Key Considerations for DTC Brands When Designing a Compensation Philosophy

A “DTC brand” refers to a consumer brand that is digitally native, deriving most of its revenue from eCommerce channels. This discussion excludes food and beverage companies due to differing dynamics.

The primary mistakes often come from thinking the company is a tech company. DTC does not have the same operating leverage as tech, so compensation should be structured differently.

• Frequent equity raises and markups are less common compared to tech. This makes it challenging for employees with equity exposure to value their shares. It is tough to create a sense of value behind any equity compensation. Conversely, most tech companies are VC-backed and raise equity every 1-2 years, making it easy for employees to see third-party validation of their equity’s value.

• DTC does not scale as quickly as tech. A few years before a liquidity event is feasible in tech but unlikely in DTC. Employees making $100,000 or even $300,000 may not be thinking that far into the future, and justifiably so.

• Outcomes are smaller. $1B+ outcomes are not as common as in tech. This makes it hard for equity to translate into life-changing money unless current equity is okay with extreme dilution or there is a dividend component included. It is essential to show the team how they will benefit from any equity exposure.

Questions to consider while designing a compensation philosophy:

• How will the classic 10x engineer scenario be handled? Can they out earn a manager? They should be able to.

• Does the compensation philosophy align with the core values? For example, if a value is “will-to-win,” the compensation philosophy should reward the team for winning.

• Is it simple to track and inexpensive to administer?

• Fairness should be the goal—not sameness!

• How and with whom is value shared? Transparency might be important, but it may differ for each company.

• How will performance-based and guaranteed compensation be balanced? This should flow from the core values.

Verne’s Magical 5 Principles of Compensation Design

Verne Harnish, the author of Scaling Compensation, outlines 5 key principles that facilitate the design of a compensation plan.

1. Align with organizational strategy: The compensation plan should support the company's overall strategy and goals.

2. Attract and retain top talent: The compensation plan should be competitive in the marketplace to attract and retain the best employees.

3. Motivate and engage employees: The compensation plan should motivate and engage employees to perform at their best.

4. Support the company culture: The compensation plan should align with and support the company's culture and values.

5. Be cost-effective: The compensation plan should be financially sustainable for the company in the long term.

What is the role of compensation?

Compensation helps attract and retain smart and ambitious people aligned with the company culture. The philosophy promotes rapid learning and generously rewards those who grow their skill set while helping the company and the team reach their goals.

How does the value created flow through the company?

Transparency about where cash flow, equity, etc., goes is critical. A document detailing compensation philosophy is meaningless if actions do not align with what is being said.

Value created by the team flows in the following order:

1. Bonus to the team, including stretch goals.

   1. Well-designed and generous compensation facilitates excellent company performance.

   2. It makes managing talent easier. The best can be hired, top performers rewarded, and good fits quickly identified.

2. Reinvesting in inventory, infrastructure, and the “physical” parts of the company.

   1. Reinvesting in the company is essential for continued growth. Compensation cannot be increased without increasing free cash flow.

   2. New and exciting learning opportunities become available if the company keeps growing. Rapid growth means constantly evolving roles and challenges.

3. Deleveraging the company.

   1. Applies if the company is operating with high leverage. Although it is low-risk and the company can default without significant issues, it makes management more difficult. Operating with less leverage will simplify vendor management, ad-hoc initiatives, etc.

   2. Operating with less leverage creates a buffer, enabling great opportunities to be seized. For example, if a distributor becomes distressed and available for sale, it could be acquired at a great price. It also provides protection if something goes wrong.