a good source of data on best practices with regard to board compensation. That’s one of the things we’re looking to fix with our Board Benchmarking survey on Bolster. Any CEO who signs up gets free access to our study results which include compensation benchmarks on things like vesting, acceleration, and basis points. You can participate in the study and get the detailed view here. But in the meantime, in this post I will at least lay out the elements of the package and the types of conversations you need to have with a new director as well as some thoughts on specifics.
First things first. In the world of VC-backed, private, early stage startups and scaleups, there should be zero board compensation for management directors (beyond their regular executive comp package and equity). There should also be zero board compensation for investor directors (cash or equity). The only time I’ve ever heard of this is when PE firms come into deals, either as minority shareholders or control investors. Beware of this. If they are coming into an existing syndicate as a minority shareholder and ask for a director fee, tell them no, that is not your model. If they buy a controlling interest in the company, it’s their money, not yours – but find this out ahead of time. It’s a red flag in my book that your new owner, who is already making a lot of money on management fees from their LPs, feels compelled to take more money out of your operating budget for doing their job.
- D&O insurance. Insurance Isn’t exactly a director compensation point, but make sure you have current and ample D&O (Directors & Officers) insurance and let new directors know what that coverage looks like. It’s best if your D&O insurance also covers board observers.
- Cash. Cash is king in startups, so it would be a very unusual practice for a startup to pay directors cash compensation (see above on management and investor directors – but this is true of independent investors in terms of cash compensation). I’ve heard of that happening once or twice, ever – and this has been validated from results of our Board Benchmarking study on Bolster But if a director candidate insists on cash compensation, you have three choices: (1) say no; (2) agree but tie the cash to specific consulting deliverables; or (3) agree to the demand – but you’d better be sure this director is in the 0.01% of top directors in the universe – and reduce the equity component of the offer. My strong preference is (1).
- Equity instrument. The standard equity instrument for directors is Non Qualified Stock Options priced at fair market value. But if your company gives Restricted Stock or Restricted Stock Units, you can offer those as well – think of a board hire the same way you’d think of an executive hire in this regard. You want to pick an instrument that optimizes tax treatment if possible.
- Vesting period. I wrote about this a bit in Size and Composition of Boards . I am a strong proponent of doing smaller, shorter vest option grants, at least for early stage companies whose needs are very dynamic. In Bolster’s Board Benchmarking study, we found that over half of boards offer 4 year vesting, but I’d suggest grants of 1-2 years if you’re pre-Series B. You can always renew a director’s term and give a new grant down the road. If you are later stage and are certain you’ll want a director for the long haul, there’s nothing wrong with doing a 4-year grant but even then, you get more flexibility with multiple shorter grants.
- Vesting terms. For directors, I always give 100% vesting on Change of Control. While this can lead to a windfall sometimes, directors will get fired 100% of the time when you sell the company, so there’s no reason not to be generous with them on this point. Notably, this doesn’t appear to be current practice, as we found over half of companies in Bolster’s board benchmarking study have no vesting acceleration provisions.
- Amount of equity. This is, of course, the money question, and since this data is always changing as we have new companies participate in our Board Benchmarking study (as I mentioned above), I hesitate to put anything concrete here. For the latest results, you can participate in the survey and see how our average benchmarks compare to your own board. In the meantime, though, I will reprint the relevant portion of Fred Wilson’s blog post on Independent Director Compensation below:
For compensation, I like to use an annual amount of $100,000. That is substantially less than public company directors make (which is more like $200,000 per year) [Note from Author - I have heard this number as high as $400,000/year], but being a public company director is more time consuming and exposes a director to more liability. So I feel like $100,000 a year is reasonable compensation for a private company director. The spread between private company board compensation and public company board compensation narrows as a Company gets closer to being public.
Private company directors are usually compensated in stock, not cash.
I like to use the following approach for stock based compensation:
- For companies valued below $40mm enterprise value, pay an independent director 0.25% of the Company per year served on the Board.
- For companies valued above $40mm of enterprise value, pay an independent director a percentage of the Company per year served equal to ($100k/enterprise valuation). For example, if your Company is worth $100mm, then you would pay 0.1% per year served ($100k/$100mm).
- It is typical to make a “front-loaded” grant of four years of value and vest it over four years. So in this second example, where the Company is worth $100mm, the independent director would be granted an option for 0.4% of the Company, worth $400k, and vest that over four years.
- However, for very early stage companies where the annual grants are quite large (0.25% per year), it is more common to make those grants annually so that the dilution from these grants comes down as the Company’s value increases. That said, front-loaded four-year grants are made for directors of early-stage companies as well.
- Equitable equity. As one final note, whatever compensation philosophy you decide, the important rule of thumb is to be consistent. Be on the lookout for any pay gap disparities that may exist among directors on your board. Where possible, seek to offer similar terms to all independents to keep a level playing field. This includes first-time directors.
For a more detailed look at compensation details across private company boards, I encourage you to participate in our Board Benchmarking study.
-Matt Blumberg, June 24, 2021