Employee compensation can be tricky to figure out.
This article offers guidance on how to calculate fair compensation and equity packages for startup employees.
The Importance of Market Research in Determining Compensation and Equity
For fair startup compensation, it’s crucial to analyze salary data and equity norms in your industry and region. This market research gives insights on what competitive and equitable offers look like, and the usual equity percentage for a given role and company stage.
Proper market research leads to attractive, sustainable compensation packages that prevent internal pay gaps. It also keeps you updated on industry trends. Update your research roughly every two years for the best results.
Additionally, this research can help you stay updated on industry trends and best practices, which can be useful as your company grows and evolves over time. It is recommended that research be updated approximately every two years.
Balancing Cash Compensation with Equity Grants
Balancing cash compensation and equity is a tough call for startups.
High salaries can attract talent, but equity aligns employees with company goals. A “total rewards” strategy balances both by considering salary, equity, benefits and perks. You could offer a lower salary for higher equity or better benefits, but be careful about individual variations, as it may lead to future compensation disparities.
Linking cash to performance metrics is another tactic. Lower base salaries with bonuses or profit-sharing opportunities based on revenue targets or milestones.
Ultimately, a strategic approach to compensation, considering your startup’s finances and employee expectations, can lure talent while driving your company’s success.
Early Startup Employee Equity Allocation
Determining how much equity to offer early startup employees can be a complex decision that depends on several factors, such as the stage of the startup, the employee’s role and responsibilities, current market conditions, talent market conditions, and available funding.
Typically, it’s common to offer a larger equity stake to early startup employees compared to those who join later, as the risk and uncertainty are higher in the initial stages of the startup. However, the exact amount of equity to offer depends on several factors, such as the employee’s role and contribution, market standards, and available funding.
Below are two rules of thumb that can help founders:
Rule of Thumb #1: The first 10 employees should receive roughly 10% of the company.
- Hires 1–5 should receive between 0.25%–3%.
- Hires 6–10 should receive between 0.10%–1%.
Rule of Thumb # 2: More equity means less cash.
In most cases, if an individual is receiving a salary considerably lower than what is considered “market” for their role, they will anticipate receiving more equity as compensation. Typically, the first 10 employees are paid well below what their job is worth and, therefore, receive a much larger share of equity compared to someone hired after later rounds of funding. On the other hand, if an early employee is demanding a high salary, their equity should be decreased.
These two rules of thumb are just that: guidelines. Don’t place too much weight on them. Ultimately, determining how much equity to give early startup employees requires a case-by-case analysis of the startup’s needs, goals and available resources. Market standards play a role in determining equity allocation. It’s essential to research what similar startups in the industry are offering their employees to stay competitive and attract top talent. It’s also crucial to balance the needs of the business with the needs of the employees to ensure everyone is motivated to work toward the same goal.
Vesting Schedules: Ensuring Early Employee Retention
Equity compensation is a great way to attract and retain top talent. However, in order to make sure that employees are committed to the company for the long haul, it’s important to implement vesting schedules. These schedules are clauses in employees’ equity award agreements that outline how their equity will be distributed over a specific period of time.
By using vesting schedules, startups can ensure that early employees stay with the company for a certain period of time before receiving their full equity stake. Vesting schedules provide both a carrot and a stick. The carrot is that employees who remain committed to the company long-term contribute more value and (hopefully) increase the value of their stock. The stick is that if an employee leaves early, they won’t receive their full equity award.
A typical startup vesting schedule is four years, with a one-year cliff. For example, if an employee is granted 10,000 shares of stock but only receives 25% of those shares after their first year of employment, they would receive an additional 25% after each subsequent year, until they have received all 10,000 shares after four years.
Lastly, vesting schedules allow both parties to evaluate whether an employee is a good fit for the company. If employees aren’t a good fit, they can be terminated before the one-year cliff and won’t walk away with any ownership in the company.
If you’d like to learn more about vesting schedules, click here.
Strategies for Communicating Comp
Here are some tips on how to discuss compensation with potential hires:
- Transparency and Clarity. Clearly explain details like cash compensation, equity grants, vesting schedules and benefits. Make any internal policies influencing these decisions transparent.
- Highlight Total Rewards Package. If applicable, emphasize all components of the compensation package from health insurance to unlimited vacation time.
- Personalized Communication. Tailor messages according to each candidate’s individual needs or preferences.
- Anticipate Questions and Address Concerns. Be prepared to clarify doubts about equity grants, vesting schedules and other benefits. Proactively address potential concerns, and provide clear answers during negotiations.
Impact of Company Stage and Funding on Employee Compensation and Equity Packages
Startup employees’ compensation is largely influenced by the company’s stage and funding. Early-stage startups, often pre-revenue, typically offer lower salaries but larger equity grants or perks to attract talent.
As startups mature with funding or revenue, they can offer competitive salaries, smaller equity grants and performance-based bonuses.
Founders need to consider their company’s stage while structuring compensation. Too much early equity can lead to dilution, while too little may discourage talent. Low salaries can result in high turnover. Long-term organizational planning is also crucial for forecasting growth and adjusting compensation accordingly.
Balancing financial stability, employee satisfaction and growth potential allows founders to create stage-appropriate compensation packages, instilling confidence in potential employees about future growth, even with low initial salaries.
Considerations for Offering Performance-Based Bonuses or Profit Sharing
Performance-based bonuses or profit-sharing plans can motivate startup employees, supplementing base salary and equity grants.
When contemplating such incentives, founders should consider:
- Performance Metrics. Define what milestones or metrics, such as revenue growth or customer acquisition, will determine the rewards.
- Plan Structure and Eligibility. Decide the structure and eligibility criteria of the plan. Consider questions like “Who is eligible?” and “Will the reward be tied to exact metrics or a subjective evaluation?”
- Payout Frequency. Determine the frequency of payouts, whether annual or quarterly, tied to performance metrics.
- Clear Communication. Explain the plan’s workings to the employees, including their roles and the evaluation timeline. This ensures goal alignment and avoids misunderstandings.
A well-planned, performance-based reward system can incentivize talent and foster long-term company growth.
Conclusion
In conclusion, building a startup compensation and equity package requires careful consideration of several factors, including market standards, company stage and available funding. Balancing cash compensation and equity grants requires a “total rewards” strategy that considers all aspects of compensation. Additionally, early startup employee equity allocation and vesting schedules are crucial for attracting and retaining talent. Founders should also consider offering performance-based bonuses or profit-sharing plans to motivate employees. Ultimately, transparency, communication and flexibility are key to creating a compensation package that aligns with employee needs while driving the success of the company.
