Beyond Salary: How to Build a Winning Executive Compensation Strategy
Executive compensation can be a hard topic to tackle, especially for startups and other growing companies that need to attract experienced talent on a smaller budget. What you may not know is that base salary is the smallest component of executive compensation, generally outweighed by incentive pay. That is good news for growing companies with smaller margins; your creativity will be rewarded.
It’s common for executive compensation to be structured to reward actual results. That means you can get top talent with a lower upfront investment, as long as you compensate executives fairly for their contributions to your company’s growth. Generally, this compensation will reward short-term accomplishments in the form of annual bonuses and long-term success through cash bonuses, stock, and equity.
You do, of course, need to keep in mind your overall budget while building a package that will help you attract and retain top-quality executive candidates. That is why it is crucial to keep your priorities straight and focus your efforts while crafting your compensation strategy so that you reward what matters, which is why it’s a good idea to align compensation strategy with your company’s short and long-term goals, backed by concrete KPIs that will track objective executive success against those goals.
Let’s explore the building blocks of executive compensation and take a closer look at how you can leverage each element to attract and retain experienced executive candidates, even on a limited budget.
At its most basic, executive compensation is divided into two parts: guaranteed income and at-risk income, or base salary and incentive pay. As we mentioned, incentive pay will make up the majority of most executive compensation packages.
There are four key elements in most executive compensation plans. These are:
- Annual base salary
- Annual incentives or bonuses tied to short-term KPIs
- Long-term incentives tied to long-term KPIs or financial objectives
- Benefits plan
In addition to these fundamentals, there are two more types of compensation that you can use to make your offer more appealing to experienced candidates. These additional benefits are:
- Executive perks: extra perks not offered to other employees (e.g., access to a company car)
- Contingent pay: severance coverage
These are the building blocks of executive compensation, but how large a role each element plays in your compensation strategy will depend on your specific priorities and budget. The standard proportions are 30% base salary, 20% annual incentives, 10% benefits, and 40% long-term incentives. As you can see, there is a lot of room to reward your executives once they have helped your company grow. Now let’s take a look at each of these categories and how you can approach them effectively.
Structuring Base Salary:
As we mentioned, base salary is a smaller part of executive compensation than incentive pay, and you can still attract top talent even if your means to provide a high base salary are limited. In addition to your company’s own budget, several factors will affect the compensation that executive candidates may expect you to offer, including:
- Desired experience level of executive candidates
In many cases, you may have to offer executive candidates a higher salary than even your experienced non-executive team members. However, if you make your incentive pay appealing enough, you can get extremely qualified executives for a surprisingly low base salary.
Another strategy to attract more experienced talent with a lower annual commitment is to offer signing bonuses. These upfront payments reward executive candidates for joining your company, making your offer more appealing with lower ongoing costs, giving greater flexibility for growing companies.
You can also stretch signing bonuses over time, for instance dividing them into four quarterly payments over the first year, allowing smaller companies to offer higher signing bonuses. You might also want to consider offering signing bonuses in the form of stock options, to vest over the executive’s first years with the company.
Now we’re getting into incentive pay territory. Short-term incentives reward executives for their contributions to the company’s growth and success over a regular and brief interval, generally a single year. The most common form of short-term incentives are annual bonuses based on short-term goals and key performance indicators (KPIs). What these are will depend on your own company and its priorities and goals, but here are some common examples:
- Increasing revenue
- Improving profit margins
- Implementing a new strategy
- Developing a new product
- Expanding into a new market
- Completing a critical project
These annual bonuses are typically offered as a percentage of the employee’s annual salary and divided into tiers. Under this system, executives are given “target” goals and “stretch” goals, getting a certain amount of money if they perform as expected, and only getting the full amount of their bonus if they achieve extraordinary results. Which works out well for both parties, because if executives reach their stretch goals, chances are that the bonus will have less of an impact on your bottom-line.
Long-term incentives are generally the single largest component of most executive compensation strategies and for good reason. These incentives get executives invested in the long-term growth and success of the company – which should be the top priority of executive compensation.
The common forms of long-term compensation include, but are not limited to:
- Cash bonuses
- Stock, stock options, or restricted stock
As with short-term incentives, executives will receive greater or lower compensation depending on their contributions to the company’s success, as measured against target and stretch goals, over a given period. The performance evaluation period depends on your company’s stage and rate of growth but is generally between three and five years.
Instead of specific and limited goals and KPIs, long-term compensation relates to the company’s financial health or its overall valuation. The theory is pretty simple, and compelling. If the company as a whole has done well over the executive’s tenure, then they will do well too. That is why these incentives can be so effective in motivating your executive team.
Except for cash bonuses, most long-term incentives come in the form of stock in the company (or other equity-like compensation). This means that the awards are worth more to the executives the better the company is doing, adding another incentive for them. Even better, it means payments will not affect the company’s operational budget since executives will generally not be able to cash out on their stocks until the company is acquired or goes public.
Benefits are one of the smaller expenses in compensating your executives, but that does not mean that you should overlook them. Your executive team will take advantage of the same benefits package as the rest of your employees, so make sure that your offerings are robust and appealing.
To attract the most experienced executive candidates possible, and keep them around, make sure that you cover the benefits basics:
- Vacation time
- Sick days
- Life insurance
- Medical insurance
- Short and long-term disability
- 401k/retirement plan
Beyond making sure that you are competitive in each of the categories listed, it is worth considering going above and beyond the standard benefits package. Wellness benefits, employee assistance programs, parental leave, and childcare benefits, and other lifestyle benefits can make you stand out against the competition and attract the talent you need to succeed.
Executive perks are add-ons for your executive team that aren’t available to the rest of your organization. They are not always expected, especially in smaller businesses, but they can help attract and reward experienced executives. Some common perks that you might want to consider are:
- Financial planning
- Company car
- Concierge service
These benefits are generally a small portion of the total compensation, but they can make a big difference in your ability to stand out from competitors and attract top executive talent. Especially for companies whose budget limits the base salary they can offer, these perks can help attract and retain more experienced executive candidates in a cost-effective manner.
Contingent pay is guaranteed severance in the case of involuntary termination, with the amount being agreed upon when an executive signs-on with the company. These agreements generally do not cover termination with cause. Contingent pay can be especially helpful in attracting executives from other companies, as it provides added security and mitigates the risk that they are taking by leaving their current employer.
Another form of contingent pay is a change-in-control agreement that compensates executives if they lose their position due to a company merger or sale. This agreement will help your executive team always act in the company’s best interest without fear of the possible effect on their own positions.
Executive compensation is a complicated topic, and your actual strategy will depend on your own means, challenges, and priorities when looking to bring on executive talent. Hopefully, this article has given you a good sense of what to look out for and how to start structuring your executive compensation strategy. It might seem intimidating, but it is feasible to attract qualified talent with any budget. Just remember the key lessons from this article:
- Base pay is essential, but it almost always makes up a smaller part of the compensation than incentive pay. And cash or stock signing bonuses can help attract top talent while keeping your annual commitment low.
- When structuring your incentive pay, make sure to focus on rewarding what will have the most significant impact on your company’s growth and financial health
- Offer short-term incentives to reward executives on their contributions to the company each year, based on your company’s short-term goals and related KPIs
- Long-term incentives make up the largest single component of executive compensation and are primarily made up of some form of stock or synthetic equity – meaning they have a limited impact on your operational budget
- Want to convince an experienced executive candidate to leave their position at their current company? Contingent pay can give them the security they need to make the leap.
- Benefits packages and executive perks may make up a small percentage of executive compensation, but you’d be surprised at how important they are to your ability to attract the best candidates and keep them around, so make the most of them.
These are the fundamentals to executive compensation that should get you started in crafting your strategy. But the good news is that you don’t have to go it alone. Business advisors and benefits consultants can help you craft the package that works best for your company.
About the Author
Carolyn Kick is the Director of Marketing and Business Development at Launchways. Launchways helps growing companies get the people side of their business right. Launchways offers strategic solutions for Human Resources, Payroll, Employee Benefits, and Business Insurance. Please visit www.launchways.com to learn more.
Do you have an idea for how growing companies can effectively compensate their executives that we didn’t get to in this article? Share in the comments below!