Startup Boards for CXO’s Series: Post 5 of 11
Independent directors in privately held early-stage companies are compensated for their board contributions, just like they are in publicly traded companies, although the numbers and currencies are not the same. In this post I will talk about the compensation package so that you’ll have an idea of how things work at startups. As always, there may be quite a bit of variation in the details, but the broad categories of compensation, what you should expect, and what to negotiate for are fairly similar across most situations you’ll find in the startup world.
I’ll tell you right now that you won’t be compensated in cash and asking for cash from a private early stage company is a red flag to CEOs. What you are likely to get as compensation in lieu of cash? Equity, of course! If you ask for cash a CEO is likely to quickly respond with “no,” or respond that they’ll consider a consulting or independent contractor relationship not directly tied to the board seat. But you’ll be shooting yourself in the foot by asking for cash if what you really want is a board position. Why is that? Nearly all startups are strapped for cash–even companies that have received significant funding–so spending money on the board of directors is out of the question. Asking for cash compensation is a clear indicator that you don’t understand startups and also don’t value the alignment that comes with equity.
The standard equity instrument for directors is Non Qualified Stock Options priced at fair market value. Some companies may offer Restricted Stock or Restricted Stock Units instead. You could negotiate for the instrument that optimizes your tax liabilities, if you can and if it matters to you, but otherwise there’s no good reason to negotiate or care about the equity instrument. It is what it is and most CEOs will only offer one type of stock unit to all board members equally.
The other component of equity is the vesting period. I touched on this topic briefly in an earlier post on Size and Composition of Boards There is a little bit of wiggle room on the vesting period so this is a point that you’ll want to address during your due diligence process. I am a strong proponent of doing smaller, shorter vest option grants, at least for early stage companies whose needs are very dynamic, but there are other approaches, too. I like grants of 1-2 years because it allows me more flexibility in building my board. I can always renew a director’s term and give a new grant down the road. If it turns out that a director is adding a ton of value, or my company is at a later stage, I’ll consider a 4-year grant, but the flexibility of short vesting periods is incredibly valuable in the very early stages of building a company. So, as a director I think you have some flexibility yourself to negotiate on the vesting period as long as you’re aware of what stage of growth the company is in and what your own preferences are for the term of your commitment.
With vesting comes vesting terms and here, too, there are options available to CEOs. I always give directors 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 from my perspective there’s no reason not to be generous with them on this point. However, other CEOs may differ and this is another point that you’ll want to figure out and possibly negotiate as part of your compensation package.
Once you figure out the equity instrument, vesting period, and vesting terms you’re left with the big question: How much equity will you get? What should you negotiate for? Can you even negotiate this point? There’s bad news and good news on actual board compensation. The bad news is that no one really knows what’s going on because private companies don’t share that information. The good news is that Bolster is conducting a first-of-its-kind Board Benchmark study with a range of survey questions that will shed light on private company board practices, including compensation. I’ll circle back to the important topic of director compensation once we have some data to share but for now we’ll have to look at general approaches to board compensation.
Fred Wilson is a long-time VC and has served as a director on many, many boards (including my board at my prior company, Return Path). He wrote a blog post on Independent Director Compensation and the highlights are 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) 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.
Author note- I have heard this number can be as high as $400,000/year, although the difference from Fred’s post might be the difference between cash-only and cash-plus-equity value.
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.
My major takeaway from Fred’s post is that there are some rough guidelines on how much equity board directors receive in compensation and it’s possible as an independent director to negotiate this point. But don’t be surprised if you’re met with a non-negotiable response by the CEO, especially in later stages where stock dilution comes into play.
One other related topic to the compensation package is to make sure the company has appropriate Directors & Officers (D&O) insurance. You want to ensure that you have current and ample insurance and you should ask to see the policy and go through it in detail to see what’s there, what the terms are, what the coverage is, and what liabilities you may be exposed to. If the company already has venture capital board members, you can be almost certain this box is already checked, but it never hurts to ask.
As a first-time director on a board at a startup you may have some flexibility to negotiate certain variables in your compensation package, but the main point to understand is that your compensation will be in equity, not cash, and that it will vest over time. Besides understanding what “market” is for this (in our forthcoming research), the best question you can ask when the CEO makes you an offer is “is this fair in the context of how you’re compensating other independent directors either today or historically?’ You shouldn’t have a specific earning target in mind here so much as you want to be fairly treated. Remember also that you’re getting hugely valuable experience and a career step out of this, too.
--Matt Blumberg, May 4, 2021
