When it comes to recruiting top executives, Internet startups have a huge advantage over their Old Economy competitors: the lucrative stock option packages that can be worth millions of dollars if and when the company goes public.
Take, for example, Charles Betty, chief executive of EarthLink Network which recently moved from Pasadena to Atlanta after merging with Mindspring Enterprises Inc. In January 1996, when Betty was hired, he received a base salary of $225,000 per year and options to buy 200,000 EarthLink shares for $4.84 per share over a five-year period.
That turned out to be a pretty good deal, given that EarthLink's shares traded as high as $90 last year.
In addition, Betty was awarded another stock option package valued at $23.1 million in 1998, which made him one of the highest paid executives in Los Angeles County.
Stories like Betty's are the reason a growing number of executives are taking off their neckties and trading their secure jobs at traditional companies for the risk and adventure of working at a dot-com.
"Just about everybody who is leaving their job in a traditional industry to work at a startup is getting a sizable options grant," said Rick Ericson, a consultant with management consulting firm Towers Perrin. "It is the centerpiece of any pay package."
Although stock options are not unheard-of in other industries as an incentive for top executives, there are some crucial differences when it comes to Internet startups. In the first place, the appreciation of equity in an Old Economy company is typically dwarfed by that of an Internet startup, as in the case of EarthLink.
Second, in traditional industries, only top management is usually given stock options, whereas at many dot-coms even fairly low-ranking employees are given at least some shares.
"It fits with the more dynamic, entrepreneurial culture at Internet startups," said Ericson. "There is a lot of internal movement, and even low-level employees will make important contributions to the success of the company. Also, these companies need to get to the market as quickly as possible, and stock options are a way to get people in the door and keep them motivated."
The composition of a top executive's stock-options package is contingent on a number of factors, one of which is how close a startup is to going public. In most cases, the further from an IPO a startup is, the higher the risk that it might not ever make it and thus, the more generous the stock options. Of course, with Internet startups, those variables can change very rapidly.
For example, Steve Schoch, formerly a top executive with Times Mirror Co., was hired as chief financial officer of eToys Inc. in January 1999, a few months before the company went public. As part of his compensation package, Schoch received options to buy 250,000 shares at $10 each.
Two other key eToy executives, Chief Information Officer John Hnanicek (who came from video chain Hollywood Entertainment Inc.) and Senior Vice President for Operations Louis Zambello (who was recruited from catalog retailer L.L. Bean Inc.), were brought aboard a month earlier, in December 1998. Their stock options were for 200,000 shares and 275,000 shares, respectively, at only $5 a share.
Schoch's $10 options initially looked to be a huge windfall after eToys' staggering IPO last May, when share prices closed at $76 on the first day of trading. Now that investors have become slightly more picky about e-commerce companies and eToys' shares are trading for a more-pedestrian $11, the options look a lot less awesome.
"There is an inherent risk in stock options," said Michael Reznick, a senior consultant with William M. Mercer Inc. "Knowing whether they'll pay off is like knowing where the market is going, and anyone who can tell that will be a very rich person."
Reznick and other Internet-industry observers agree there is a bias in the stories we hear about executives striking it rich with Internet startups little is heard about those who strike out.
"It's still a little early to tell because there are not that many companies that have failed so far. That's likely to change, though, in the coming years," Reznick said.
Meanwhile, a very tight market for seasoned executives with the skills to take a startup to an IPO means that the best of them can demand even larger option packages.
"Only a small percentage of Old Economy executives will have the key skill you need to run an Internet startup, and that is adaptability," said Bert Hensley, managing director with executive recruiting firm Morgan Samuels Co. "When a CEO who has this skill makes the transition, he or she can get 6 to 8 percent equity now, whereas a year before they might have gotten 4 to 6 percent."
With the increasing influx of venture capital in Internet startups, the cash component of executive compensation is seen as growing in importance in addition to the stock option packages.
"Cash is starting to become more relevant," said Richard Spitz, managing director with recruiting firm Korn/Ferry International. "A startup will lose out if it's looking for talent on the cheap and tries to save $50,000 on recruiting a chief executive. The best CEOs will get over $200,000 and increasingly more often, over $250,000."
However, equity is still the main pull for executives switching over to a dot-com, and it's expected to stay that way for the foreseeable future.
"The alternatives, as far as incentives are concerned, are pretty poor," said Ericson. "What are they going to do? Tie bonuses to the company's profit? All these companies need to make huge investments in marketing, which cuts into their profitability. Stock options are the most effective way to promote the success of startup companies."
For reprint and licensing requests for this article, CLICK HERE.