Money talks: Your biotech compensation questions, answered
a RApport Q&A
featuring Stephen J. Hoffman, PhD, MD
Steve is an experienced board chairman, former CEO, and venture capitalist who has served on the boards of over 20 biotech companies, from raw start-ups to commercial-stage public companies. He has a lot of gray hair, in part from learning things the hard way.
February 29, 2024
We wanted to expand RA Capital’s Gateway library of teaching modules to cover compensation-related topics, so we peppered Steve with questions. His answers did not disappoint.
* * *
What’s your general compensation philosophy? Do you shoot for compensating folks at the 50th percentile in relation to comparable companies? When do you start below? (Surely half of companies must be below – everyone can’t be at or above average!)
That's the news from Lake Wobegon where all the men are strong, all the women are good-looking, and all the CEOs are above average. If that sounds dated, it is. I believe in paying for performance; everyone wins if goals are met according to the operating plan. I tend to target total cash compensation at no more than 50th percentile (with bonus percentile greater than base) and target equity compensation at greater than 50th percentile.
And it’s best to be flexible. Recruiting great people is the key to success. Adapt comp to what it takes to recruit and retain the specific people you want for a job versus limiting yourself to candidates for whom the selected range is acceptable.
Have you ever deviated meaningfully from what compensation consultants (e.g., Radford) have recommended? Why?
Only in very rare cases, unfortunately, because for some reason compensation consultant recommendations are often seen as gospel. I had a situation once where my Chief Scientific Officer was only awarded a modest equity grant at year-end per our consultant's recommendation. This person was vital to the company’s next few years, his existing options were underwater, and he was a significant flight risk. I couldn't get the committee to give him more options, so I actually offered to give him some of mine!
Why was it so hard to get the committee to grant him more options? What were their concerns? And what ultimately happened?
This was a classic example of a compensation committee chair being beholden to the comp consultants; they were unwilling or afraid to think outside the box. (No one on this committee had any operating experience – this is another reason to have industry-hardened people on your board, not just investors.) I was unable to get additional options for this person and explained to him why. He stayed, for the time being, but was disappointed.
What is the best way to use stock option grants?
Option grants should be used to retain talent and reward folks if value is added and the company is successful. I'm more inclined to give people excessively large grants at low strike prices, but weight vesting of the grants to later years or on hitting key milestones. There's nowhere that says vesting must be linear – I'd rather grant a boatload of options at a cheap price that vest greater in years three and four than a lower number of options monthly. For employees who really say they're committed to the company, this is a good way of testing that and rewarding them – a true win/win. Longer-term retention and a bigger payout if successful.
However, one problem I have with stock option grants is that they typically have an exercise period of 90 days post-termination. This goes for both management/employees and directors. Unless the exercise period is stated otherwise in the option grant, extending it results in a non-cash accounting charge to the company, which is de minimis but could still be a slight impediment. It can also trigger the option’s transformation from an incentive stock option (ISO) to a non-qualified stock option (NSO), which carries complications. But if that’s the difference between being able to exercise a grant versus letting it go, the employee will likely be okay with that.
Given that equity compensation is part of overall comp, I think the 90-day exercise period is too short, because oftentimes grants have not appreciated too much. This is especially true in private companies. While an exercise period shouldn't be excessively long, I think it should be longer than 90 days – maybe 1-2 years.
The circumstances matter, of course.
Clearly, if an employee resigns because they see more value elsewhere, then the standard 90-day period makes sense.
If the employee exercises the options they have earned, that’s great for them and is a show of faith for the company from the departing employee. If they don’t, then at least the company preserves its option pool; the employee was looking out for themselves, as is their right, and the company therefore understandably looks out for itself by maximizing its option pool.
And I have absolutely exercised options that were vested upon leaving a private company because I truly believed in what we were doing – two times this has worked out; one more time is yet to be determined.
If someone is terminated without cause, for example in a downsizing, then I think an extended exercise period can be justified. Or on occasions where a valued employee has to resign for other reasons than just taking another position (e.g., health or family). Sometimes it’s just the right thing to do.
Have you seen performance-based vesting (i.e., not time-based) used in development-stage (pre-revenue) companies? If so, what were the vesting triggers?
Yes, I use these all the time, especially for C-level people. Triggers can be anything from scientific milestones to business development deals and financings. As always, defining the triggers and really understanding what behavior you’re incentivizing is key. For example, getting a trial recruited early is awesome… unless crappy patients were enrolled; similarly, getting a big upfront payment for a licensing deal at the expense of lousy downstream economics isn’t in the company's best interest.
For private companies, have you ever instituted formal practices for managing equity of founders or former employees (e.g., repurchasing equity, setting up a secondary market)?
Only one time. A prominent Boston-area founder who was on the board was leaving and – amazingly – got the investors to purchase his common founder's shares for over $1M even though he hadn’t done much other than lend his name to the company. Wild! Certainly not common to see this happen in biotech.
One thing I do feel strongly about is I don't think founders’ shares should be considered in an overall equity package for founders who become part of management. Companies will need to recruit CEOs, CSOs, etc. anyway, so I've always felt and argued that founders’ shares are separate from stock options. They should be set up to vest over 2-3 years but shouldn't be considered as part of an equity package.
When thinking about compensation for a private company with multiple geographies, how do you think about determining appropriate comp that balances expectations across the organization but also across those different geographies, where benchmarks can be different (e.g., different regions in the US, but also different countries)?
It's easier for the Bay Area and Boston/Cambridge because there is more data for those ecosystems than for, say, Seattle, Gaithersburg, Austin, or Denver. And the EU is totally different. I've seen much less discord among employees of EU companies that also have US operations because folks are largely used to differences, and there are often more perks for EU employees than US personnel (employment agreements at all levels, more vacation, company cars sometimes, etc.). Another complication these days is that so much work is now virtual that it makes determining geographies even more difficult. The real challenge comes for US companies that are outside the main biotech corridors, and there's no magic solution other than doing solid diligence and trying to get the best information you can.
In my experience people outside the major markets do get somewhat smaller base salaries and bonus potential compared to Boston/SF, but not greatly so. It really is a function of supply and demand. It’s worth anticipating and managing any drama resulting from doing pay-by-geography.
When is the appropriate time to start thinking about benchmarking to public company comps as a private company preparing for an upcoming IPO?
Public company cash compensation is usually a lot higher than in private companies, so I always tell management not to expect cash comp to change overnight once public but to state a goal to get there in 1-2 years post-IPO. Managing expectations is part of the challenge. Again, part of effective comp for private companies is to lock in low strike prices for equity grants, so I'm a big believer in giving large grants prior to an IPO and using vesting to put in place effective incentives for people to stay, especially back-loaded non-linear vesting.
One thing that's important to think about before going public is to harmonize employment agreements among senior management. In many companies they're put in place as needed when someone's recruited, so oftentimes terms for severance are not aligned and the contracts are written in different voices.
Keep in mind that more and more private companies are competing with public companies for the same talent so it’s inevitable that public company compensation metrics be considered even for private companies, especially in geographies where great people can walk across the street to a new job. Our virtual world complicates this even more.
Do boards avoid modifying employment agreements because they are afraid to rock the boat and lose key employees? Is there a point of maximum leverage when a company should do that?
I’ve seen employees object a couple of times but generally the terms being harmonized are more generous than not, so it’s not usual. If someone objects, the CEO or Board just has to deal with it and either capitulate or risk someone being disgruntled. I’d say generally the time to make that kind of change is when there’s high confidence in getting an IPO done but before the IPO itself.
If a company hopes to stay private for a long time, how might that alter the way the board thinks about compensation when it’s competing for talent with companies that might go public sooner and therefore offer their employees liquidity?
For companies in major geographic ecosystems, cash comp in private companies isn't at much of a discount to public companies – we're competing for the same talent. And even though these days rank-and-file employees are way more sophisticated about option packages than they were years ago, in my experience, most are focused primarily on cash. To make the argument to potential employees that share prices of public companies are very volatile and what looks good today could easily be less attractive down the road, you could, for example, refer to public stock share price data after a typical six-month lockup period. One beef I do have with a lot of public companies is that they restrict selling (buying) of options and shares to way more employees than necessary during trading lockouts.
And for companies that decidedly want to stay private for a long time, the best tool is to give continuing option grants as in a public company so that a meaningful number of options vest in the future.
When setting corporate goals that bonuses will be based on, do you find setting pre-baked "stretch goals" (weighted by percentage of bonus) helpful or detrimental?
I do believe that there are some goals that can be expressed in a matrix where varying levels of accomplishment result in partial credit, full credit, or even extra credit (i.e. stretch goals).
The idea behind the matrix approach is that it takes a little bit of the arm wrestling out of negotiating with management for goals that were partially achieved or achieved late. For example, a manufacturing run that was supposed to yield 5 g/L and they only got 3 1/2, does that mean the goal wasn’t met in its entirety? Strictly speaking, yes, but not giving partial credit will lead to some degree of frustration or anger on the side of management. I recognize that as boards we deal with partial credit all the time; this is just a way to try and quantify things.
I think stretch goals can align with a pay-for-performance philosophy, they just need to be carefully constructed. A trial can be completed on time and we call that 50% of the goal, late by up to two quarters and we call that 35%, or early by a quarter and we call that 60%. Of course one might worry that management will set low-base-case goals to be more likely to hit stretch goals, but that’s why it’s important that the board be involved in establishing the deliverables and knowing what’s reasonable and what’s too slow.
I may be approaching this from more of a management perspective, but I’ve seen it work, and it’s a way of getting the management team and board to buy into the plan instead of giving the board entire control over ascribing value to things that may not have been completed on time or on target.
In the end, if the stretch goals add up to 120%, that’s great. But it also means that if the team falls short and earns only 65% of their corporate goal, they need to own that, or certainly the CEO should.
Obviously, at the end of the day this is all mushy stuff and dealing with shades of gray.
I’ll add that most biotech companies, data and deals drive value, so non-science or BD execs (e.g., CFO, general counsel, HR, etc.) have little control over what happens to the major milestones that drive bonuses. This is part of the reason less effective goals get put in place, like “managing to budget,” "increasing visibility of the company," and "successfully maintaining and enhancing a values-based work culture,” measured by something like “achieving an Employee Net Promoter Score >12.” If people feel strongly that these types of goals should be included I'd give them very small percentage inputs.
Also, I've always tied the CEO’s compensation (and often that of other C-level executives) to purely corporate goals. If a personal goal component is necessary for C-level folks, I don’t believe it should be more than 20% of the total.
And finally, it’s a good idea to reassess goals halfway through the year to confirm that they remain relevant. If by April it’s clear that the company needs to solve an important new regulatory problem, slot that in.
How do you financially motivate a team with underwater options during a difficult financial period for biotech (e.g., it's hard to raise money so cash is tight and stocks don't seem to be going up)?
Another really good question. I know (too many) examples of public companies where everyone's options are really underwater. For companies such as that, I would propose offering that management and employees forfeit their existing underwater options and then have the company reissue to them options at the then-fair market value six months in the future (this assumes a minimal risk for a miracle to occur that would drive up the share price in the meantime). In this case, receiving a bunch of new options at a lower strike price benefits the team, and restarting the vesting clock benefits shareholders (one could even accelerate some percentage of options if desired). Plus, it would, in theory, minimize the need for going to shareholders every year and asking for additions to the equity pool.
Sometimes comp consultants and/or lawyers say that shareholder services groups won't support doing this, but a solid argument can be made for doing so, and for many nano-cap public companies, does it really matter what these groups say? Retaining great talent and managing dilution are more important.
In your experience, which are the hardest roles to retain and why are they uniquely hard?
Great CBOs and CMOs are difficult to retain because they're just so sought after. Plus, they're sophisticated about comp issues. In terms of non-comp incentives, I urge physicians to continue to see patients if they can (maybe half a day per week) because it benefits the company to have their physicians stay current. For business development executives, I think companies should allow them to engage in a little outside consulting. There are a lot of hours in the day and I find great execs have time for a little outside stuff that doesn't hamper their day-to-day duties (and it may even enhance their internal performance). Finally, I encourage most C-level people to try to get an outside board role, if possible – if nothing else, it helps bring best practices home.
What non-cash, non-equity incentives are most valuable for employee retention? Which ones are a waste of money & effort?
I've found that good 401(k) plans and pre-tax withholding for non-reimbursed health costs and dependent care are valued by employees who are a little older and have children (but folks fresh out of college or grad school may not really appreciate them). Unlimited PTO is a scam and most employees know it – of course it sounds good but folks still know it isn’t really real. One social benefit I've found to be really popular with employees is having access to season tickets for local baseball or basketball teams. And spontaneous rewards for special performance work wonders, too. We used to give out $100 AMEX gift cards to people who made an effort to do something special. People loved it.
Have you seen a company use much higher comp to retain someone who complained about their comp? How did that go?
Sure, some executives can get really greedy when they have leverage over a company, in the spirit of, "If you don't give me what I want, I'll start looking around." It leaves a bad taste in everyone's mouths. Once I had a CEO of a public company tell me as Chairman of the Comp Committee that he was planning to start a VC fund while he was CEO. Seriously! I said he couldn't do that – he could leave to start a fund or he could be CEO, but not both.
I've also found that as hard as you might think you can't live without a certain person, you generally can. And life's too short to put up with prima donnas.
Please click here for important RA Capital disclosures.
Related reading
