Startup C-Level Executive Salary, Equity and Severance Compensation Package was originally published on uConnect External Content.
By Robert A. Adelson
Are you a senior executive looking to move up to C-level by joining a startup?
Being a startup C-level executive can be rewarding in many ways.
But taking that role has many risks too, so it is wise to go in with a job offer that protects you from the risks and ensures that if the startup succeeds, you will share financially in that success.
To help you negotiate your C-level job offer with the startup, this article discusses the –
- Cash compensation expectations – base salary and bonus,
- Startup equity to seek in a funded vs. unfunded startup,
- Huge tax opportunity of QSBS if you structure it right, and
- Severance triggers and package key terms to seek.
Cash compensation expectations – base salary and bonus
Startup C-suite pay packages vary widely depending on the stage of the company, industry, location, and other factors, typically including a combination of salary, bonus, and equity.
When a startup is strongly funded, such as a life science startup with over $10 million from a series A round, securing the best talent quickly can be paramount. If that startup targets you, the recruiter might say: what will it take for you to join now? …and you negotiate a huge pay raise and hefty signing bonus.
However, it is more common that early-stage companies, with seed and even Series A funding, are anxious to conserve their cash as they take the company to and through the next milestone when they can go out and complete the next round of funding before cash runs out. As a result, you may have to take a pay cut for that C-suite position, receiving a base salary well below even that reported by Mercer, Gartner, or other executive compensation surveys.
There are two ways to recover from that pay cut.
First: a “springing salary” – if the startup achieves a milestone, usually more funding, your base pay would automatically spring to a level closer to market.
Second: a robust bonus – perhaps a 100% or more target bonus, also potentially tied in whole or part to the company’s achievement of the milestone.
More often, the lower cash compensation is made up by the much greater potential upside of equity, discussed next.
Startup equity: Funded vs. Unfunded Startup
Equity compensation exists in various forms, including for corporations – stock options, qualified (ISOs) or non-qualified (NQSOs), restricted and unrestricted stock, restricted stock units (RSUs), and for limited liability companies (LLCs), profits interests and capital interests and more. There is also the option of phantom equity and performance interests when actual equity will not be issued.
Startup equity provides a big tax opportunity for greater take-home pay in the long run.
Before you take a startup C-level position, you should carefully consider the tax structuring and terms of your equity. Your goal is to delay taxation of the stock appreciation until you sell it and to get capital gains treatment on the stock appreciation when you sell.
Here are two scenarios:
- Unfunded Startup – You join a pre-funded early-stage startup and get “founder’s shares.” The stock value is nominal. So, you pay it and own the shares, which are restricted – subject to forfeiture if employment terminates within a specified period (typically, vesting occurs over four years.) An IRC section 83(b) election is made to assure there will be no tax as shares vest. The sale of the shares after one year would be long-term capital gains, hopefully after the appreciation.
- Funded Startup – You join a funded startup. In this case, if the shares are too costly to buy, you would wait until you vest. Here you can use RSUs, where you receive the shares and face tax as they vest, tied to a provision that the company buys back a portion or lends you money to pay the taxes. Alternatively, you could get stock options, but with special provisions for an extended period (post-employment termination) to allow exercise and/or to allow you to issue your own promissory note to purchase. There is no tax on options until you exercise them, at which time you face ordinary taxes.
Huge tax opportunity of QSBS
Beyond the allure of startup equity’s potential for immense appreciation and lower tax rates, the tax law offers yet another special gem for startups that qualify as a “Qualified Small Business Corporation” (QSBS).
For the founder’s or executive’s QSBS shares, the first $10,000,000 or 10x growth, whichever is greater, is exempt from US capital gains taxes. You can learn more in my article “Achieving Zero Taxation on Sale of Your Startup Equity.”
Startup C-Level Executive Severance Pay
Startup C-level compensation can be highly lucrative if the company is successful.
But if the company fails, as many do, it is the opposite. Not only that, startups often go through many changes in management, and you may lose your job in the shuffle. Therefore, it is important to have severance terms in your executive employment agreement.
Remember that you are making a big commitment to join the startup by leaving your current job. In return, your new employer should commit to a suitable severance if they decide to terminate you without cause.
A suitable severance for C-suite executives should include severance pay, prorated bonus, accelerated vesting of equity, and on occasion, a clawback provision that if the company goes IPO or is acquired within two years of your termination, to give you all or part of what you would have received had you not been let go.
Finally, big potential financial rewards should not be the only reason that lures you to a startup. After all, startups are risky business.
You should evaluate the startup’s vision, mission, business plan, and resources and ask yourself whether you are likely to succeed in this company.
Ensure that those representations are also written into your executive job offer. For more information about executive contract terms, please read my article on this subject.