Executive Compensation Best Practices

Why Executive Compensation Is Complex

For mature, venture-backed companies, executive pay refers to compensation for three layers of executives.

1. The top five executives (CEO, COO, etc.)
2. Senior and executive vice presidents
3. General vice presidents

Unlike pay for the general workforce, executive compensation requires sign off from the board of directors or investors. For pre-IPO companies, these approvers generally focus on the top two layers.

The influence of decision-makers outside the core operating team can make executive compensation complex, especially if their preferences don’t align with a company’s stage or compensation philosophy. (A compensation philosophy is the “why” behind how a company plans to pay and reward its employees based on the market, its finances, and goals.)

Also, executive compensation typically includes large investments in equity. This makes it important for board members to understand the nuances of equity ownership and implications for burn and dilution.

Common Executive Compensation Mistakes

Here are some things to avoid as you plan executive compensation at your company.

Mistake #1: Winging it

One of the most common mistakes made by new companies is hiring without a plan or letting candidates dictate their compensation. This creates a shaky foundation that won’t scale — and one that would generate compensation inequities often.

Companies who wing it will inevitably play catch-up by providing costly follow-on grants or restructuring their compensation programs.

A lack of strategy can also lead to expensive turnover. Replacing a CEO can cost 213% of their salary. For someone earning $200K, that’s $426K.

To avoid headaches, base your compensation structure on solid data and hire a head of people early to get compensation right from the start.

Mistake #2: Using the wrong compensation data

Basing compensation on the wrong data means you could underspend or overspend for talent.

To prevent errors, avoid self-reported data, or data that’s 12 to 18 months old. Instead, find a reputable provider who can give you fresh data that’s relevant to your funding stage and industry. This is critical – a Series A company can’t compare itself to a later stage startup or large public company.

Once you have your data, drill down to roles, experience levels, and location. And be precise about your needs to get the most relevant information.

If you’re benchmarking for an emerging industry where data isn’t readily available, look at the industries or segments that your target talent comes from. Use that data to inform your plan.

Mistake #3: Lacking long-term strategies

A strong compensation program includes a plan for dilution, refreshes, and additional grants, even if you won’t need it for years.

A plan for significant (and financially responsible) equity reassessment will help attract top talent and encourage them to stay. This is especially critical for founder executives who are approaching full vesting from the most recent round of financing.

Best Practices And Guiding Principles

Create an intelligent and competitive compensation program with these tips and strategies.

Best practice #1: Institute pay ranges

Pay based on titles can cause problems, especially in early stage companies whose executives juggle responsibilities typically handled by multiple individuals in varied roles. It’s hard to find the right data set for multitasking.

Pay ranges, sometimes referred to as salary ranges or salary bands, can help businesses solve for this variation in responsibilities. One strategy is to take a broad range of executive roles (whether they’re in seat or planned hires), gather and average their data, and build a pay band around this average. This band will address a range of skills sets and expertise.

Sometimes, you’ll need to make an offer above the pay range to attract in-demand talent for critical roles. In those cases, identify the skill set, industry, or previous experience you want and make your exceptions consistent.

Best practice #2: Lead with your best offer

Eliminate the back-and-forth of salary negotiation and present your best offer first.

This is a shift from historical practices that put the onus on individuals — who don’t have access to market data — to negotiate, outperform, and then fight for a refresh.

The responsibility now falls on companies to pay fairly, be transparent, and support individuals so they can perform at high levels.

Share the pay and equity ranges, where the candidate falls in those ranges, how their offer compares to the market, and how your company’s compensation philosophy was applied.

This removes the stress from salary discussions and helps create a culture of trust and transparency from day one.

Best practice #3: Pay for performance

How will you reward high achievers?

Creating and communicating a rewards strategy based on performance helps move salary discussions past the initial offer. It also clarifies expectations and paths for career progression.

A clear rewards strategy also helps in-seat executives create measurable and cascading goals tied to company milestones.

Non-Compensation Factors For Success

Hiring the right executives involves more than the optimal mix of cash and equity. Consider the following nonfinancial strategies as you develop your executive compensation plan.

Hire at the right level

Before you begin your search for candidates, get clear on whether you want someone on the promotion track or someone moving laterally. Are you open to hiring someone who’s ready to rise to their first executive role? Or do you want someone with proven experience?

Alignment of expectations gives people a greater chance to flourish.

Look for opportunities to hire internally

Companies with big budgets often look externally for executives and miss chances to reward high-performers with promotions.

Are there current employees you can groom for executive roles? This might not be feasible for all companies, but look for possibilities as you grow. Your advantage is having first-hand knowledge of a person’s strengths, accomplishments, and potential.

Employees stay 41% longer at companies with high internal hiring.

Conduct the Tahoe Test

Personality matters, too.

When evaluating a candidate, ask yourself the simple question that OpenComp’s founders consider during the hiring process: Would I want to drive to Tahoe (from the San Francisco Bay Area) with this person? If the answer is yes, and all other boxes are checked, it’s probably a good hiring decision.

Much like a long road trip, worklife is fraught with unexpected, stressful, and wondrous moments. The ride is better when you appreciate the company.

Practice transparent and open communication

Extend compensation conversations beyond the hiring process and annual reviews. Ongoing discussions about pay are core to a culture of trust.

Here are the pillars of meaningful compensation conversations.

• Consistency. This is key in compensation. Make sure everyone receives the same message and understands how compensation is handled across the board.
• Transparency and education. These two pillars go hand-in-hand, because information without context is meaningless. Don’t just share compensation information, help people understand what it means for them.
• Open door policy. Extend pay conversations beyond the hiring process and annual reviews. Executives, managers, and employees should feel comfortable and empowered to talk to each other about compensation whenever a need or question comes up.

Model Equity And Diversity

Executives aren’t immune from the black box of compensation or gender pay inequities.

In 2019, the highest-paid senior executive women earned 84.6 cents for every dollar earned by male counterparts. And females are underrepresented in the C-Suite 7 to 1.

Historically, women have been at a disadvantage in the workplace for many reasons:

• They’re often the only women in the room, especially at the executive level.
• Women have a harder time than men advocating for themselves. Even during virtual meetings, 45% of women business leaders said it’s hard for women to speak up
• Women who take time off to have children or care for families face a negative impact when they return to work. According to a Pew Research survey, 1 in 5 mothers said they were passed over for a promotion or important assignment, while 27% said they were treated as if they weren’t committed to their work.

To build a diverse workforce, executives and boards must have open discussions about it, analyze internal data, and set recruiting goals and requirements.

Don’t overlook the opportunity to model a commitment to gender and racial diversity and equity from your C-suite, executives, and even your board. Successful cultural shifts are advocated for from the top.