Compensation

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It isn’t easy to build pay systems that inspire, guide, and energize people without at the same time damaging your organization and people… Don’t try to solve every problem with financial incentives.Jeffrey Pfeffer and Robert Sutton, co-authors and professors, Stanford*

​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 may be in any combination of cash (salary and any bonuses); equity in the company; and non-cash pay, such as health insurance or other benefits, family-related protections, perks, and retirement plans.

Some companies underestimate the importance of compensation, perhaps by not understanding a candidate’s financial needs or by overlooking what compensation can signal. Compensation can be intertwined with other things candidates care about. For instance, a candidate might implicitly correlate the impact of their role with their level of compensation and thus interpret compensation as a signal for whether their company cares about them and the work they do. Candidates might consider an increase in compensation as a signifier of progression in their career. They may derive their self-esteem from that number, or compare it against what’s earned by peers, friends, or family. Or, they might use compensation as a proxy to judge how “elite” a team is. These correlations may not always be valid—a company with high salaries may be packed with all-stars, or it could just be overpaying to compensate for something else, like poor work-life balance or a toxic culture.

The more you consider the candidate perspective on compensation in the early stages of your hiring process, the more capable you will be of having open and honest discussions with candidates about compensation later on. This will also give you a chance to think about how compensation fits into your company’s mission and values—and the other way around. Some companies overestimate the importance of compensation, spending too much time on equity percentages and not enough on their value proposition. These companies will likely make compensation a key discussion point when communicating with candidates, which will undermine the company’s ability to engage candidates with other potentially motivating factors, and will affect how closely they can get to candidate-company fit. Some companies will discuss compensation directly and negotiate it aggressively, while many companies—and candidates—might shy away from discussing compensation because it feels awkward and transactional.

Elements of Compensation

​Definition​ Total target compensation (TTC, total compensation, target compensation, or TC) is the value of an employee’s cash and equity compensation, assuming any relevant conditions are met. This measure typically does not include benefits, which may also be part of an employee’s compensation package.*

Depending on the company, a compensation package may be made up of some or all of the following:

​Definition​ Base salary is a fixed amount paid to an employee at regular intervals. Although it is often expressed as an annual number, companies generally pay it out in weekly, biweekly, or monthly installments.

​Definition​ A sign-on bonus (or signing bonus) is a one-time payment to an employee that is associated with them joining a company. Sign-on bonuses are often contingent on the candidate staying with the company for a certain period of time—usually one year. If an employee’s sign-on bonus includes this contingency and they leave the company before the end of the relevant period, they may be required to repay the sign-on bonus.

​Definition​ A relocation bonus is a one-time payment made to assist candidates who might incur moving expenses as a result of their new role. Companies can offer relocation bonuses when a new employee is joining or when an existing employee is moving to a new role at the company in a different location.

​Definition​ An annual bonus is compensation issued once a year to an employee. It can come in the form of cash—a lump-sum payment on top of an employee’s base salary—or equity. When companies pay annual bonuses in cash, they often quote the bonus as a target percentage of the employee’s base salary. Some employers make annual bonuses contingent on employee and/or company performance.

​Definition​ Equity is ownership in a company, and it can be given to employees as a form of compensation. Equity may take the form of stock, stock options, restricted stock units, warrants, and so on. Many technology companies, including most startups, grant some form of equity-based compensation to employees.

​Definition​ Benefits are non-cash services and advantages that a company offers to employees. Benefits may include various levels of healthcare coverage; family-related protections like childcare or health insurance for partners and dependents; perks like meals, the coverage of transportation costs, or enrichment classes; retirement plans; paid leave for vacations, parental leave, and family medical leave; and more unexpected benefits that emphasize health, curiosity, and mission alignment. Benefits programs vary from company to company in their level of systematization, treatment of seniority, and rules on the inclusion or exclusion of contract workers and part-time employees.

Cash vs. Equity

It has become common practice in the tech industry, both at startups and large companies, to grant some form of equity to employees. And compared to cash, equity may much better align the interests of employees with the long-term interests of the company—or at least that is its intention. For earlier-stage employees, equity is a much riskier form of compensation because of the wide variance in eventual value—an employee’s shares in the company (not to mention those of the founders and investors) could end up being worth nothing, or hundreds of millions of dollars or more. Equity compensation is a notoriously complex subject. (For a deep, practical dive into the complexities of equity compensation, see The Holloway Guide to Equity Compensation.)

Candidates can have very different needs and preferences when it comes to cash and equity. Cash has a guaranteed value (setting aside changes like inflation), while equity can end up being worth a lot more or less than anyone’s best guess. Cash is a commodity; equity in a company is not.

A candidate’s response to equity vs. cash may stem from their risk preference. But often, it comes down to practical necessities. Founders may feel that a candidate unwilling to sacrifice cash for equity doesn’t believe in the company, when in fact, differing financial and familial situations may determine candidate response. For example, a candidate who has a family to provide for, or obligations like student debt to repay or mortgages to maintain, may be unable to sacrifice a guaranteed salary, even if they are passionate about your company’s mission. Companies do well to foster sensitivity to this reality in their candidate pool.

Ideally, the candidate’s position on cash vs. equity will align with what your company can offer. A candidate that really needs more take-home pay might not be a good fit for an early-stage startup that can only afford to offer—or prefers to offer—partial ownership in the company instead. If you have flexibility, one technique you can use is to offer candidates the ability to “trade cash and equity” by letting them choose between a low equity/high cash or high equity/low cash offer, depending on their cash needs and risk appetite. Matt Mochary’s book, The Great CEO Within, recommends offering the amount of cash a candidate would need to live comfortably, finding what an all-cash offer might look like at a large company, and then bridging the difference in equity.

Mapping Compensation to Job Levels

Where I have seen most companies get this wrong is that they do not extend their leveling system into the hiring process, or they do not have compensation tied directly to leveling. Missing either of these leaves huge loopholes in any system.Marco Rogers, veteran engineering manager*

Compensation is a complex subject rife with potential pitfalls. It’s important to develop a compensation philosophy and explore various strategies when building a compensation plan for new hires. Even if you work for a large company with an established compensation plan, you still may gain from reading through these strategies for mapping levels to compensation, as it will help you better understand your company’s and candidates’ perspectives, and will better prepare you to communicate with candidates about compensation.

The best use of money as a motivator is to pay people enough to take the issue of money off the table.Daniel Pink, bestselling author*

When interviewing and assessing candidates, taking a candidate-company fit approach helps you map candidates to your existing structure. The goal is to be able to predictably determine their compensation based on the role and level.

Understand the Market

Developing an understanding of the talent market in which you’re competing is the first step. For example, early-stage startups may rely more on equity than cash for compensation. Roles that are more senior or more scarce might command higher compensation. Supply and demand really do come into play here. Ultimately, for a particular role—with its associated level of seniority, geographic area, and stage of company—there will be a distribution of what companies offer to their employees (with a high end and low end, and some mix of cash, equity, bonuses, and/or benefits). You can find this type of data through specialized companies that run salary surveys (like Radford, OptionImpact, RHR, or Connery Consulting), on AngelList, through your investors, or even by browsing sites like Levels.fyi, Glassdoor, or Paysa. (The latter group of sources rely on unvalidated, self-reported data, and so may be less accurate.)

The benefit of using data from sources like Radford and Connery is that they’re inherently tied to their leveling rubrics; if your levels correspond to theirs, you’ve got a head start on mapping your compensation to those levels. These data give you a solid indication of what market rates are. The next step is to adjust for your own hiring philosophy and practicalities, and then actually test out your numbers in the market. If you’re losing a big chunk of your offers because of your compensation package, that is the market’s way of telling you something is off.

​caution​ In dynamic markets, large-scale salary survey data can lag as an indicator, and tend to be weighted toward levels in larger companies in larger markets. So you’ll want to factor this in as you consider your own company’s size, maturity, and needs.

Levels.fyi has collected a trove of employee-submitted salary and level data, allowing you to benchmark compensation across levels for a variety of larger tech companies (bearing in mind that these are not vetted in the way that data from formal salary surveys are).

Figure: Compensation by Level

Source: Levels.fyi

Establish Your Compensation Philosophy

Once you understand the market, you will likely want to consider how or whether your compensation plan might align with your value proposition to candidates, the types of candidates you want to hire, and your company’s constraints. For example, you might consider offering top-of-market compensation to all candidates (sometimes called “the Yankees approach”), in the hopes of increasing your offer acceptance rate. But keep in mind that offering high compensation won’t hide a bad work environment or lack of vision from new employees.

On the other hand, you might compensate a little more conservatively, hoping to put more of your money into scaling your company. If you can offer candidates a really strong value proposition, like opportunities for growth or a mission they are passionate about, or if they have confidence in how successful your company will be, they might place less weight on cash, and you might offer more in equity.

​danger​Some companies can use this strategy exploitatively—but it’s unscrupulous to over-promise on any dimension simply to convince someone to take lower pay than they should. It is likewise short-sighted to pay someone less than they deserve because they are motivated by the company’s mission and might choose to work for less. Others may be motivated by mission but unable to sacrifice making a living.

Ultimately, the best strategy is to compensate as fairly and transparently as possible, and to find candidates whose needs align with what you can offer. If you overpay, you risk attracting the candidates who only respond to extrinsic motivations. If you underpay, you may not be able to hire and retain the people you need to succeed.

Pick a Range

Building a healthy compensation system requires associating a compensation band with each job level.

A compensation band (or pay band) is the range of compensation a company offers to all employees at a certain job level. Within a band, individual employees’ compensation varies based on factors such as job function, experience, location, and performance.

Again, salary survey data offer good starting benchmarks for this. Companies typically make compensation bands wide enough to have some flexibility, and often these bands overlap. If you want to be really structured, you can peg your compensation to a percentile. For instance, you might decide your compensation will be at some percentile of the data you gathered when developing your compensation philosophy. The 75th percentile is usually a good place to aim for—it’s higher than the average, but not high enough to make your offer “only about the money.”

​confusion​People often confuse percentiles and percents, with serious consequences. When someone recommends compensating at the 75th percentile, they are talking about percentile rank, or paying at a rate that is greater than what 75% of companies pay for a role (in a given market, stage, et cetera). This is very different from paying 75% of what a fair market salary would be.

​caution​How you fit people into roles or levels and how those levels relate to compensation is a minefield for discriminatory practices. Take great care when leveling a candidate and deciding compensation. Under-leveling may result in a weak offer that won’t appeal to the candidate and is also more likely to happen to URG candidates. Former Google engineer Kelly Ellis and two colleagues filed a class-action lawsuit against Google alleging that they were consistently placed in lower levels than male colleagues, resulting in lower salaries, bonus and stock grants, and promotion opportunities.* Conversely, over-leveling might mean you have expectations for performance beyond what the hire can deliver.*

Veteran engineering manager Marco Rogers wrote a must-read Twitter thread about how he approached mapping levels to compensation at Clover Health, and the pros and cons their approach had when it came to bias, discrimination, and the overall integrity of their hiring practices. (He also discusses salary transparency and non-negotiation policies, which are helpful to understand when preparing to make offers to candidates, and which we will get into next.)

Salary Transparency

When you start talking about pay transparency, the first thing everyone thinks is ‘I’m going to know how much everybody makes.’ I think a better way to frame it is ‘I’m going to understand why I’m paid what I’m paid and how I can increase my comp.’bethanye McKinney Blount, founder and CEO, Compaas*

An important decision for leadership to make is how much transparency to offer in compensation and leveling. The social media management company Buffer holds transparency as a key value and has made compensation information completely transparent, publishing not only formulas for how they determine compensation, but also publicly releasing every employee’s salary and level. That level of extreme transparency is rare, but many companies appreciate the benefits of some level of transparency around compensation.

​caution​ However, there are many other companies that try to avoid any level of transparency around compensation in order to avoid negotiation with candidates. This is both unrealistic and counterproductive; and in some cases it might even be illegal (for instance, in California, employers have to provide pay scales for positions when asked, but it’s complicated). First, platforms like Glassdoor or Blind (or plain old gossip) usually make compensation data for most companies available to the public. Second, avoiding a conversation about a candidate’s level and expected impact might only end up kicking the can down the road and creating surprises later—and these conversations are a lot more difficult to have after someone joins a company.

First Round has some additional insights into why it is wise to treat compensation transparency as a spectrum, and shares some of the risks involved. It’s perhaps best to consider a middle ground, which might not entail making everyone’s salary and level public (though Buffer has enjoyed positive reactions to their efforts), but could include letting candidates know what level they would be joining at, and then letting them access information about what you expect at different levels. This can help set expectations around their role when they join and point to future avenues for growth. You can do this directly with a candidate or by publicly sharing your rubric or ladder. You can also explain the logic behind how you determine candidate compensation. This will help force you to be fair about how you compensate, while potentially avoiding zero-sum negotiations.

If you would be mortified to find out that all your team or company’s compensation data was leaked to the public, asking yourself why can be very eye-opening. There are serious pros and cons to consider on both sides of the debate, and each company has the right to decide where on the spectrum they belong; but it’s wise to reflect on how you compensate your team before you post a job opening or extend an offer. If you wouldn’t be comfortable explaining to a candidate how you arrived at their compensation package, you may need to take a look at your current approach and go back to the drawing board.

Making Exceptions

Having a clear policy around compensation, levels, and titles can help make sure you are able to attract the right talent for the right reasons. However, you will come across cases where your structure doesn’t quite match candidate expectations. After all, the data you gathered about the market or about the candidate may not be perfect.

While ignoring your structure may lead to arbitrary and unfair decisions, sticking to your policy too rigidly may result in losing out on great candidates. (Some people are OK with this in the long run, based on their specific values and hiring philosophy.) No incentive structure is perfect. So when and how should you make exceptions?

A balanced approach would be for every company to be highly disciplined about how they compensate employees, but allow themselves a certain degree of flexibility to exercise in certain situations. These guidelines may be useful:

• If a candidate is going to bring disproportionate value to your company, it’s fair to compensate them disproportionately. This is especially true in the early stages of a company or for highly specialized roles with very scarce talent. Sometimes, a single hire can dramatically change the trajectory of a company either directly, by bringing a unique set of skills; or indirectly, by showing credibility to investors, candidates, and customers.

• When compensating disproportionately, it’s worth considering skewing toward equity over cash. This will help maintain long-term alignment and minimize risk.

• ​danger​ Don’t make exceptions for candidates who are simply good negotiators, have astronomical competing offers, or were overpaid in their last role. (Note that while this information may surface, it is illegal to ask candidates about past compensation in several states, including California; the “salary history” bans are an effort to combat pay disparity and discrimination.) These types of exceptions aren’t fair to your existing team. It’s also important to know that some types of candidates will be less or more likely to feel empowered and entitled to negotiate. For instance, young women are a lot less likely to negotiate than men of any age, because people treat them differently in negotiations, not because they “lack confidence.”

• If you find that you are frequently making exceptions, you might consider revising your existing structure and applying changes both to future candidates and to your existing team. If you had to rehire your existing team, what would their compensation look like?

​caution​ Even though experts recommend having discipline and structure around compensation, many companies don’t run their hiring this way. Certain large software companies are notorious for making notable exceptions for candidates with competing offers (especially if those offers are from competitors), and “bidding wars” can ensue. On the other hand, high-growth startups that have substantial funding and a “grow at all costs” mentality can be very undisciplined about the offers they extend. It’s helpful to know that you might end up faced with these dynamics. The companies that navigate this the most successfully—both for themselves and with their candidates—have a combination of structure, awareness around unconscious bias, and integrity in their decision-making processes.

When to Bring up Compensation

Compensation can be a tricky subject. It’s uncomfortable for a lot of people, and there might be laws that govern how you can have that conversation (for example, in California and a number of other cities and states it is illegal to ask a candidate what their current compensation is, and you are legally required to disclose a salary range for a position if they ask you). However, compensation is an important criterion for all parties, and it has to be discussed—but when?

Bringing up the issue of compensation too early can be a distraction for you and the candidate, pulling attention away from more important issues. That said, there’s a risk that if you don’t broach the subject early, you can both waste a lot of time working through the rest of the process only to realize later that what you can pay is incompatible with what the candidate needs. For example, if a candidate is moving from a large, well-paying company to a startup where cash compensation might be much lower, it’s important to bring this up early to avoid surprises later. And of course, even if your plan is to delay that conversation, it’s not uncommon for a candidate to bring it up before you’d planned to.

Furthermore, some companies run a candidate through their process, extend an offer, and have the candidate reject the offer based primarily on compensation, without either party having ever brought up the subject. Sometimes the company isn’t even aware that compensation was the problem; often, this is because both parties are uncomfortable discussing it.

One way to avoid such situations is to give the salary range early and ask the candidate if there is enough overlap with that range to continue the conversation.

​story​ “The best way I’ve seen this done is giving a range for the role in the initial phone call. This way they know the lower bound and can make a determination based on that. In one situation I was told the upper bound, and they noted it was rare for that to be offered to a candidate. That upper bound was my lower bound, so I knew right away it wasn’t a fit.” —Laurie Barth, Staff Engineer, Gatsby

If you are certain that your offer will be the fair market rate for a company of your stage, it’s fine to ask the candidate whether being paid fair market rate works for them. (Unfortunately, some companies will claim that they are paying market rate, but aren’t, either knowingly or not.)

​caution​ Avoid asking specifically about a candidate’s compensation needs. Whether they have financial obligations that necessitate a certain monthly income may be uncomfortable for them to discuss, and it’s not fair for you to ask this of some candidates and not others—you also don’t want to skirt any legal issues with your questions. However, it is appropriate to ask whether the candidate has a strong preference on cash vs. equity.