Essential Steps in Developing a Compensation Plan

Make the compensation planning process successful from the start by developing a company specific strategy and effectively communicating it to management.

STEP 1: INPUT INFORMATION & STRUCTURE ORGANIZATION — Proper data comparisons, projections, and employee organization will assist in building the correct compensation plan for your company.

Data

Accurate data metrics are essential to pulling the correct data and ensuring correct company comparisons. Based on accepted practices at the board level, capital raised is the correct data set to use unless the company has annual revenues of $25M+ at which point a revenue-based data set is generally more acceptable.

Hiring

Projections are a must to understand your total budget. In order to forecast the actual cost of the plan, you will need to use both current employees and hiring projections. A 12-month hiring forecast is typical for communication at the board level.

Review Workforce

This review is critical to the future success of your compensation plan. Be sure that all employees are leveled correctly and have the correct families associated to ensure the best data comparisons available. Levels relate directly to how market data is collected and reported so modifying the actual structure is not advised. However, some companies do add company specific attributes to each level.

STEP 2: CONDUCT A PRELIMINARY EXECUTIVE REVIEW — Discuss high-level company strategy while looking at preliminary data. Gather strategic information from the senior team to align expectations.

A. Review Preliminary Analysis

Once your initial review of the workforce is complete, you can view your employee market position for both cash and equity. Please keep in mind that this analysis is based on market data and a company strategy against the data is necessary.

• Data Usage: Private company data should be used for benchmarking executives and staff-level equity compensation. It’s seen as best practice to compare staff-level cash comp to public company data, as these employees do not typically receive enough equity to accept significant cash discounts. It is important to reference public company data so that you remain competitive in the broader labor market when trying to attract top talent.

B. Develop an Executive Overview

We suggest an initial discussion with the CEO and CFO that covers the following information:

• Data Usage: Provide a statement of data usage that defines what data sets were used and when.
• Company Compensation: Compare founder, investor and employee holdings to market data.

1. Identify the differences and understand why they might be occurring. For example, are there relatively few employees compared to the equity raised?
2. Are there any limitations to the amount of dilution (additions to the stock option pool) that have been discussed at the board level?

• Executive Compensation: Review executives by position to confirm correct job family/level selections and discuss expectation and strategy.

1. What is the market strategy (cash v. equity) needed to recruit going forward?
2. What does cash compensation look like in terms of market adjustments and bonus plan? Note: executives typically receive adjustments versus merit pay.
3. Is there an equity retention plan for executives?

• Staff Compensation: Review preliminary market data and vesting, then discuss expectation and strategy. It’s a good idea to prepare the market data available as sometimes execs want to look at a specific person.

1. What is the market strategy (cash v. equity) needed to recruit going forward?
2. Should ranges target a different percentile of the market to accommodate competition? Groups such as engineering might require a >50th percentile market strategy.

Example: A SW Engineer (>8 years of experience) base salary being driven by specific labor market competition; Data from early 2017.

3. Will a merit plan be used?

4. Is it time to consider a bonus plan?

5. What is the plan for staff-level retention?

6. How much equity should be used for retention? How should the grants vest?

Best Practice: “Tag” vesting onto the back end of a new hire grant to create a horizon of unvested stock. Approve an option grant now, locking in a lower strike price, but delay vesting until the new hire grant is vested.

Aggressive Retention: 25% of a new hire grant annually for top employees and 10% of a new hire grant annually for great employees.

Here is a sample way to organize plan information for discussion.

• Hiring: Review to determine that the correct employees have been captured as hiring plans change rapidly at times.
• Logistics and Program Administration: If the company has not already decided on an administrative approach, the following points should be discussed:

1. When will cash and equity be distributed? Employee anniversary is typical in a smaller company whereas an annual review and distribution is typical in a larger company.
2. Should the budget be allocated by each manager or a central group? A central group is typical in a smaller company whereas manager allocation is typical in a larger company.

STEP 3: MEET WITH DEPARTMENT HEADS — Reviewing employees with the head of each department is essential to proper employee skill and key talent assessment. This is a two-way conversation discussing the company’s general compensation strategy.

A. Job Families

Are the selected job families correct? At times, there is not a perfect match so you need to find the best fit.

B. Levels

Revise levels to make certain that employees are with their peer groups and title inflation is not affecting their current level.

C. Key Status

Which employees are more important to retain? Is the assessment combining performance with critical skills or just looking at performance?

D. Market Strategy

Understanding the needed position against the market data from each department head/recruiting point of view will be useful when building cash and equity ranges.

• How do you need to pay against the market?
• What strategies should be used when market data is insufficient or does not represent company practices? Which departments are similar?

Product Management: Many companies pay product people like engineers, however, the market data doesn’t support this practice (some companies pay their product people like marketing people). If your company values product like engineering then think about paying your product people within the same ranges as the engineering team.

Data Science and Design: These are relatively new functions from a data collection perspective. Many companies pay these people like engineering while some pay these positions more like marketing people. If data is scant, attach the data science or design ranges to another department based on value to the company.

QA: Market data typically shows that the QA function receives about 10% — 15% less than engineering. If your company considers QA to be more integral to the development process then consider paying the QA team the same as the Development team.

STEP 4: BUILD OUT YOUR COMPENSATION PROGRAM — Market data is only a reference point and not the sole answer to your compensation planning needs. The real planning comes from building a program that incorporates market data with company strategy to understand the full cost in both cash and equity.

A. Review Final Analysis

Has the preliminary analysis changed significantly? Is an additional meeting with the CEO and CFO needed to reset expectations?

B. Build Strategic Ranges

The object of ranges is to (1) create a market strategy and (2) smooth erratic market data.

Create a streamlined structure: The most basic ranges are: Executive, Technical, Business and Sales.

1. Combine or link departments with the idea of creating as few ranges as possible.
2. Staff-level base salary ranges are generally constructed with ~10% differential between range midpoints for each set (ie; technical vs. business vs. sales).
3. If the equity data doesn’t look reasonable, staff-level equity ranges are generally built with business at ~85% of technical ranges and sales at ~75% of technical ranges.

Set the Market Strategy: Consider the following when setting the “percentile of market”:

1. What did the analysis say about current employee compensation? It might not make sense to set your mid-range at a lower percentile than you’re already paying.
2. What percentile of market do the hiring manager or recruiters believe is needed to be effective in your labor market?
3. Decide if base salary ranges should address total target pay data or just base salary. Some companies chose to forgo the administration needed for a bonus plan and increase ranges.

Tips for Consideration: Good rules of thumb include:

1. Decide if you will develop a bonus plan. If so, will it only include specific levels of the company or will it be company-wide? Sales departments are not typically included in bonus plans due to commission or incentive pay plans.
2. While you may want to create geo-specific cash ranges, you might not want to create differing equity ranges — especially within a single country or continent. Most non-US jobs have equity of between 60% and 80% for comparable US jobs.

STEP 5: FINALIZE THE PLAN — Meet with the CEO and CFO to discuss cost and finalize the plan.

• Data Use and Project Methodology: Include a statement about the private company data cut.
• Company Ownership Analysis: The current breakdown of founder, investor and employee ownership and a comparison to market data.
• Staff Compensation Analysis: Department-level cash and equity comparisons to market data.
• Executive Compensation Analysis: Individual comparison to market data for cash and equity.
• A statement about strategic market position and targets for staff and execs in both pay and equity, including refresh.

Staff Compensation Recommendations:

Retention/performance strategy overview.

Proposed cash needed for merit, adjustment and bonus by department.

Technical equity ranges along with differentials for the other groups/departments.

Proposed equity needed for refresh and adjustments by department.

Executive Compensation Recommendations

Proposed base salary increases and bonuses.

Proposed equity adjustments and retention grants.

CEO Compensation — Often times the CEO will have a separate slide for discussion that repeats data or makes a statement such as “CEO prefers package more heavily weighted with equity.”

Option Pool Needs:

Detailed option pool needs for both current employees and hiring projections to show total estimated options required. If an option pool increase is needed, provide the resultant total employee ownership post pool increase and new percentile of market if necessary.

Now, get started on the compensation plan for your next cycle!

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