Severance considerations.

Author:Reda, James F.

There are several ways to compare severance packages between private companies including emerging pre-IPO companies, and public companies.

While public companies routinely provide severance protection for their senior executives, private companies are lagging in arranging this protection. It is particularly important that private companies provide severance protection for newly hired executives, and when a company is beginning a strategic review where parts of the organization (or the whole company) may be sold or merged. Adequate severance protection will allow senior management to focus on business needs and goals, and it does not result in an expense--unless needed, of course.

Severance is one of the seven elements of compensation, along with salary, annual bonus, long-term incentives, benefits, perquisites and sign-on or other bonuses. These are also the key components covered in terms of employment.

There are several ways to compare severance packages between private companies including emerging pre-IPO companies, and public companies.

Public vs. Private

There is only one labor market for senior executive talent. While there may be additional skills gained by working at a public company (e.g.. SEC reporting requirement and investor relations, to name a few), the jobs are basically the same between private and public companies.

Private companies tend to be smaller due to the lack of access to the capital markets and locally or regionally based vs. multi-national.

However, over the past 30 years, private company compensation practices have been conforming to those of public companies for a variety of reasons, including:

* Competition for talent. Private companies need to match public company pay practices to be competitive. This is particularly the case for pre-IPO companies. It is not uncommon for private companies to hire from the public company market.

* Private company boards are typically made up of directors with experience from private and public companies.

* While there is arguably less risk with a private company, these companies are typically closely held with the chairman of the board being a representative of a large shareholder group. Thus, senior executives can find themselves in trouble.

Private companies, in general, do not offer the same severance protection as public companies. However, large mature private companies provide similar severance benefits as public companies for reasons including:

* Private companies do not contemplate a change-in-control of ownership;

* The CEO/CFO job at a private company is not considered as risky;

* Private companies tend to be more paternalistic and have more latitude to be fair upon severance;

* Private companies tend to be smaller than public companies.

Public company compensation levels and programs are a key factor in determining compensation levels in private companies. It is important for companies to devise and follow a compensation philosophy as part of their compensation program, which includes public company benchmarks.

Does this conclusion extend to include severance-related compensation? How do private companies, including emerging/pre IPO companies design their severance packages?

Employment and Severance Agreements

First, let's look at how executive severance payments are structured among public companies, starting with the employment/severance agreement. An employment/severance agreement can provide the following benefits:

* The improved comfort and reduced distraction of the executive.

* The certainty of employment arrangements that define the relationship between the executive and the company clearly.

* The reduced harm an executive can cause the company by imposing restrictive covenants.

As an alternative or in addition to severance agreements, companies also may put in place retention agreements that make certain payments for continued service. This is sometimes called the "push-pull" method, with the retention payments providing the push and the severance payments providing the pull. The big drawback to retention payments is that they provide an additional expense while severance payments are not an expense unless they are paid.

History of Severance Agreements

The use of severance agreements has evolved over the past 60 years. In the 1950s--and earlier--it was very uncommon for...

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