On one hand, compensation is merely a way to trade value with your employees. You give them a salary, they give you their time and skills.
On the other hand, compensation is a way to demonstrate your company values. Through things like equity and bonuses, you can incentivize better performance and retention and also encourage a meritocratic culture. How you communicate compensation also has a big role in both helping employees feel valued and improving offer acceptance rates.
It’s not easy though. There are all sorts of confusing equity terms. It’s hard to know how to set the guardrails, and when to make exceptions. And what about benchmarking?
That’s why we wrote this guide. We drew from our experience talking to dozens of companies. We also interviewed founders of four companies (Mathilde Collin, CEO of Front, Waseem Daher, CEO of Pilot, Ant Wilson, CTO of Supabase, and Christina Cacioppo, CEO of Vanta) to get on-the-ground insights.
In this guide, we’ll cover everything a founder needs to know about compensation:
- Where compensation can go wrong
- How to set compensation including when you should think about it and how to determine the amount and terms
- How to communicate compensation
- How to measure compensation
- How to scale compensation (differences from 0-20 and 21-100)
Let’s get into it.
Where can compensation go wrong?
Imagine this: you’ve been working on your startup for a few years and you just finally start to get traction. You’re growing from word-of-mouth and your two sales reps have been bringing in a lot of business too. You decide to hire a Head of Sales to take your go-to-market to the next level. You find someone with the right background and stellar references. You make the offer and they accept.
Only problem: 2 months after the Head of Sales started working, you realize that you paid too much for them. They are valuable, sure, but between the cash salary and equity grant you gave them, you’re running into issues filling out the rest of the team. You still need to hire an engineering leader, and that’s not even mentioning the rest of the sales and engineering teams you need to build out.
What do you do?
Besides this first story, compensation can go wrong in a number of ways:
- Salary inversion. This is when new hires end up making more than old hires, merely because they are new. As your startup grows, you might increase the budget for salaries. If you don’t have a plan for early employees, they can get left behind.
- Running out of equity. For each round of funding, you’ll allocate a percent of the options pool for employees. What you don’t want to happen is to run out of those employee options before the next round of funding — otherwise you’ll have to go back to your board asking for more (and explaining why you weren’t able to plan properly).
- Overpaying executives. Another common mistake is overpaying executives that aren’t useful for you. Or, maybe even more commonly, is paying someone who is good but paying them far too much.
- Gaps between salary bands. Over the years, the gaps between salary bands can increase to the point that it creates a problem. If you start a small number of levels, and they increase each year, the gaps between the levels will increase. Then, when you want to give raises, you have a problem: do you give an employee a large pay raise that comes with a responsibility increase? Or do you keep them at the same pay and level?
- Giving an employee a salary band below expectations. Somewhere in between “we’re starting a company with two co-founders” and “we are going to IPO”, you as a team will implement compensation levels and salary bands. If you delay this and do it when you have lots of employees, it creates a situation that only has downside. For example, when Waseem Daher was at Dropbox, they implemented levels when there were hundreds of people. If an employee was slotted at the level they thought they were, they feel neutral about the situation. But if an employee was slotted lower than they thought, it created tension. Employees felt that the situation was unfair.
A big part of why we wrote this guide is because a lot of these problems are preventable. You just need to know about compensation best practices and plan ahead.
How to set compensation
When should you think about compensation?
The best time to think about compensation is before you’re in the middle of a negotiation with a candidate. It’s easy to make exceptions even when you do have rules; when you haven’t made anything yet it’s almost impossible to be objective in the moment.
Waseem Daher told us that Pilot put an official program into place before they reached 20 employees. It gave them a ton of leverage because they didn’t have to start from scratch each time they made a new hire. They had a framework.
Ant Wilson (co-founder and CTO of Supabase) told us a similar story. The Supabase team wrote down their compensation rules when they had fewer than 5 employees. The only mistake they feel like they made is when they strayed from the rules.
“When we broke our [compensation] rules, we learned the hard way that we shouldn’t have.”
Besides at the beginning, there are a few other times you’ll need to think about compensation.
- Giving new offers. When you give out a new job offer, you need to reference your plan to figure out which level to place them at and where in the salary bands to give them an offer.
- Fundraises. Another key time you need to think about compensation is when you raise capital. One of the key decisions for each fundraise is the option pool size: how much do you want to reserve for employees?
- Employee anniversaries. When should you give out promotions, bonuses or raises? “Every year” is a good benchmark for how proactive startups should think about fundraising for employees.
How to determine the amount of compensation?
There are many ways to determine how much salary and equity to give employees; here’s one that we’ve found to be successful for a lot of the companies that we help.
First, determine the needs of the business and the levels of responsibility and experience for those needs. For example, in your first 10 employees, you probably won’t need to hire an executive. There’s not very many people to manage, so hiring an executive who only manages people wouldn’t be a good fit. However, you might need an experienced product designer that can fully run projects on their own. In this case you could “level” them as an L4 designer and request having 5-7 years of work experience.
Once you’ve determined your need, you can anchor the position around salary bands using benchmarking data. There are many sources for benchmarking data and it allows you to create salary bands updated with the current market. The key for benchmarking data is finding the right data: there’s a lot of data out there, but you need to match it to your particular org structure and role responsibilities. Some more complicated roles (such as Developer Advocate or Head of Community) are notoriously hard to find data for, and it can also be hard to find robust international benchmarking data.
Finally, determine what percentile you want to offer salary and equity. The median is (obviously) 50th percentile, and sometimes that’s all that’s required for the role. Other times, companies want to incentivize hires with higher compensation and choose a higher percentile.
This will give you a framework in order to give an offer: you can start with salary bands, match to your percentile, then adjust up or down based on experience.
One other nuance: if you are hiring internationally, think about if you are planning to pay all employees the same amount or if there will be a geo-adjustment. As one example, Supabase hires from all over the world and has a uniform pay scale. If Supabase hires two mid-level engineers from two different countries (one from Canada and one from Singapore), they will earn the same amount. Supabase wants to attract talent regardless of where they live and their compensation strategy reflects that desire: they don’t make geo-adjustments.
What about the terms?
Besides the amount of compensation, there are also a lot of terms that you need to decide.
There are some terms related to annual salary that are worth talking about during a job offer. While salary itself is pretty straightforward, this is a good opportunity to talk about career progression and planned merit cycles. How often do they happen? What determines raises? Supabase, for example, tied salary increases to company revenue milestones. A milestone approach is something you could consider as well.
While salary is straightforward, equity is a topic that has a lot of nuance—and opportunity for you as a founder to differentiate your company to candidates. The rest of this section focuses on equity. We explain the terms and offer suggestions for how to make your offers stronger to candidates and employees.
Before getting into the terms, a quick reminder: none of this article is financial or legal advice specific to you or any individual. We recommend speaking with a trained financial or legal advisor for specific advice.
There are three basic kinds of equity: stock options, restricted stock awards, and stock units.
Stock options are common ways to grant equity to employees at small to mid-sized startups. Stock options have a key advantage over other kinds of equity: they don’t trigger an immediate tax event because the employee is receiving an option, not a share. (Although employees do face that issue when they exercise their option, more on that in a second).
There are multiple kinds of stock options. The two most common are incentive stock options (ISOs) and non-qualified stock options (NSOs or NQOs). The main difference between ISOs and NSOs is the tax treatment for employees: ISOs are generally more tax-friendly.
Restricted stock awards (RSAs) are the most basic kind of equity. They are stock awards because the company grants them to the employee as compensation. They are restricted because they come with certain, well, restrictions. The most relevant restriction is vesting: they only become “yours” according to a certain schedule based on your continued employment at the firm. But there are other restrictions like “transfer restrictions” which typically make it harder (through board approval or something else) for grantees of RSAs to sell their shares.
RSAs are also the least common type of equity granted. They are typically given to you and your co-founders, plus maybe some of the first employees. And that’s it. This is because RSAs, as compensation, trigger an immediate tax event. And if the price of the shares has increased substantially (something that typically happens, especially in the first years of a startup), the tax burden is too large for employees to pay.
Stock units (also called Restricted Stock Units or RSUs) are the most common way that late-stage startups ($1 billion+ valuation) and public companies grant equity to their employees. Stock units aren’t technically shares or options, but are instead a different thing that’s contractually tied to the value of shares.
RSUs are used at later stage and public companies because of their tax treatment. They are taxed when they vest, so if an employee is issued ¼ of their total shares after 1 year, they would be taxed at that time. At a late-stage private or public company, you can set up a program to help employees get liquidity by selling some of their shares to pay for the cash taxes.
Vesting is the mechanism to earn full legal right for shares or stock options. Before an option or share has vested, the employee doesn’t own it. For startups, the vesting schedule is typically time-based.
The standard vesting schedule is 4 years with a 1-year cliff, meaning that 25% of the options will be earned by the employee after 1 year and an additional 2% (1/48th) will be earned each month after that. If the employee stayed at the company for 11 months, for instance, they wouldn’t earn any of their shares or options. If they stayed at the company for 19 months, they would earn 39.6% (19/48) of their shares.
Options exercise period is the amount of time that an employee has to exercise their shares. This time period starts from when the employee is granted shares and the length is typically seven to ten years as long as the employee stays at the company. For most employees, this doesn’t come into consideration as they exercise their options or leave the company before the period is closed. But for the few who stay, it often creates a tough tax situation as the company’s valuation has likely increased a lot and the employees’ cash tax burden to exercise will be very large (often 6 or 7 figures).
Post-termination exercise window is the amount of time that an employee has to exercise their options once they leave the company (by their choice or yours). The typical post-termination exercise window is 90-days, meaning that if an employee hasn’t exercised their options and they leave the company, they’ll have a few months to do so (or they’ll lose the options). Employee-friendly startups have been giving employees longer post-termination exercise windows to give them more flexibility.
Early exercise is the ability for an employee to exercise their options before they’ve vested. Without an early exercise clause, employees can’t exercise their options before they’ve vested. If the employee exercises their options when the strike price is equal to the 409a price, they likely won’t pay any taxes on it. By giving employees the right to early exercise, it gives them the option to benefit from this tax advantage (assuming they also file what’s called a Form 83(b) indicating they want to trigger the tax event before vesting). Early exercising, however, is not yet the standard in the industry.
It’s more flexible than you think
One final thing to remember: this is all made up. It’s more flexible than you think.
Yes, there are industry standards. Most vesting schedules have a 1-year cliff with a 4-year total vesting cycle. Most of the employee options pools at 10% of each fundraise.
That said, it doesn’t mean it’s the best way to operate. If you want to give your employees more equity, you can do that. If you want to write more employee-friendly terms in your job offers, you can do that. If you want to try a different org chart, you can do that.
You don’t have to go crazy, but thinking from first principles can give you an advantage in the hiring market.
How to communicate compensation
“Every compensation conversation with candidates is easy when you have data to back it up.” Mathilde Collin, CEO of Front
Setting compensation is just half the battle. An opportunity for every startup is to improve how they communicate compensation to their employees and candidates. Here are a few tips.
Decision first, communication second. One of the biggest benefits of having a compensation philosophy is approaching each employee the same way. If you don’t stick with it, you’re at risk of treating your hiring or merit decisions inequitably. Additionally, if you make one-off compensation choices, it’s easy to make a decision that you regret later (“Where did my options pool go?”) because you were caught up in the moment.
Give the “why”. Candidates and employees want to feel like they are being treated fairly. They might feel regret if they didn’t negotiate and learn that one of their colleagues did. If you’ve established a compensation philosophy based on your company stage, hiring roadmap, revenue goals, and benchmarking data, communicate that framework to candidates and you’ll be much more likely to get a positive response.
For example, Front provides data to their candidates in advance. They tell candidates the percentile that Front pays for cash salary (75th) and equity (90th), and they show candidates the benchmarking data for how they developed the salary bands. They explain their promotion processes. In return, candidates feel like they are treated fairly and the conversations become easy.
Explain the equity terms and amount, and model various outcomes. Equity is hard to understand for everyone (yes, even the lawyers). Employees have it even tougher because they often don’t have legal counsel they can ask questions to. You can’t advise employees to exercise their options or not (that’s financial advice), but you can—and should—explain all of the terms and model scenarios based on company exit valuation.
For the terms, explain the basics of how they work and the likely tax implications of exercising. To go a step further, provide information like fully diluted shares outstanding (FDSO) and share prices (409a and preferred) up front so that candidates have a clear picture of how much equity they own and what it’s worth.
For the scenario modeling, consider a few different methods. One way is to model your outcome based on a highly-visible outcome in your industry. If you’re building a fintech company, how much would the candidates’ equity be worth if we became the size of Stripe? What about Robinhood? You can also show them probability-weighted outcomes. If there’s a 5% chance of becoming a $1 billion company, and a 20% chance of becoming a $200 million company, etc., what is the weighted average of their equity?
Share the right amount at the right time. The new California pay transparency law requires that companies provide a salary range for new jobs: at the very least, comply with these laws if you are hiring in CA. However, in each step of the process you can continue to share more about your compensation philosophy with candidates, probably at a faster pace than you initially expect. Some companies (a few examples here) even have publicly-facing compensation philosophies.
If we leave you with one takeaway it’s this: a lot can change based on how you communicate compensation. You don’t necessarily have to spend more money to get the candidates you want, you might just need to tell a better story. From Waseem Daher:
“So much matters about how you present the offer. You’re telling a story and I think people forget that… It’s not just about the cash, it’s about the equity and the value of the equity and how that will trend over time. It’s about the ownership, agency, impact, and learning that you’ll get from working here.”
How to measure compensation
“Your business is the people you have. [Compensation] affects your ability to get high quality candidates — you have to keep a close eye on it.” - Waseem Daher, CEO of Pilot
At a startup, your people are your most important asset and compensation is how you measure the financial cost of those people. Compensation can account for 50-70% of total costs, yet a lot of teams don’t track compensation in any meaningful way.
Metrics you should track
Monthly burn is the amount of money your company spends in a month. There are two kinds of burn: gross burn and net burn. When people talk about burn they usually are referring to net burn which is the difference between cash inflows and cash outflows. Monthly burn is important for compensation because compensation is likely your largest expense, it’s critical to headcount planning and it is a key input into calculating runway.
Total cost of workforce
The total sum of the amount of how much your startup spends on its workforce. This includes cash salaries of employees, but it also includes the cost of benefits, equity and HR operations like sourcing, interviewing, onboarding, training and development. We also recommend breaking it down by function. Generally, there are two big buckets:
- Fixed cost of workforce (engineering, design, product)
- Variable cost of workforce (sales, marketing, some operations)
Breaking it down in these two categories enables you to compare what’s required to keep the company functional to what’s required for growth.
Salary bands are how you set compensation based on job function and level. For example, an L3 engineer salary band might be $145k-$170k. This has a few key benefits:
- You can track metrics like percent of employees above or below salary bands to course correct. It’s common for early employees to be paid lower salaries than later employees, even for the same job. There are also common salary discrepancies due to gender or ethnicity. These gaps can be closed by setting salary bands and making sure employees are paid accordingly.
- You can track how many of your job offers fit within the compensation bands. Not every candidate can be a stretch candidate! This keeps you on track.
Cash cost per employee
Cash cost per employee is the amount of cash you are paying on average for your employees. To calculate it, take the total salary expense divided by the total number of employees to get the average. This helps you more accurately forecast headcount expenses.
Option pool granted / remaining
The employee equity pool is the amount of shares reserved for the company to grant to employees via options or stock units. Once you’ve allocated shares to your employee equity pool, it’s critical to track how much you’ve granted to employees. Given the cash constraints of a startup, make sure you have options to incentivize your employees.
Metrics you shouldn’t track
Another common criteria that companies use for promotions is inflation. It’s especially top of mind in 2023 given significant increases in inflation in the last 12-18 months. Should you adjust salaries up based on the high inflation? We don’t think so:
- Inflation and wage growth are correlated, but different metrics. Inflation is driven by changes in the price of a basket of goods, while wages are driven by worker preferences, demographic trends, changes in productivity, technological advances, and the labor participation rate.
- It sets a tough precedent. If you increase the salaries by 4% this year due to inflation, employees will expect something similar in the future.
Instead, compensate your employees according to your own compensation philosophy and not to worry too much about inflation.
Metrics in practice
At the end of the day, each company is different and you can be successful tracking other metrics. For example, Pilot uses the following metrics to report to their board:
- Headcount (and the change in headcount month over month)
- Regrettable vs non-regrettable attrition. (To determine regrettable vs non-regrettable attrition, Pilot conducts exit interviews, talks to their manager, and looks at their historical 360 reviews).
- Voluntary vs non-voluntary attrition
- Breakdown of headcount by geography and functional area
Learn more about compensation metrics in our guide here.
Scaling compensation: 20 to 100+
This guide is geared towards founders of smaller startups (say, under 20 employees). There’s a lot of things listed in this article that you can do early on to prevent a lot of problems later. But even with the best preparation, the nature of hiring changes. Hiring your first 20 employees is categorically different than hiring your next 80.
We partnered with Christina Cacioppo, CEO of Vanta, to write a section on the best practices when scaling from 20 to 100+ employees. Here are the biggest differences we’ve found:
Cost per employee balloons. You can think of compensation as four broad buckets: salary, performance-based pay, benefits, and equity. Companies and employees often call the combination of those four broad buckets “total compensation.” This is more accurate, in that it covers all the compensation an employee receives, but it can be a shift from just thinking about cash compensation. Total compensation – and, often, each piece of total compensation – increase as your company grows.
Early employees often understand that their compensation will be weighted toward equity, rather than cash compensation. Very practically, this means they might make less cash working at your startup than they would in a role at a larger company, though they may also see the value of their equity grow quickly, be working on something impactful, take on more responsibility, and have autonomy over their work). As roles and hiring profiles shift, base salary may become more important to some candidates, and you may find yourself competing for candidates that value cash compensation over equity or other benefits.
Scaling a business often requires a sales team, which is incentivized by commissions or bonuses. Then, as companies grow, they may institute performance-based pay beyond just the sales team. As companies grow, they may be expected to offer more generous (and expensive) benefits packages. Benefits can include healthcare, meal stipends, transportation, 401ks and financial planning, and wellness.
Finally, equity. The value of equity is often calculated as the percent ownership in the company multiplied by the valuation of the company. For private companies, the valuation is often subjective; it’s worth coming to your own point of view on how much a company is worth today and could be worth in the future, both as an employer and as a candidate. Over time, any new employee’s percent ownership of the company will decrease, but the company should be getting more valuable, so the dollar value of each equity grant may go up over time.
And they look at total compensation when evaluating their offers.
The type of candidate changes. The first few hires will most likely be from the founders immediate network (or 2nd degree connections) – most startup ideas look questionable in the earliest stages, so personal relationships are crucial to early recruiting. It’s best if these first hires are generalists: they’re great at something (back-end engineering, for example) and understand they’ll do a bit of everything. The best early startup hires are energized by that ownership and responsibility.
As the company grows, you’ll need to change how you source candidates and what type of candidates you source. When the team is 65, you don’t need many generalists anymore; you’ll need specialists, experts in their fields. Sourcing specialists is different from sourcing generalists, and besides: the founders’ network probably already knows about the company at this point.
You need explicit plans to grow and develop your teammates. As your company grows, employees will expect more active support of their career goals. In the early days, employees are often more concerned with the work in front of them than how it ladders up over time; if the company succeeds, they succeed. But as the company gets bigger and hires leaders from the outside, employees will want to know which skills they should hone so they can take on bigger roles in the future.
Planned career progression also matters on the company side: if you have three new grad engineers, they may be able to get a lot done – and they may want to learn from a more experienced engineer. Similarly, last year’s new grads may be wonderful mentors to next year’s hires or interns.
Finally, you’ll need to be disciplined about your equity options pool. For each funding round, you’ll set aside a portion of the company for options grants to new and existing employees. You’ll determine the size of that pool by estimating how quickly you'll hire, which hires you’ll make, and how much equity you’ll grant to each; you’ll also want to add in retention grants for existing employees. Then you’ll need to stick to the plan.
There’s more training, coordination, and administrative work. Running the same process takes more time and coordination for 86 employees than it did for six employees. Though you may have the support of a finance, people, and/or recruiting team, you’ll also need to coordinate across all of those roles.
As a quick example, imagine you’re considering giving an annual merit raise. With six employees, you can collect peer feedback, think through their performance, decide on a budget for compensation increases (salary or equity), and talk each person through their package.
With 86 employees, this same objective can take 4-6 weeks and involve multiple approvals, e.g. manager, Head of HR, CFO, department VP(s), CEO. Training on bias, empathetic conversations, and feedback frameworks can be helpful. There’s more tasks to complete to accomplish the same objective.
Treat humans like humans
There’s a lot of information in this guide. And we get it — there are more fun things to do than spend hours reading the tax code only to have to pay a 5-figure legal bill to make sure it’s not wrong. Talking to customers and building products is a lot more rewarding.
But compensation doesn’t have to be that bad. It doesn’t have to be just about the cold, hard numbers. You can be softer with your approach — at the end of the day, it’s a human to human interaction. Both parties benefit if you treat each other that way.
It’s a big reason we started Complete. If you spend the time to set the right compensation philosophy and communicate the reasoning to candidates and employees, they are much more likely to understand. Studies have shown that the thing candidates care most about in hiring processes is that they were treated fairly. Start on the right foot by setting a best-in-class communication standard.