May 15, 2007 | Perhaps the single greatest task of being a venture capitalist involves recruiting for our portfolio companies. Those who are very good at it build very successful companies and serve as a real source of value to the entrepreneurs we back. An important aspect of recruiting is being conversant with current compensation trends, which is why I was so interested when the 2006 Compensation Report from WilmerHale, Ernst & Young and J. Robert Scott hit my desk. For venture capitalists it is a must read.
“The informatics field is at an important crossroad...four or five years ago the sector was one dimensional but now many of the informatics companies have developed a number of other applications which has placed a real premium on talent...these people are very valuable,” observed Bruce Rychlik, a partner a J. Robert Scott, a leading life sciences recruiting firm based in Boston. As informatics infrastructure companies converge with therapeutic companies, pharma is more broadly embracing the biomarker phenomenon. All of this is driving up compensation rates in the bio-IT field.
For a venture capitalist obsessed with extending the runway of cash that is raised by portfolio companies, there is the eternal debate between amount paid in salary and bonus versus equity to employees. In general VC’s prefer that key, if not all, employees have meaningful stock ownership in their companies. A standard starting point for venture-backed companies is that the management team in aggregate should own 20%; this is complicated by founders’ ownership positions, which can be meaningful (founding CEO’s in 2006 averaged 13.6% ownership) and is in addition to the targeted 20% amount.
Total salaries in 2006 increased by over 5% from 2005 for all life science companies in the survey; non-founder CEO’s had a base salary of $290k and held 5% ownership stakes. Targeted bonus payments were between 15-20% across all executive positions. For most venture investors, there is an acknowledgment that it would be short-sighted to under-invest in the senior leadership of portfolio companies. Rychlik cautions that “there may be an all out war for talent looming as executives from therapeutic companies “cross pollinate” other sectors of the life sciences...biotech companies’ pay scale may distort traditional views of compensation.” He goes on to observe that “venture capitalists are investing in a number of medical device, tools, and informatics companies, and for the most part investors are having to recruit from the pharma and biotech companies.
Chris Palatucci, a partner at Polachi & Co, another leading recruiting firm in Boston underscores the pressure on venture-backed boards when recruiting as “the shrinking drug discovery pipeline has made ‘doing deals’ harder and has placed a real premium on talent...additionally the rotation in what venture capitalists are finding interesting demands a much greater level of competency in the life science executive.”
Overall compensation for many start-ups could be 40-60% of the total annual operating expense budget for a venture-backed company; it is often the single largest expense component so corporate boards are very focused on managing this “monthly burn rate.” A rule of thumb many investors use would be that the monthly all-in cost of an employee is approximately $15k, perhaps meaningfully greater for biotech companies. Granting of equity is a method to both reduce monthly burn rates as well as aligning incentives between investors and management. In excess of 80% of the companies surveyed granted options while less than 5% utilized restricted stock.
There are a number of other components to executive compensation packages. Of particular note is that approximately two-thirds of all CEO’s surveyed had severance provisions which had a median duration of 12 months. Most severance packages were at least 6 months in length. It is reasonably common that founding team members are no longer involved in a meaningful senior capacity at the time of liquidity, which can be five to seven years forward, so this is an important, and heavily negotiated, term with senior executives.
Quite clearly compensation matters are tricky and case specific. Start-ups, by design, pay little in cash salary and bonuses but are more aggressive on stock ownership. Top venture capitalists understand that in order for the investor to make a reasonable return, the entrepreneur and executive team needs to be richly rewarded. The focus needs to be on the alignment of those objectives so while it may ultimately be a zero sum game, make certain that the compensation structure allows the company to recruit the right team to play the game.
Michael A. Greeley is managing general partner of IDG Ventures. E-mail: mgreely@idgventures.com.
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