editione2.1.1Updated September 12, 2022
Definition Compensation is any remuneration to a person (including employees, contractors, advisors, founders, and board members) for services performed or rendered to a company. Compensation comes in the forms of cash pay (salary and any bonuses) and any non-cash pay, including benefits like health insurance, family-related protections, perks, and retirement plans.
Company strategies for compensation are far from simple. Beth Scheer, head of talent at the venture fund Homebrew, offers a thoughtful overview of compensation in startups.
Another term you may encounter is total rewards, which refers to a model of attracting and retaining employees using a combination of salary and incentive compensation (like equity), benefits, recognition for contribution or commitment (like awards and bonuses), training programs, and initiatives to improve the work environment.
Definition In the context of compensation and investment, equity broadly refers to any kind of ownership in a company that can be held by individuals (like employees or board members) and by other businesses (like venture capital firms). One common kind of equity is stock, but equity can take other forms, such as stock options or warrants, that give ownership rights. Commonly, equity also comes with certain conditions, such as vesting or repurchase rights. Note the term equity also has several other technical meanings in accounting and real estate.
Definition Equity compensation is the practice of granting equity in exchange for work.
In this Guide we focus on equity compensation in stock corporations, the kind of company where ownership is represented by stock. (We describe stock in more detail in the next section.) Equity compensation in the form of a direct grant of stock with no strings attached is very rare. Instead, employees are given stock with additional restrictions placed on it, or are given contractual rights that later can lead to owning stock. These forms of equity compensation include restricted stock, stock options, and restricted stock units, each of which we’ll describe in detail.
The purpose of equity compensation is threefold:
Attract and retain talent. When a company already has or can be predicted to have significant financial success, talented people are incentivized to work for the company by the prospect of their equity being worth a lot of money in the future. The actual probability of life-changing lucre may be low (or at least, lower than you may think if your entire knowledge of startups is watching “The Social Network”). But even a small chance at winning big can be worth the risk to many people, and to some the risk itself can be exciting.
Align incentives. Even companies that can afford to pay lots of cash may prefer to give employees equity, so that employees work to increase the future value of the company. In this way, equity aligns individuals’ incentives with the interests of the company. At its best, this philosophy fosters an environment of teamwork and a “rising tides lift all boats” mentality. It also encourages everyone involved to think long-term, which is key for company success. As we’ll discuss later, the amount of equity you’re offered usually reflects both your contribution to the company and your commitment to the company in the future.