Equity Compensation has been slowly going through its own version of climate change. Much like our planet, the environment for equity compensation has been changing for decades and very few have adjusted or even noticed. Whether you agree with the causes of climate change it is hard to deny that weather is different than it was even 50 years ago. Regardless of the driving forces, it is impossible not to recognize that equity compensation is delivering different results than it was when it became the major currency of tech startups in the 1980s and 1990s. The question at hand is if or how companies will address the issue,
- Monolithic plan design is no longer effective
When equity started out it was relatively easy. You granted stock options, probably Incentive Stock Options (ISOs). They vested annually over four or five years. Only your US employees received them. Big companies paid in cash and were not a challenge.
Over the past couple of decades, there have been changes to accounting rules, tax codes, dilution models, extended times to an exit, global workforces, and more. Through all these most companies have continued using stock options, vesting schedules have changed slightly (most are now three or four years and vest multiple times a year). Companies use RSUs more frequently, but generally only when forced. Nearly every company, in just about any industry, uses equity. Things have changed, but I don’t think we can argue they have kept up with the surrounding environment.
- Long-term is increasingly short-term
It wasn’t uncommon to have grants with 25 year lives in the 1980s. The ISO rules restricted the tax benefits to a life of 10 years and companies followed the path of least resistance for all grants. Vesting was designed to get the company and the participant to a potential exit event.
Today it takes longer to reach and exit than in those heady early days. At the same time, executives and employees are increasingly less patient. Three years is considering by many to be a reasonable time to build value. In some cases, companies are exploring “long-term" awards designed to retain people for one year!
- Funding rounds are bigger, but equity percentages haven’t changed
IPOs are a funding round. Companies looked to an IPO as the major funding round required to move them from a start-up to a competitive business. They were the ultimate value creator and liquidity event.
Today the average pre-IPO company seems to be a “unicorn.” Companies can be so well funded without tapping the public markets that IPOs are used as an escape hatch, not a necessity. With so much money pre-IPO, there are still very few companies that have made the effort to allow for employee liquidity prior to an IPO.
I can, and eventually will go on. This article was originally created with 5 reasons, which quickly morphed into eight and the makings of a whitepaper or e-book. Once have a foundation of the challenges we face we can begin to discuss why this is happening. We can discuss why investors, boards, and founders have done so little to address the challenge. We can discuss long-term, lasting solutions and what they will take to become real. But, for now, we need simply to first recognize the changes are taking place around us and will not fix themselves.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.
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