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Q&A With Dee DiPietro on Startup Compensation

In a previous post I mentioned Dee DiPietro, CEO of Advanced HR, who is a seasoned startup compensation expert. Well, over the past couple of weeks, I've had the opportunity to have an email Q&A session that I put together here on the topic of equity compensation philosophy in startups.

FN: What philosophies have you seen work in terms of how to use equity to compensate employees?

DiPietro: Although compensating at the 75th percentile of equity is always a great practice, the key to a successful equity program is communication versus any one particular strategy. I have seen many lucrative programs that were marginally effective (read as employee discontent and turnover) due to a lack of communication to employees – resulting in a lack of belief about potential value or position against the market. In the absence of information, people tend to construct their own information which is typically not the same information as the company beliefs. A second key to a successful program is hiring the right people for the right stage of company development. Early stage employees that are comfortable with a larger equity stake and higher risk may not always be a long term fit for the later stage company. Conversely, more risk-adverse people do not typically value equity compensation as highly and opt for a later stage package with a larger cash component. This does not mean that salaries are significantly reduced in private companies as was typical prior to the late 1990s but rather positioning in the market and the size of cash bonus provided.

FN: What’s your view on option refreshes?  When do they work and when not? 

DiPietro: Option refreshes are now a critical part of an equity program due to changes in acceptable metrics for private companies to achieve before an [exit]. Up through 2000 when a typical path to an [exit] was about 4 years, a refresh program was not conventional in privately held, venture backed companies – although I personally found this practice a bit short-sighted for retention after an IPO or sale. Now that the models for development have changed to larger revenues with typical development times of 5 – 6 years, a four-year grant without refresh is not an effective retention tool. Most companies wait until vesting is at least 75% or three years complete before implementing a refresh program and this practice puts the company in a reactive versus proactive position. At this point, the early technical team is seriously considering diversification, especially in light of a lack of information about refresh practices. So, for each person who gets an offer from a public company, the thought process goes like this: I am valuable but not critical to success so they can replace me, the company will go on and my stock will be worth something. I will get a sign on bonus and have two weeks of vacation that will need to be paid so I have enough cash to exercise options the 80% of my options that are vested. I will get an increase in base salary of 10-15% and I will get an annual cash bonus of 20% so I will have paid options in a private company with potential upside and a cash package from a more stable public company. In successful schemes I have developed, companies do not wait as long to implement refresh programs but there were difficult choices to be made and communicated to the board. The primary factor in developing an effective compensation program which includes refresh is the competitive stance required for the labor market in which you are competing for your talent.

FN: Is there really a cash-equity tradeoff?

DiPietro: At the executive level where there is a larger amount of equity being given, most definitely. Data typically shows a 20-25% reduction in exec comp compared to small market cap companies. For a few early hires who get a larger equity stake, quite possibly more. But for most positions, no. A company is lucky to be able to use equity to offset bonus for some period of time.

FN: It seems that use of equity ebbs and flows, where is it now and what’s the outlook?

DiPietro: The changing practices in public companies will make use of equity for staff level positions more strategic and less prevalent as many have focused changes necessitated to address equity spend and dilution issues on the staff level grants versus executive. However, the use of cash has increased significantly to offset these changes. In response, privately held companies will need to determine the best use of their available compensation elements to compete effectively. In consideration, one might wonder what this will do to current investment models and the decisions boards will make when faced with increased cash spending resulting in a delay of liquidity versus increased option pools resulting in reduced investment return.

Startup Seeks CFO In DC Metro Area

As a follow up to a recent post on Mobile Posse, I wanted to mention that the company is currently recruiting for a CFO.  This is a new position just created after closing on a $10 million round of venture capital.  Details of the job description are here, however the quick summary is that they are looking for a seasoned startup veteran (i.e. previous experience as CFO of a venture backed company, ideally with a happy exit).  I can attest that this is a great company with a strong team and prospects and they are the clear leader in mobile idle screen advertising...heck, I'd apply myself if the company were in Boston!  If you or someone you know are interested, feel free to contact me or the company directly as indicated in the job description.

Hiring Your First Salesperson

I was recently asked about this topic by a talented first-time founder/CEO and decided to post this excerpt from my response.

So you want to hire your first salesperson?  As founder of your company, you have raised some initial capital, recruited your initial development team and even gotten your product to a beta level.  Now, you're talking to customers and starting to sell in earnest.  This is a pretty important milestone and decision for you and the company.  Here's a couple of tips based off my own experience.

• If your background isn’t in sales, then you should find someone whose background is to help you hire the right person. Salespeople interview well so if you don’t know how to cut through that you’re in for a ride. But the key is to find someone who’s hired 100+ sales people and sales managers in their career and leverage their experience. Put them on your advisory board and interact with them frequently.  You might even retain them as a "buyers agent" to help with recruiting.  Ask them to do actual interviews and help source candidates as well.
• When in doubt, "hire junior."  Except in rare cases, it is probably premature to hire a VP of Sales that you’ll keep for 2+ years. You want someone who’ll be out in the field selling and bringing back customer feedback (and sales!) probably more of the former in the first year. Terry Gold wrote a good blog post on this some time back.
• Depending upon how far along the product is, you may also want someone who doesn’t fit the classic sales mold. Ideally, the person who you hire will come back and help translate why the “customer said no/not now” (or "yes" for that matter) into new product features/pricing/packaging. Someone who has product experience or maybe even someone who once worked on a help desk for a product selling into similar firms could work.
• Read and re-read the “Sales Learning Curve” by Mark Leslie. While it’s not directly relevant to every company, the principals are the best I have seen on how to bring a new product to market and who to recruit to do that.
• In terms of structuring compensation, be careful not to apply a classic sales compensation package. If you hire someone with a comp package of $70K times two with commission on sales, you’ll end up getting pulled in a direction you may not want to go. In my experience, the right compensation package is a base plus discretionary bonus that gets them to an on-target earnings you both are comfortable with. You’ll want to agree with them to review the metrics every 3-6 months. Put them in writing. To pull this off will require establishing some trust between you and your new hire. Take the time to develop it.
• I would stay away from hiring through traditional job boards for this position. Assuming you don't know someone already, I’d place an ad on LinkedIN jobs and also spend a bunch of time doing searches on LinkedIN for people who might be a fit or who may know someone who would. You will want to upgrade your LinkedIN account so you can do searches and send intro notes (costs a couple hundred per year for a biz account, I think).  Network with sales people you admire. Call some of your customers/beta users and ask them who are the sales people or companies whom they admire. I found this to be a great source of candidates early on.

The Future of Job Recruiting?

I just saw this.  This is huge!  Why are job postings text?  Why not video?  The future?

Death of Headhunting

Long term, the market for recruiting companies will shrink, commissions will fall and many recruiting companies will go out of business (all the while employment and the number of jobs filled will increase).

Let me make my case by providing an analogy. The job market is a marketplace, just like the stock market in many ways. There are buyers and sellers, there are regulators, there are data vendors and brokers. If we look at the stock market in general, and the NYSE in particular, as a parallel, the last few years have seen a huge wave toward greater transparency and greater efficiency through electronic connectivity. One of the byproducts of these trends is that there has been tremendous pressure on brokers and market makers (to the point that many have gone out of business).

Essentially what happens is that the buyers and sellers have more information and great access to each other directly (LinkedIn is a great example for human capital) which reduce the need for brokers (who historically relied on their relationships to justify their commission).

Then there is the argument that certain jobs are too sensitive to recruit directly, a CEO where the incumbent is still at the company for example.  I don't buy this argument.  Wall Street used this excuse for a long time (if I had 1 million shares to sell, I'm worried about that information leaking out so historically I'd go sell the whole block to a market maker who would deal with it from there).  Well, that bubble was burst when Liquidnet created a billion dollar business crossing anonymous block trades and today these crossing networks are all the rage.  The same thing could be done w/ LinkedIn or other online / relationship tools for recruiting.

Here's a simple test for CEOs who use headhunters to illustrate my point.  Are you using carve-outs in your engagement letters and is the list of executives who are carved out getting longer?  My bet is yes.

Smart recruiters will embrace this new environment in the same way that progressive brokerage firms embraced electronic trading. Some new types of recruitment firms will emerge (in the same way ETRADE and others evolved in the trading business) and many recruitment firms will simply disappear because they can no longer charge for the "relationship" (how can they charge if the hiring manager and the candidate are connected on LinkedIn?).

I also think that smart recruiters will evolve so that they advise companies on "what type of person they should hire" as opposed to "filling an order" in the same way that smart stock brokers evolved from executing the trade to advising money managers on what trade to do.  The companies that use headhunters will do more internal searches first before resorting to recruiters and they will have more and more carve-outs thus putting pressure on commissions.

It's hard to say over what period of time this change will happen. For the NYSE it took 10-ish years. I would think that the human capital market will evolve more quickly, say the next 3 to 5 years, because there aren't any NYSE or LaBranches of the world to slow things down and technology is evolving at an ever faster pace.

10 Things To Consider Before Joining a Startup

So you've decided to consider joining a startup.  Whether this is your first time or the most recent in a string of many, there are several things to consider, particularly when compared with an opportunity at a larger, more mature company.  For purposes of this post, by startup I mean a company that is small (less than 50 people), has little or no revenue, is not profitable, may or may not have outside investors and is unproven in the marketplace.  So, here are some tips for candidates considering making the plunge:

10.  Calibrate your expectations.  Unlike mature organizations with an HR department, formal recruiting programs and on-the-job training, your startup probably doesn't have any of these.  The recruitment process will seem jerky, but that's probably because the people you are interviewing with just pulled an all-nighter preparing an investor pitch, writing some code or otherwise doing something that, in their ideal world, you would have been helping them with.  Mature companies can afford to have people dedicated to recruiting but you won't find that in most early stage startups so it's best to reset your expectations now before you get disillusioned.

9.  Discuss the move with your family and friends.  The beauty and bane of startups is that they are an emotional roller coaster ride.  One week you'll have launched a new release, signed your biggest new account, landed some great press and then, the next week, you're firefighting production bugs and trying to keep your customers while running out of cash.  Even if that sounds like fun to you, your friends, spouse and children might call it something else.  While resetting your own expectations, it's best to discuss your thought process with those around you and use the opportunity to educate them as well.  The more you do this up front, the easier it will be down the road, particularly when the company hits an inevitable rough patch.  In this case, it's better to ask for permission rather than forgiveness.

8.  Get to know the team.  For early stage companies, odds are there is really not much behind the curtain other than some (hopefully) smart, motivated people.  Joining the company means that you will probably be spending more time with your coworkers than you will with family and friends so my advice is to get to know them.  If you're not invited to a social situation as part of the recruiting process, invite yourself.  Are these the kind of people you'd like to hang out with outside of work?  Do they seem to get along well with each other?  Have they created a work environment that suits you?  At my last company, I purposefully left the foosball table in the lobby (originally because we didn't have any other space) in part to send a message.  What messages are you seeing?

7.  Do your homework. While this advice applies to all companies, I think a lot more diligence is warranted when considering joining a startup.  Almost like a VC, you want to understand the market, the competition, the company history, the product, etc.  Do as much diligence as you can.  Ideally you want to independently find customers, former employees, competitors, partners, etc.  Talk to as many as you can.  I recommend using LinkedIn to help with this process.  If you are persistent, you can find out a lot about the company and the market.  Not only will this help with your interviews, it will help you come to an informed decision on whether to join or not should you be offered the job.

6.  Expect the unexpected.  In early stage companies, you're probably going to be interviewing with people who are a level or two higher in the organization that you would in a more mature company.  If you're interviewing for a VP role, you might meet with a board member; if you're interviewing for a developer position, you might meet with the CEO or founder.  I know one founder who often used to ask candidates if they had ever been in a fist fight.  Sometimes I would conduct an interview over a game of foosball.  The senior folks in the company have probably gone through a lot of VC pitches and know how to dish it out as well as receive it.  If you go in expecting to be pushed off balance, you'll be better prepared.  The goal of this, I guess, is to get you to drop your guard and see how you think on your feet.

5.  Surprise them.  The parallel to my previous point is for you to take the opportunity to test the folks you're interviewing with.  It doesn't necessarily have to be something big or shocking.  For example, when someone worked at a large organization previously, I like to ask them about how the company is organized to get a feel for their responsibilities in the position (which isn't typically obvious from the title...I think almost everyone at Goldman is a vice president, for example).  Anyway, I recall a candidate who after a couple of questions, jumped up to the white board and started diagramming the org chart for the firm.  I was impressed not only with her confidence but with her ability to communicate simply and concisely.  So, my advice is to surprise them.

4.  Check references.  I confess that I've never seen anyone do this, but I would be impressed if someone did.  Every good company serious about hiring someone asks them for a few references.  I'd recommend responding, "but of course!  Would you also mind if I checked a few references on the firm as well?" 

3.  Be prepared to discuss compensation.  Odds are that by working for a startup you will be making less in cash and other compensation than if you went to work for a more mature company.  That's partially offset by a "lottery ticket" in terms of equity options, but I'd argue that the best reason to take the hit is for psychic reward.  That aside, you should familiarize yourself with vocabulary and mechanics of stock options.  There are a ton of resources on the web.  For senior positions in a startup, there are some really good comparables available in this study conducted by Prof. Noam Wasserman at HBS.  Everyone has a different strategy on this, but mine is to be straightforward and, when asked about compensation, to respond, "here's what I need to keep the lights on."  If you and the company do well, then you'll certainly be making a lot more in a short period of time so haggling over a few pennies up front is really not worth it.

2.  Act as if you are an investor, because you are.  In light of the aforementioned hit to compensation, you will be, in fact, an investor in the company should you join.  The most successful team mates I've had in a startup really viewed themselves and acted like they owned the whole company.  Not from an ego perspective, but by continually asking, "is this the right thing I should be doing for the business?" and then acting upon that.  Thinking like an owner causes you to see the forest through the trees and when strategy is changing that is critical for success.  If it's not in your DNA to do this, I'd suggest startups aren't the right career path.

1.  Build a culture you enjoy. So you've decided to join.  What you'll find is that in a company this small, you can have a major impact on the company culture (something not possible in a more mature company).  Whatever level you join at, you can have a big impact.  If you're annoyed by meetings that start late or run on too long, probably others are (or will be) too so you can take it upon yourself to change things.  This is the beauty of startups, you can do so much more than your "job."  Start a weekend ultimate frisbee group or create a company book club.  All of these things will make you more successful at the company and the company more successful...not to mention more enjoyable along the ride!