Budding leaders of emerging companies don’t often spend a lot of time thinking about how they’ll be paid five years down the road. Validating a concept and building an organization takes precedence. But compensation issues will need to be addressed at some point. To chew on that topic, Post Editor Geert De Lombaerde spoke recently with Bruce Doeg, a partner at Baker Donelson Bearman Caldwell & Berkowitz and chair of the firm’s business department, which is home to more than 200 attorneys. Here are some excerpts from that conversation.
Post: How should entrepreneurs think about paying themselves and other key people in a company’s earliest stages?
Doeg: In the first stage before outside capital arrives, you’re often thinking about compensation only in terms of stock and maybe you take some of the cash that’s left around. At some point in a young business’ growth, outside capital comes in. When that happens, you’ll often see the use of employment agreements for the first time. That’s usually at the behest of the investors; if they view the founder as critical to the company, they’ll want to make sure the founder is also invested in the company’s success. And for the founder, it’s also a good thing to have a clear path.
Do you typically see features such as long-term incentive plans at this time?
You tend to see some incentive structures here because of the outside capital. It’s often a combination of stock options or shares, some form of salary and sometimes some cash incentives for reaching certain milestones such as the sale of the company.
Here’s chance for you to tout your services: Should a founder bring in professional help when drawing up that first real contract?
It’s a good time to consider doing that. It’s often the first time that you’re putting in writing what you expect to receive for your work. And because it’s the first agreement, you should look at it as a basis for future contracts. So in that sense, it’s important to get it right and set the proper tone and expectations.
So let’s forward 18 months and say that things are going swimmingly and the investors are happy. How might the conversation about compensation be changing?
You’re starting to see a bit of a market check. The investors will compare the pay structure to their other investments and what they’re paying people there. And the founders are probably doing the same thing. There might be an evolution underway that would involve formal compensation advisors in the future but at this point, to be frank, it’s all still very informal.
Another component that helps in this process is that you’re adding people to the management team. As you do that, you’re opening up your approach to the broader market. What you have to pay to lure new talent will necessarily impact what you are paying to existing talent.
So it’s a very organic process.
Right. Add to that that you also have investors and board members bringing their own expertise and experience.
I would imagine the same changes take place when it comes to identifying peer groups as a company grows.
Yes. Investors will again bring a lot of expertise and as you’re hiring from competitors and elsewhere in the market, you’ll get information as to where you stand. And if you’re engaging someone to help you recruit people, they’ll generally have information to tell you if your compensation is competitive.
What are some of the best practices when it comes to the use of equity at this point?
Tying the vesting of options or restricted stock to performance targets is an accepted practice, but it can hard to figure out what exactly the measurable goal should be. In highly regulated industries — medical devices, for instance — you can set milestones that are very clear. For example, FDA approval. But it’s much harder to do in technology or other fast-growing industries, in part because companies are often pivoting in new directions throughout their evolution.
So without wanting to oversimplify things, it sounds like a lot of these questions come down to keeping your antennae up and being proactive?
Well stated. It’s key to have a good understanding of the prospects of a company and the marketplace. Things change rapidly so you have to be flexible.