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Director Equity Compensation Examples
While its easy to compare cash compensation from company to company, there are several reasons whey its much more challenging to accurately compare equity compensation.
This page illustrate how dilution affects equity compensation using two examples:
Company with no dilution after the third round
In the first simple example, assume that the angel backed company raises only three rounds and is then sold at the end of five years.
In this case, lets assume the board is the CEO, Chair and two independents. It would be reasonable to allocate the 10% director share trust 2.5% to each independent (assuming two) and 5% to the Chair (assuming an active Chair). These would all be allocated when the director joined and vest on the same terms as the employees.
If the company is sold at the end of five years, without any additional dilution, everyone would vest all of their equity and the independent directors would have earned about 0.5% of the shares outstanding at the end of the third round per year. The Chair would have earned about 1% per year. These are the numbers shown in the table at the bottom of the Director Compensation page.
Public Company with 20 to 25% Option Plan
At the other end of the spectrum, consider a public company executing a roll up strategy. This example company is double the number of shares outstanding every year as it finances and uses equity for acquisitions.
In small public companies, the standard practice is to maintain an evergreen option pool of 20 to 25% of the total number of shares outstanding. Using the same rule of thumb ratio that one third of this is allocated to compensating the board (roughly the same as the CEO) then the board allocations might be maintained at 2 to 3% for the Chair and 1 to 1.5% for the independents (assuming three).
If the company doubles the number of shares outstanding every year, then the independent directors would receive, very roughly, additional options equal to 0.5% of the outstanding shares (at the end of the current year) per year and the Chair about 1% per year.
This model is only approximate and there are challenges with the AGM timing in the assumptions above, but again these rough numbers are the same as shown in the table at the bottom of the Director Compensation page even though the dilution in this example is very different than in the first one.
These illustrations are intended to illustrate the math and to show that it is possible to compare board equity compensations in very different dilution environments and come up with similar benchmarks.
These models are probably as accurate as they need to be considering that any compensation plan is very imperfectly matched to the actual contribution that a single board member makes to a company - even the CEO. Value creation is a highly non-linear process. It is often the case that a single, good director could conceive a strategy, or help the board make a decision that could double the value of a company, or even more likely, prevent the value from going to zero. This means that the value received by the company could easily equal the entire value of the enterprise. In that situation, any amount of compensation would be inadequate.
