For those focused on the hard tangibles in a total compensation package, too often private equity compensation pitches miss the plate entirely with talent and dismissed as pie in the sky. We sit down with Amanda Mallow, EVP and Chief Human Resources Officer of Sophos, a cybersecurity company with a large Vancouver presence, to talk about why, particularly in tough economic times, when it comes to private equity compensation, communications are as key as the offerings themselves.

Key Takeaways:

• Private equity compensation should be a key component of any competitive total compensation package aimed at senior talent or employees in general in a startup environment.
• HR needs to be able to walk the acronym talk, while making private equity compensation understandable and valued as a retention/recruitment tool.
• Developing a private equity compensation calculator is a critical tool for bringing the pie in the sky down to the plate when making the pitch to talent.
  

“If you want to grow your career to senior levels in HR, you really have to understand employee equity at a detailed level. In addition, as a recruiter or HR business partner/generalist, you need to be able to explain equity compensation in a way that is understood and valued by potential candidates and/or employees to help with recruitment and retention efforts. Otherwise, you are missing out on an important untapped employee incentive.”

Fortunately, as Amanda points out and will share from the stage at the upcoming Tech Talent North in Vancouver, success is mostly a matter of being able to talk the walk.

Private Equity’s Allure, Impact and Challenges

“In the technology world, whether you are private or public, equity can be a key part of employee compensation. It is common in most companies, especially at certain levels” said Amanda before explaining its allure. “It can be a big reason why people join a company because at the end of the day if they have financial success with their equity that can be a lot more lucrative than any of the other cash incentives that they are receiving.”

Similarly, it can strengthen bonds on the organizational front, while helping to align talent around longer term company success. 

“The other thing that equity does is help tie people to the longer-term goals of the organization, it is very motivating when people feel like they have skin the game and helps align people’s efforts within the organization. So, for all those reasons, equity is an important part of the overall compensation story for employees, especially at senior levels. I don’t negotiate cash with senior people, I negotiate equity.”

One of the problems with private equity compensation is its future forward nature.

“The problem we have always had with private equity, as opposed to public, is that it is not financially rewarding until there is some kind of liquidity event. Typically, the company has to be sold, maybe to another financial institution or investor, strategically acquired by a bigger company or the company could go public,” said Amanda.

Amanda notes that we are still experiencing a tough macroeconomic climate. This results in higher uncertainty around potential liquidity events and less IPO activity than previously experienced. While employer turnover has stabilized, there is always a competitive marketplace for top talent. For those focused on the hard tangibles in a total compensation package, too often private equity discussions are poorly explained and /or are dismissed as pie in the sky by talent as a result.

Particularly in tough economic times, this puts extra emphasis on HR to help communicate equity value when the present looms uncertainty. In short, in this milieu and moment, HR needs to add one more super power to its tool kit—being able to talk the walk of private equity—which Amanda will help bring down to earth on stage at the upcoming Tech Talent North conference.

Why More Than Numbers are Needed to Explain Equity

“The key thing at the end of the day is that people want to know how much money they are going to make, when and what’s that going to look like,” said Amanda. “They want to know estimated timelines to an exit. They want to know what type of liquidity event is most probable. They want to understand the vesting conditions and if there is acceleration—because, as an example, if I get an equity grant that vests over four years and then after one year of service, there is an exit with 100% acceleration in those other three years I am getting a four year value in one year and that is pretty attractive.”

Amanda targets a handful of these common questions below, with further on tap at TTN:

“How long to liquidity event?”

“Time to liquidity event can be a hard one to answer and can depend on who your owner is. If you are owned by a private equity firm, as an example, what you can share is, ‘Well, in the PE world, typically they hold companies three to five years. It can be slower or faster, but that is a typical hold period and btw, we’re four years through that journey. There’s no guarantee it’s going to happen in the next year, but we’re closer to that average timeline than others.’ That sounds so much better than ‘Who knows?’ to talent,” said Amanda.

"What type of exit?”

“Again, it’s a matter of, ‘Well, there is no guarantee of exit type, but let’s talk about what is more probable for our company,’” said Amanda. She encourages HR professionals to get a steer from their senior leadership team and it is okay if the answer changes over time, markets and conditions do as well. Examples include: “As a smaller company, it is more realistic that we will get purchased by a larger company. As a larger company, it would take a really large company to purchase us, so that is less likely from a financial perspective, so more likely another financial investor would be more probable. IPO markets are pretty closed right now too though they are starting to come back, so never say never.” said. Amanda.

“Do Tax Implications Matter?

“Tax treatment is another thing. If you can get a plan with capital gains treatment, sell the crap out of that because that is extra money in people’s pockets,” said Amanda. “Not all equity plans have this as a competitive advantage.”

“We are not tax experts, just to be clear. HR can’t give tax advice, but HR should at a minimum understand at a high level the types of tax treatments between the different equity plans because it can make a big difference in employee financial outcomes,” said Amanda.

“Can I take this talk to the bank?”

“No, there are no guarantees on any of of what I just said. Everything has to be framed with a legal disclaimer of ‘This is for modelling purposes only. This is not a guarantee of what is going to happen.” said Amanda. “You can’t have these discussions without these legal disclaimers, so I really have to highlight that for HR.”

How to Communicate Value? Focus on Future Potential

Amanda appreciates that too many people focus on current value of their equity verses future potential value. This is a less incentivizing way to view equity, especially in a down economy where lower company valuations in tech have cast a further pall on that perspective and can result in people’s current equity being “under water”.

“A real challenge right now is that I don’t think a lot of people understand future equity value, because it can be hard to quantify. Just because the current valuation of equity might be lower, that does not necessarily mean that future payouts at time of exit will be lower,” said Amanda. “I think what you need to do as an HR professional is have people less focused on the current company valuation and more focused on what drives the future valuation—the exit valuation. After all, at the end of the day, the exit valuation is going to be what is the reality.”

What drives that exit valuation, Amanda notes, is quite different by design.

“This is an important distinction, especially as people are feeling down about lower company valuations, which I don’t think a lot of people understand. Typically, the way current company valuations are done, more emphasis is put on historical performance and values are governed by specific tax regulations as an example,” said Amanda. “When you are looking at future value though, there is more emphasis on competitive interests. What is the marketability? How does this company best fit into future strategy? While there are some similarities, I think it’s really important for people to understand the differences between the drivers of current and future valuations. We in HR need to be able to explain that to people so that they focus on that future value over the current.”

Bring an Equity Calculator to the Conversation

Most importantly, Amanda has one recommendation that goes beyond the power of words when anchoring any private equity compensation conversation.

“The biggest number one thing to do is to create an equity calculator. I won’t go too deeply into it here, but we will dig in at Tech Talent North. If you are dealing with private equity though, if you don’t have an equity calculator, it’s probably the best thing you can use with employees,” said Amanda. “Essentially, you can work with your finance people to do some modelling around, ‘If I have X amount of units and potential variables like strike prices or participation thresholds, at different exit multipliers when there is a liquidity event, what is the potential value that this could be worth?’ This actually shows people the potential future value.”

“Usually you have a large range, but you can narrow that for them. ‘Hey, based on our long-term plans, current initiatives and some of the things we are doing as a company to drive enterprise value, this is why we think THIS range is realistic. We could be higher or lower, but this is why THIS feels right.’ If you can just show that to people, even though it’s for modelling purposes only and with no guarantees, it gives them a sense of value,” said Amanda. “You have to be able to explain as a company what you are doing to drive those values, otherwise it’s just numbers on a page, but those numbers are an important piece of it.”

“If you, as an HR professional on behalf of your company, can better answer future potential value of equity in a convincing way, you can better compete with candidates with other offers because what I find is that very few companies do a good job of explaining future value in private equity—which gives you the ability to do so and get them over the line,” said Amanda. “So, it’s a huge, huge competitive advantage when it comes to recruitment. I really have to highlight that just the act of being able to better explain private equity compensation value will win over candidates and even compete with publicly traded equity.”

Know Your Market, Set Your Guides, Trust Your Experts

As for HR’s additional responsibilities on the equity front, Amanda points to two key areas—collecting comparable market data and deciding on employee participation eligibility and targeted equity value guidelines.

While pointing to compensation consultants like Southlea, Radford and hopefully future TAP surveys for equity compensation data, Amanda encourages a targeted approach to how it is distributed.

“When you are dealing with a constricted equity pool, you don’t want to peanut butter spread your equity grants. It doesn’t add value if everyone is going to make enough money to buy a cup of coffee,” said Amanda. “You’re better off to have more concentrated amounts at senior levels, where quite frankly it is more common and more valued.”

In Conclusion…

Translating PE equity compensation from pie in the sky to a unifying driver with tremendous payout potential might indeed take another mind-expanding evolution of HR, but rest assured, the results lead to brighter futures—and Amanda will be there for you to talk things through at TTN.