Board Compensation - Cash versus Equity - 13 Nov 2008

By Dr. Earl R. Smith II

DrSmith@Dr-Smith.com

www.Dr-Smith.com

Some of my engagements are with start-up and middle market companies
that are experiencing very high growth rates. These companies face a
challenge in recruiting high-quality directors. The combination of risk
(the exposure of board service is much higher these days) and limits on
the types of compensation available, make the search particularly
challenging. Such companies are generally limited in their options. The
most logical alternative is equity as compensation.

Although the responsibilities of directors have remained the same,
much more prudence and diligence is required from directors who face
increased scrutiny and access to information at the click of a mouse.
Directors need to have the latest inside information on the companies
they sit in governance over and understand the latest trends developing
in their industry.

Stockholders still expect the same thing. They expect directors to
act to enhance the share value of the company. Stockholders expect
directors to effectively address social issues while still maintaining
profit margins. High growth industries such as technology companies
need a governance structure with a balance between directors with
experience in corporate finance of a fast growing company and directors
with technical expertise related to the company’s business.

With expectations of directors so high, companies often find it
difficult to find qualified directors. The function of supply and
demand has driven up the cost to companies attempting to attract highly
qualified directors. This cost is particularly burdensome to companies
during their rapid initial growth phase. Many fast growing companies
with limited cash resources elect to offer directors equity in the
company as a large part of their compensation. Two factors limit the
possibilities:

o Cash flow - cash is a scarce resource in a rapidly growing company

o Leveraged returns - investment of available cash in areas that are supporting continued growth is a priority

Many companies choose to compensate directors with stock or stock
options. Stock options do not affect reported earnings and when
directors elect to exercise their options, it increases the company’s
cash reserves. The company and other large stockholders also see stock
options as a tool that aligns director’s interest with the interest of
large stockholders. Directors with a strong belief in the company and
its products also like the stock option compensation packages. Because
options are normally granted at fair market value, directors can
leverage their cost and earn a substantial return if the stock rapidly
appreciates in value.

Directors are normally reimbursed for normal expenses associated
with meeting attendance. Companies will also often reimburse directors
for expenses associated with attendance at leadership development
seminars on behalf of the company. Leadership development is a
paramount issue for companies in the fast growing phase of the business
life cycle. Professional governance by highly qualified leaders and
advisors can make the difference between a company running out of cash
or achieving stock appreciation. Directors willing to forgo some or all
cash compensation in favor of the opportunity to serve on a high growth
company’s board can often reap great financial rewards, but the
pressure and demands placed on directors in leading such a company are
tremendous.

Boards responsibilities for a high growth technology company include the following:

o Corporate finance: ensure adequate lines of credit to sustain operations

o Product development: ensuring product testing and appropriate marketing budgets and campaigns are developed

o Corporate image: Directors must be savvy about the technology or
product being developed and be seen as leading a cutting edge company

o Corporate logistics: Directors must locate areas for manufacturing
the product with highly skilled and sustainable workforce capable of
delivering quality high tech products to the market-place

Companies with large shareholders willing to grant stock options to
directors with skills needed to grow a high tech company from small
product development stage to full-scale manufacturing will often find
dedicated, diligent directors with the leadership skills to serve on
the company’s board of directors. Stock options and other equity
compensation tools can be a great way to compensate skilled directors
without cutting cash flow requirements a high growth company must have
to sustain operations.

If your company is facing these challenges and you want to know more about possible solutions, send me an e-mail and we will arrange a time to talk.

Related Articles:

• Good Governance - Board Member Selection Criteria


• Good Governance - Keeping Ahead of Fast Company


• Successful Board Assessment Models


• Governance By Visionaries


• Governance for Growth


• Corporate Talent - Coaching and Retaining the Best


• Board of Directors - Major Legal and Moral Responsibilities

Dr. Smith is a proven
senior executive, successful entrepreneur, published author and public
speaker. He serves on boards of directors and advisory boards or as a
strategic advisor to CEOs. Dr. Smith specializes in turnaround
management, strategic planning, leadership development and executive
coaching. He also works as an executive and/or life coach in the areas
of personal growth and spirituality. He is the author of Amazing Pace: Turbo-charged Business Development - a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living - a book of Raven Tales and exploration.