Tuesday, July 5, 2011

Lesson #58: How to Determine Employee Compensation

Posted By: George Deeb - 7/05/2011


& Comment

At the end of the day, a couple key themes rule your employee compensation strategies: (1) the market is the market, so you need to pay competitively to attract talent; (2) you get what you pay for; and (3) you can creatively lower cash salary with equity-based compensation, to keep your cash burn rate at a low.  I will tackle each of these points below.

There is a "market rate" for each job within your company.  And, the market rates for any one position can wildly vary based on: (i) the stage of your business; (ii) the industry/competitive skills you are hiring for; and (iii) the city you work in.  As an example, check out Crains Chicago's 2010 Wage and Salary Survey to get a good sense to average wages and salaries by job position for employees in the Chicago area.  You should try to find something similar for your home cities, or use the Chicago numbers as a rough ball park, understanding bigger/more competitive cities, like New York and San Francisco, have be pay more, and smaller cities can pay less than what is paid in Chicago (given the lower cost of living in those smaller markets).  And, don't forget the laws of supply and demand for specific roles.  As an example, if tech coders with expertise in C+ and Ruby are in high demand and short supply in your town, they are going to be paid more than people with more readily available HTML coding skills.

Sometimes you will see CFO's being recruited in the $100K salary range, and other times you see them being recruited in the $1MM salary range.  Why the huge discrepancy?  Because proven Fortune 500 companies have to report to their public shareholders and need proven CFO veterans with public company expertise and a track record of successfully managing multi-billion dollar P&L's.  But, a CFO of a startup does not need that level of expertise, and most likely can get a away with a less experienced CFO, who would probably be more of a VP level executive within a bigger company.

But, the message "you get what you pay for" never holds more true than in your recruiting efforts.  So, you never want to be "cheap" in your recruiting efforts.  If you want a battled tested startup CFO, as an example, you are going to have to pay more than you would for a first time CFO with limited startup experience and no track record.  But, that past startup experience is worth its weight in gold.  In the CFO example, knowing how to "stretch pennies into manhole covers" and attract outside capital could be the key difference between getting your company funded or successful.  So, don't always go with the cheapest alternative.  Go, for the best alternative you can afford.

That said, there are creative ways to structure compensation packages to attract "A Players", without having to pay "A Prices", and that typically comes down to offering them rich equity packages in your business.  As an example, the CFO who takes a straight salary may get $150,000 in a startup company.  But, you may only need to pay them $100,000 if you add 2.5% stock options to their package.  And, frankly, if they are not willing to "put some skin in the game" and work for some piece of equity, they may not have the risk profile for a startup or the confidence in their own abilities, and perhaps should not be pursued for the position. 

I typically offer employees a matrix of options to choose from including a mix of high salary/low equity; medium salary/medium equity; and low salary/high equity, and letting them choose the right mix for them.  But, if your goal is to keep cash low, then you have to do an equally compelling job of selling them on the future value of the company, and their resulting equity value (where a lot of equity is their best option).

There is no exact science or "one size fits all" to creating a motivating compensation structure for all employees, as every exployee has their own specific objectives and cash cushions to rely on.  So, it is usually best to let the employee throw out a starting salary that works for them (validated by asking their most recent salary history), and then negotiate it down from there with equity.  But, be realistic and disclose your "salary range" in your job postings, to ensure you are pulling in candidates you can reasonably afford.

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