Compensation and commitment
Being on a board is a job. It’s not an honor, not a trophy. It’s not a lifetime recognition award. It’s a job and it involves work, lots of legal risks, financial risks, and reputational risks.
First Principle:
It’s okay to be paid. It’s not charity work.
Second Principle:
It is essential to maintain as much independence as possible, both in the appearance and actual independence. And there’s the obvious conflict that directors, in essence, set their own pay within a framework, and it’s very easy if compensation gets out of whack for independence to be challenged.
All directors ought to have “real skin in the game” and consider making an open-market purchase as soon as a window opens. This shows you believe in the company and that you are willing to bet your own money on it, not just the company’s.
There are benefits not to sell any stock until you are off the board. First, this gives you some protection in case you get sued. Second, it shows your commitment to the company’s success.
Be mindful that a director’s independence and approach to the job may be affected if the compensation they receive as a board member is much higher than their typical income, especially for some first-time directors. An example might be if a scientist makes $200,000 at their “day job” and makes $300,000 – $600,000 by being on one or two boards. There have been times when such a director has lost de facto independence because their financial strategy is now based on receiving that income.
When directors lose their independence, they can end up going with the management flow and not having the courage to do or say things that might risk their board position.
A director should always have the ability, and the guts, to quit. Usually, it never comes to that, but it is important philosophically.
- Directors need to behave like a long-term owner – they own and hold – they ride the ups and downs. It gives a director credibility with broad stakeholders, the employees of the company, and the management of the company. It is important that investors see that you have your own money on the line, the same way they have their money on the line.
- Some directors sell enough of their RSUs through a 10b5-1 plan to pay for their taxes. If you state upfront that this is what your strategy is going to be, then you can better defend your actions if anybody ever challenges them. While not all companies have a formula for how much of a company a director ought to own, the more your ownership goes up during your tenure, the more you show your commitment to the company.
Joining a board is not necessarily good for cash flow. You can end up negative on cash flow for several years because you get some nominal cash, you get shares that you have to pay taxes on, and you probably buy shares at the time you join.
NomGov committees must focus on the character of a potential director, not only their financial independence. Wealth does not guarantee independence.
Companies are increasingly stipulating minimum shareholding requirements. When you’re asked to be on a private board with a venture-funded board, or private-equity board, you have less credibility with the other owners if you have no skin in the game.
Compensation – during the pandemic and beyond
Given the situation of companies during the pandemic, boards and directors have been exercising various ways of structuring their compensation with cash, shares, deferred payment, reductions, and/or foregoing bonuses. Various factors go into thinking about these kinds of changes, especially the type of company it is, whether it takes government assistance or not, and whether there have been lay-offs or not.
Benchmarking is a standard process that your compensation consultant will help you go through to ensure you are competitively compensated as a board member. Together you will look at peer companies and work out how to get to a moderately safe place and check that you are operating within the constraints and guardrails of the proxy advisors. Err on the side of being conservative because the way you make money is through the success of the company. There is no advantage to being an outlier on board compensation.
Typical compensation package
When you join a board, usually there is an initial equity grant, a vesting strategy, and an annual grant that is made on the date of the shareholder meeting (or on some other fixed date).
In terms of other compensation, most boards today have cash retainers for board service and serving on committees and chairing committees. Very few boards have per meeting fees only, which used to be very common.
When “having some skin in the game” is a priority, equity compensation will almost always trump the cash compensation – it ought to be equity-based, and long-term equity based.
If there is going to be an annual grant to directors, the date of the grant should be formulaic so you are not in the position of having to pick a date each year. This practice will help you avoid old days of stock option backdating (where dates were chosen that would be convenient in terms of setting the strike price).
You receive a 1099 at the end of the year for your board compensation.
Some companies pay quarterly in advance, some pay in arrears, and most have an annual grant for equity. Companies just have to be consistent in the practice. Some companies offer deferred compensation plans for directors.
The CD&A (compensation discussions and analysis) in the proxy statement shows how much directors get paid, how much stock you own, what your equity is going forward, and what is paid for that peer group.
Opportunities to monetize and 10b5-1 plans
All new directors be aware that your compensation is not liquid 100% of the time. There are blackout windows when you can’t buy or sell based on the standard quarterly cadence. Occasionally, when there are significant events or potential transaction underway when you will be subject to additional blackout.
Most boards have a 10b5-1 in place. These plans force you to plan and schedule when you sell your shares. Using this plan takes away the judgement call and reduces the perception of selling due to specific circumstances within a company.
Although you are protected by having a 10b5-1 plan in place for stock transactions, you still have your reputation at risk if the transactions are suspiciously close of material events.
Even when the window to sell is open you should be sensitive to the optics. You never want to be seen to be buying or selling when you clearly have information that other people do not have. Even if it does not rise to the level of illegal selling or trading on inside information, be very aware of creating that impression. There is enough to be criticized for as a director, and you never want to be criticized for self-dealing.
A 10b5-1 plan must have everything specified in advance, including a timeframe, details about the stock price, sale date, and duration. The details must be formulaic and something that an investment bank can put into their system and then automatically execute the trade.
These plans can provide valuable protections, but do not think that you are always going to have four windows a year to put one of these in place. It can be difficult to come up with a time to do one of these plans. During the open windows, oftentimes you are going to have material non-public information that will preclude you from putting a plan in place.
As an example, a director on the board of a semiconductor company was buying a company every quarter. They tried for two and a half years to put a 10b5-1 plan in place, but because the company was always on the edge of buying something, they never could put it in place.
Research into whether these plans correlate with people making more or less money is sparce. Challenges in court are also rare.
Research is being done to study the opportunistic discontinuing of a 10b5-1 trading plan. If you have a multi-period trading plan, and you terminate that plan, the SEC may look back at the trades that were made earlier.
Remember that insider trading is a possession standard, not a use standard, so you potentially imperil yourself if you cancel a plan. A good approach to these plans is to wait 90 days before putting a plan in place and to keep it in place for 13 months. Other useful restrictions are to not sell in the last five days, or first five days, of a quarter. You will also want to avoid selling five days before, or five days after, earnings. If your companies encourage 10b5-1 plans, they should consider putting in some of these rules.
Corporations should encourage these 10b5-1 plans and set the rules. Setting these plans up is a good protection mechanism for both the corporations, the management team members, and the board members.
These plans take time to put in place and you cannot do it on your own. You need a broker to write it up and you need the corporation to sign off on it. Think about it at the beginning of an open window as opposed to the last week of an open window.
Your plan will include a separate exhibit that will be an agreement between you and the corporation that says that they have reviewed the 10b5-1 plan and that it is in-line with their policies.
Setting up a 10b5-1 Plan
Try not to overly complicate the plan. Avoid selling every month or every week, as this creates a lot of work for management and just looks bad.
You need to review these plans very carefully. Do not do a glossy-eyed reviewed of them because once it’s set up, you really do not want to terminate it. Terminating a plan starts to look like you’re just trading shares.
Two main reminders:
non-public information can really limit the time that you have to put one of these plans in place
there are a lot of people involved in this process, so you need to make sure you leave time to get the plan in place
Companies should consider making these plans the exclusive selling method available to their board. One way people have tried to game the system is to work with their financial advisor to sell shares during the closed windows under their 10b5-1 plan, and also sell shares in open windows outside the plan.
Difference between private equity board and venture-backed company board
Cash compensation seems to be a bit higher with private equity boards, and equity compensation tends to be higher with venture-backed companies.
Exits can be more lucrative because there is a definitive timeline in private equity that is shorter than VC, which is typically five years or less.
