Electric-car maker Tesla (NASDAQ:TSLA) has announced a new compensation package for CEO Elon Musk, one that is intended to retain him for at least another decade. The package consists of a 10-year grant of stock options that is split into 12 different tranches with specific vesting milestones. The company points out that none of the tranches will vest over time, making Musk's compensation entirely dependent on hitting those milestones.

Here's what investors need to know.

Second-generation Tesla Roadster driving on a road

Image source: Tesla.

The 2018 award

Each of the new 12 tranches -- each tranche is equal to 1% of current shares outstanding -- have two related milestones: a market cap milestone and an operational milestone.

The first market cap milestone will be achieved once Tesla's market cap hits $100 billion, with each subsequent milestone coming in $50 billion increments. In order for all 12 tranches to vest, Tesla's market cap will need to reach a mind-boggling $650 billion. That would put Tesla in the same league as the most valuable tech companies in the world, and above Amazon.com's current market cap ($640 billion). Tesla's current market cap is about $59 billion, but Musk has previously suggested that Tesla could one day become a $1 trillion company.

The operational milestones relate to revenue and adjusted EBITDA growth, with the only adjustment on the latter metric being to exclude stock-based compensation (SBC) expense. Here are the milestones:

Revenue

Adjusted EBITDA

$20 billion

$1.5 billion

$35 billion

$3 billion

$55 billion

$4.5 billion

$75 billion

$6 billion

$100 billion

$8 billion

$125 billion

$10 billion

$150 billion

$12 billion

$175 billion

$14 billion

Data source: Tesla.

There are 16 milestones listed above, so Tesla would need to hit 12 out of 16 in addition to reaching a $650 billion market cap for Musk's award to fully vest.

As far as the employment requirement, Musk must either remain as CEO or serve as both executive chairman and chief product officer. That leaves open the potential of Musk stepping down as CEO at some point in the future, which Musk himself has previously said is a possibility although he would remain with the company in some capacity.

The new package will go up for a shareholder vote at Tesla's upcoming annual meeting, with Musk and his brother Kimbal Musk (who sits on the board) recusing themselves so that shareholders can properly vote for the grant without worrying about being steamrolled by the brothers. They don't wield majority voting control combined, but have quite a bit of sway. Elon holds 33.6 million shares, or about 20% of total shares outstanding, while Kimbal has a little over 150,000 shares.

The 2012 award

The package is "modeled after Elon's 2012 performance award," according to Tesla. Way back in 2012, the company awarded Musk with nearly 5.3 million stock options, split into 10 vesting tranches. This compensation package would effectively compensate Musk for running the company in the years that followed, as Musk does not accept a cash salary from Tesla.

One of the key requirements for each tranche was that Tesla's market cap had to increase by $4 billion, compared to the company's $3.2 billion market at the time of the award. In addition to that, here's where the 2012 award stands with its required milestones:

  • Completed: Successful completion of the Model X alpha prototype.
  • Completed: Successful completion of the Model X beta prototype.
  • Completed: Completion of the first Model X production vehicle.
  • Completed: Aggregate production of 100,000 vehicles.
  • Completed: Successful completion of the Model 3 alpha prototype.
  • Completed: Successful completion of the Model 3 beta prototype.
  • Completed: Aggregate production of 200,000 vehicles.
  • Completed: Completion of the first Model 3 production vehicle.
  • Not completed: Aggregate production of 300,000 vehicles.
  • Not completed: Gross margin of 30% or more for four consecutive quarters.

Tesla begins recognizing SBC expense as soon as any milestone is considered "probable of achievement." The milestone for producing 300,000 vehicles was first deemed as such back in Q3 2016, so it began recognizing the related SBC expenses then, with only $1 million left unrecognized as of the end of Q3. The company has $5.7 million of unrecognized SBC expense for the final remaining milestone related to gross margin, which is considered "not probable of achievement."

Great expectations

When Tesla reported Q3 earnings in November, it pointed out that it had delivered its 250,000th vehicle. After delivering nearly 30,000 vehicles in the fourth quarter, hitting the 300,000 milestone is imminent. With 90% of the 2012 grant earned, it makes sense that Tesla would grant Musk a new compensation package that retains him while aligning his interests with those of shareholders.

If Musk is able to lead Tesla through a decade of insane growth, he will become one of the richest people (if not the richest) in the world. It's also worth noting that the nature of the milestones is different. With the 2012 grant, the milestones (not including market cap milestones) focused primarily on vehicle development and production, with only one milestone relating to financial results (gross margin) -- the only milestone that Musk failed to deliver.

This time around, the milestones exclusively relate to financial metrics, which investors should appreciate as the eccentric billionaire has to deliver on that front in order to get paid.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Tesla. The Motley Fool owns shares of and recommends AMZN and Tesla. The Motley Fool has a disclosure policy.