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When it comes to executive compensation, particularly equity grants, the stakes are high—both for the executives and the company. Recently, we were asked a thought-provoking question about how to manage annual review option grants for executives when operating with a limited option pool. It’s a challenge many companies face, especially as they grow and their valuation increases. The key is ensuring consistency in approach across all executives, even if the grant amounts differ based on roles, contributions, or market conditions. Below are some common practices we’ve seen regarding annual review option grants for executives, particularly when managing a limited option pool.
Common Strategies for Executive Equity Plans
1. Eligibility Tied to Full Vesting
- Definition: Executives become eligible for a new refresh only after fully vesting their prior grant.
- Example: An executive with 1% equity vesting at 25% per year would only become eligible for a new grant in year 4. This new grant would be at the current new hire equity rate, which tends to decrease over time as the company’s valuation grows (e.g., 0.5% instead of 1%, but with a higher dollar value).
- Benefits: Conserves equity and provides an opportunity to evaluate the executive’s performance before issuing additional grants.
2. Threshold-Based Refreshes
- Definition: Equity refreshes are granted only if the executive’s total held equity falls below a pre-defined target.
- Example: If an executive’s target market rate is 1%, they would only receive additional equity if their total held equity falls below that threshold due to dilution or other factors.
- Benefits: This approach aligns with market rates while minimizing unnecessary equity grants. Typically, this means you’re giving new grants after funding rounds or changes in market conditions.
3. Discretionary Annual Refresh Caps
- Definition: Executives are eligible for annual refreshes, but only up to a capped percentage of their target.
- Example: If an executive’s target is 1%, they might be eligible for up to 0.1% annually, subject to board discretion.
- Benefits: Maintains flexibility and provides an opportunity to reward executives without guaranteeing annual refreshes.
4. Matching Employee Vesting Rates
- Definition: Executive equity refreshes are designed to mimic the annual vesting rate of employees.
- Example: If an executive’s target is 1%, they receive an additional 0.25% annually that vests on top of their existing grant.
- Considerations: This offers the least equity preservation, but it ensures alignment with broader employee practices.
Conclusion
Ultimately, the goal with executive equity is to align grants with performance and market expectations while balancing the constraints of a limited option pool. With higher initial grants, it’s common to adopt more conservative refresh practices for executives compared to other employees. Ensuring clear communication with executives about their market alignment and refresh eligibility is also crucial to managing expectations effectively.
Closing Note: About Pequity
At Pequity, we’re passionate about helping companies navigate complex compensation challenges with data-driven insights and best practices. Whether you're structuring equity grants or refining compensation strategies, we’re here to help.
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