May 9, 2021
By Susan Schroeder
As competition intensifies for attracting and retaining diverse and talented directors, private companies are reviewing the plan design and pay levels of their director compensation programs to compete for talent with their publicly traded peers. There are four best practices in designing and implementing a new director compensation program.
Step 1: Determine the Primary Objectives of the Program.
Most board pay programs, whether at private or publicly traded companies, will strive to compensate directors for their time and the value received by the company for the director’s contributions. Other common objectives of board pay programs are:
Private companies trying to compete for talent or attract unique skill sets should strive to provide a competitive board compensation package, although total compensation does not need to be as high as at a public company. Private company boards have a lower level of risk, disclosure, and regulatory requirements than their publicly traded counterparts. There are also intangible factors that have to be considered as to why individuals choose to serve on private company boards. It is not all about money!
Step 2: Conduct Internal and External Assessments
Once the objectives of the compensation program are defined, the next steps are to conduct internal and external reviews. The internal review involves looking at the company’s situation and the board dynamics. In general, boards and board roles with greater complexity, risk, and challenges merit higher compensation. Issues to consider include:
The external review involves considering how the company compares to its peers and collecting board compensation information for similar companies. Sources of compensation information may include informal information from executives and directors about what other companies offer, and more formal information such as public peer company proxy data (generally excluding the equity data) or survey data like the 2020 Private Company Compensation and Governance Survey, published by Compensation Advisory Partners (“CAP”) and MLR Media, which contains data from close to 1,000 private companies.
The goal of the external review is to understand competitive compensation practices and ranges and inform the company’s decision-making. Once the internal and external reviews are completed, company shareholders can decide which director pay model makes sense for the company.
Step 3: Decide Which Pay Components to Adopt
Retainers Only for Cash Compensation
Publicly traded companies are moving toward a “retainers only” approach for cash compensation. However, the CAP-MLR Media private company survey indicates that 50 percent of private companies still use per-meeting fees to compensate directors. The retainer-only pay model makes sense for companies that wish to pay for overall board roles rather than time spent at individual meetings. Indicators that favor this pay model include material director time required outside of meetings, ambiguity about the definition of a formal meeting, a more predictable board workload, and a desire for administrative simplicity.
According to the CAP-MLR Media survey, the median annual board retainer ranges from $20,000 for private companies with less than $50 million in revenue to $60,000 for private companies with greater than $1 billion in revenue. The amount of the retainer could range from 0.25x median at the low end to 3x median at the high end.
Meeting Fees Only for Cash Compensation
At the opposite end of the spectrum, some companies may choose a “meeting fees only” pay model. This pay model makes sense if most of the board work is tied to the meetings themselves. Per-meeting fees can be set to take into account typical meeting length, preparation, and follow-up time. Indicators for this pay model include an unpredictable number of meetings, comfort with the administrative efforts required to track and compensate meeting attendance, and the majority of work accomplished during the board and committee meetings. According to the CAP-MLR Media survey, the competitive range for meeting fees is $1,000 to $5,000, with $2,500 at median. Telephonic/virtual meeting fees range from $500 to $2,000, with $1,000 at median.
Combination of Retainers and Meeting Fees
For companies that fall somewhere in the middle, a combination of retainers and meeting fees might make sense. Some companies with the potential for a flurry of meetings can stipulate that the basic retainer covers a certain number of meetings. If meetings are required above the number covered by the retainer, then meeting fees will be paid to directors for the extra workload.
No Cash Compensation
For start-up companies where cash is tight or companies expect a value-realizing event (VRE), compensation is solely offered in the form of equity. In these cases, there is often no cash compensation for board service.
Overall, the prevalence of long-term incentives for private company board service is low compared to public company board pay practice. The decision to offer and the amount to offer depends on the shareholders’ appetites to offer equity. When offered, real equity — stock options or restricted stock/units — are favored. Typical long-term incentive practices for private companies are to grant the awards annually and to have the awards subject to vesting, typically over three or more years.
The total pool allocated for board member grants is typically less than 5 percent of total shares outstanding. Individual award values can range in size. For companies that pay cash compensation, a useful “rule of thumb” is 1.0x the annual Board cash retainer. For companies that do not pay cash compensation (such as start-ups or pre-VRE companies described above), the amount granted to directors varies by company size and is usually granted at the director’s appointment to the board, not annually. The average amount granted to an individual director is 0.5 percent of total shares outstanding.
Private companies’ use of long-term incentives in board pay programs indicates that these companies are competing aggressively for board talent and are working to retain board members and align them with the company’s overall success. We expect this trend to continue and result in increased use of long-term incentives to compensate board members, especially in larger private companies.
Step 4 – Calculate Total Cost of Director Pay Program
Before implementing a new director pay program, companies should consider the prior year’s board schedule and workload to calculate what the company’s board compensation expenses would have been last year using the proposed compensation program. This step is particularly important for companies that offer meeting fees. Modeling payouts under a new pay program will help validate the proposed program and flag any potential issues. The company should look at the modeled expenses of the new program relative to past spending on board of director compensation and determine whether the new program’s costs are reasonable.
Susan Schroeder is a Partner in the Los Angeles office of Compensation Advisory Partners. She is also a director at the National MS Society.