A compensation philosophy is critical to a growing startup. As soon as you start hiring employees, you’ll need to figure out how to pay them. You could compensate your employees without much consideration, but doing it randomly is like setting the foundation of a house randomly. It’ll crumble as soon as you build on top of it.
There are lots of specific reasons why you as a founder or HR leader might want to review your compensation philosophy:
- You haven’t ever set a compensation philosophy
- You’re making one-off compensation decisions
- You want increased employee retention
- You want increased candidate pipeline volume
- You want to improve your offer acceptance rate
- You want to reduce / eliminate pay inequities
If any of these apply to you, now might be a good time to review your compensation philosophy. This guide covers how to set and communicate your compensation philosophy along with best practices and examples from companies we admire. Let’s get into it.
Part 1: Set your compensation philosophy
Once you’ve decided to review your compensation philosophy, the first step is to make a bunch of decisions that affect compensation. These include big decisions like, “how much should we pay people?” to decisions that appear small but are actually big like, “should we be up front with candidates about our promotion schedule?”.
We’ve pulled together a checklist to help you check all the compensation boxes.
Company and values
What is your company’s remote work policy?
- This is a key decision your company needs to make: are you going to require employees to work in person? The benefits of working in-person is everything you get by being side-by-side: communication and camaraderie. The benefits of remote work are more flexibility (potentially targeting a larger pool of candidates) but it often requires more intentionality to foster a cohesive culture.
What are your company’s mission and values?
- What does your company stand for? If you haven’t set your mission and values, during it when you review your compensation philosophy is an excellent time to do so. Your mission and values can set the stage for compensation discussions and help candidates understand where you are coming from.
What kind of compensation structures do you allow?
- The most common types of compensation at startups are base salary and equity. Salary is the cash you pay out on a regular cycle and equity is an ownership stake in your company awarded through stock.
- Besides salary and equity, you also might choose to offer bonuses, have commissions for sales reps, or other kinds of compensation.
- A final component to consider here is if you will offer equity refreshers. They can be useful for retaining top talent as your company grows, but they can also become very expensive. For all types of compensation, having a philosophy allows you to plan ahead so that you can do the best both for your company and increase your chances of closing your candidates.
Do you benchmark salaries? If so, what percentile of the market do you target?
- One way to decide on the amount of compensation is to define the role you need to hire for, figure out what experience level you need, then compare that to what the broader market is paying for that kind of candidate.
- If you choose to adopt this policy for compensation, a key input will be the salary and equity percentile. Paying at the higher end (above 50%) of the market can be great for recruiting and retaining talent, especially if you've had trouble in that area. However, this does come with increased costs. Paying on par with the market is a popular option, and in certain situations, paying below the market trends may be necessary if your company is particularly cash-strapped.
Do you have a location-based pay policy?
- This question especially applies to remote teams, but it also applies if your company has several offices. Sometimes hybrid companies offer different pay based on if the employee is located in a city that has an office. Often, remote-first companies will pay the same amount regardless of location.
When and how do you adjust salaries?
- Given the fluctuating nature of the compensation landscape, it's important to decide on the criteria that would necessitate an adjustment in pay. This should be communicated to candidates early on in the hiring process. Clarifying these upfront can save your company much headache and expense.
- A few common reasons to adjust salaries include market competition, inflation / cost of living increase, changes in responsibilities / position, internal compensation reviews, duration at the company, and company goals.
What equitable compensation practices can you commit to?
- Some common practices to ensure you are being equitable in your compensation include annual compensation reviews, utilizing pay bands and leveling to determine compensation, and being transparent with your compensation philosophy to all candidates and employees.
Will you negotiate with candidates?
- Negotiation has become a common practice. Some people advise candidates to negotiate in every job offer, and some employers give offers expecting that candidates will negotiate. Regardless of your stance (negotiate, not negotiate, or decide per-employee), make sure you decide in advance and stick to it.
What type of equity do you offer?
- Generally, you’ll give employees stock options, restricted stock awards, or restricted stock units. A lot of the decision will come down to the company stage: the founding team generally receives restricted stock awards, employees early on receive stock options, and later stage companies grant restricted stock units.
What are your vesting terms and why?
- The standard vesting terms are a 4-year vesting window with a 1 year cliff. This means that 25% of the stock will vest after 1 year, and an additional 1/48th will vest each month after that. However, you might consider other vesting options such as a front-loaded vesting schedule or a milestone-based vesting schedule.
How long is the post-termination exercise window?
- The post-termination exercise window is the time period an employee has to exercise any vested, unexercised options after leaving a company. The industry standard exercise window is 90 days. However, this can put the employee in a tough situation as they may have to pay a large cash sum to exercise their options and pay the associated taxes in just a couple months. Employee-friendly companies have longer exercise windows (for example, 10 years).
Do you offer early exercise?
- Early exercising is when an employee exercises their options before they vest. This can have tax advantages for the employee. However, similar to exercise windows, the industry standard is to not offer early exercising to employees. Employee-friendly companies may choose to offer early exercise to their employees.
Titles & promotions
How do you decide what title should be used to set someone’s salary?
- Most startups commit to incorporating levels (L1, L2, etc.) into their titles after a certain size (say, 30 employees). However, deciding this early on and communicating it to candidates can make it clear that you are serious about their career growth and paying them the right salary amount.
How do you decide when someone should be promoted?
- There are many options for how to determine if and when someone should be promoted: duration, performance, change in responsibility, and other criteria.
Part 2: Communicate your compensation philosophy
Once your team has answered the questions and developed a compensation philosophy, it’s time to communicate it to candidates, employees and other stakeholders.
Make your decision before communicating your philosophy. If you make your decision before you talk to candidates and make offers, you’re less likely to make mistakes based on one-off information or feelings. A huge benefit to having a compensation philosophy is consistency; decide in advance and you don’t have to make the same decision over and over.
Start by explaining the framework, then talk about the numbers. Rather than just giving an employee salary and equity numbers, start with the “why”. You have a good reason why you are making this offer: communicate that reason to them. It will make the interview process easier for both sides.
For equity, show various outcomes. Equity is notoriously hard to understand and is riddled with complicated acronyms like ISO, AMT and QSBS. It’s also difficult for people to wrap their heads around the probabilities of a startup success and also the scale of that possible success. Communicate equity to employees and make sure they understand what their portion could be worth given the success of the startup and the time they spend at the company. A calculator is a good tool for this.
Communicate to current employees. A compensation philosophy won’t affect the compensation of current employees, but it could affect how their compensation changes and what their coworkers make. Make this clear to them. Then share the full compensation philosophy so they understand you and your team have done the work to create a fair compensation plan. You can also use the new pay transparency laws as an excuse to update (or create) your compensation philosophy and communicate it to your team.
Share your compensation philosophy with candidates. This decision is ultimately up to you. Most companies don’t share a public link, but are very open with sharing it with candidates. We think this is a good middle ground. Some companies post it publicly and use it as a marketing tool. This can work but has obvious tradeoffs (others will know your compensation philosophy and could copy / criticize it).
Best practices and examples
As you go through the above list, it’s sometimes not obvious what policies you should choose. Oftentimes your default might be, “let’s just do what the other best companies are doing.” Here are a few best practices and companies that are doing just that.
Employees should be incentivized primarily through equity. For candidates that want a large cash salary (whether to live a more expensive lifestyle or to save), there are other jobs that they can pursue. At startups, equity is generally a better motivator beyond immediate needs as it aligns incentives. You can build this into promotions as well — for example, if they increase their responsibilities, you might offer an equity refresh to them.
Communicate your compensation philosophy. This might seem obvious given this article, but it’s important to say again: communicate your compensation philosophy! This is one of the major goals of developing a compensation philosophy. It helps you find the right candidates and also helps increase offer acceptance rates.
It’s okay to change. Your compensation philosophy can change over time. Between market dynamics, priorities at your company and other factors, your needs will change. Developing a compensation philosophy will force you to think about these questions and put pen to paper, but it’s okay to change it if your company changes.
What we like about it:
- Comprehensive compensation calculator
- Speaks directly to the types of candidates (and customers) they are trying to attract (developer)
- Clear breakdown of job grades broken down by job family
What we like about it:
- Compensation philosophy driven by principles and stated clearly at the top
- Explains what percentile they pay their employees and why it differs based on job family
- Functional calculator to allow candidates to check compensation on their own
What we like about it:
- Clear charts explain principles and components to their compensation philosophy
- Incorporates job family and experience level into compensation
- Strong sections on benefits and intrinsic rewards
What we like about it:
- Answers common questions employees have about compensation up front
- Relatable and straightforward tone
- Uses examples to explain hard-to-understand concept (choice between high/low equity/salary)
If you need help reviewing your compensation philosophy, Complete can help. Check out our Compensation Philosophy Builder to build it on your own or request a demo from our team.