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Compensation Packages in Venture-Backed Companies

You’ve been offered a job at a startup. The folding tables look romantic, the smell from the Chinese restaurant next door isn’t too annoying (yet), and there is a plunger in the one bathroom. The founders tell you that cash is tight but they are having lots of meetings with VCs and a financing is just around the corner. What should you expect regarding compensation?

Of all the questions that we’ve gotten, the most popular have been surrounding compensation. It runs the gamut from “how much do you pay X” or “how do VCs feel about deferred comp” or “what are standard compensation terms.” Given all of the interest in what cash and equity compensation is, we’ve decided to create a series of blog posts to address the issue. This series isn’t just for employees, but also founders. If you’ve been a regular reader of Brad’s blog, then you’ll know we’ve partnered before in discussing such topics such as Term Sheets, Letters of Intent and 409A.

As with all of our series, but probably even more so here, please take our opinions as just that – our opinions. There aren’t “right” or “wrong” answers here, every case is special, your mileage may vary, etc. There are many factors that go into determining compensation packages – it would be inappropriate to simply print this blog series, take to your next board meeting and demand a raise (especially if you work for a company we are an investor in.)

Over time we will publish individual posts on particular topics concerning compensation, including such scintillating missives as “compensation by job title” and “advice for paying outside board members and advisors.” If at any time you’d like to read or print the entire series as one post, check out the “Download Our Content” feature on the upper right of this frame.

We hope you enjoy this series and welcome your comments. If there are areas that you think deserve their very own series (say – like “Angel Investing” which we are currently working on) please suggest them to us.

- Jason and Brad

May 11th, 2007 by     Categories: Compensation    
  • http://www.podglo.com Doug K.

    Really looking forward to this. I’ll work for free for a period but I don’t expect others too. We all have families to support but you are put in a tough spot as a startup.

  • http://lallylogic.startitup.net Brendan Lally
  • http://OnStartups.com Dharmesh Shah

    Look very forward to further posts on this topic.
    I think it’s a fascinating area about which not enough has to be written.
    I’m in the situation right now where we need to figure out this stuff for my startup.

  • http://www.newmanva.com/blog Ari Newman

    Looking forward to the series also. Having been through this discussion numerous times in the last few months I am anxious to see how specific your guidance is, especially w.r.t angel-backed companies. Issues such as accrued comp. (we’ll pay you later) and equity bonuses come up often.

  • http://TBD Marc Burch

    Great. Having been at a number of start-ups, I’m looking forward to this series.

  • http://www.fonjax.com Mark Moore

    Forgive me for the longish post, and I hope I don’t come across as glib, but I’ve found this to be a particularly easy question to answer for the situation you’ve described: pre-funding, or (the essentially equivalent) funded, but pre-revenue startup.
    In this situation, the startup is zero sum; if you pay a penny more to someone, that’s a penny less you have to survive or that you have to pay for something/someone else.
    Therefore, the amount to pay any employee at this stage is the absolute minimum the particular employee can afford to live on.
    This may sound radical, but I’ve successfully had this discussion and negotiation with about 12 individuals over the last two startups I’ve founded. Bear with me before you jump to dismiss.
    The most notable characteristic of this negotiation (IMHO) is that it has almost nothing to do with the startup’s finances, *nothing* to do with what the prospective employee was paid previously or what I pay others, and has even less to do with what the “standard”, “average”, or “typical” compensation might be within the industry. It’s an intrinsic property of the individual you’re looking to hire (including their particular domestic situation).
    The only reason it involves the startup’s finances at all is that once you’ve identified the true minimum acceptable salary, it’s a fairly simple, but necessary, step to determine whether the salary is supportable or not. If not, you need to find someone else to hire.
    Once you accept the zero-sum premise, the only question left is how do you determine what *is* the “absolute minimum” an individual can afford to live on? My experience is it’s generally much higher or much lower than they think at first.
    What I’ve found works is first to give the previous setup, and then to be quite direct and tell them I won’t make an offer. They will. But first, they need to go home and work out their finances, *with* their SO if they have one, because the number will be driven by their needs which I simply have no visibility into. I challenge them (remind them actually) that they should find a number that is supportable – while not comfortable, not overly painful either.
    I let them know that if they come in too high, I’ll work with them to push it down a little, but not too much since it’s presumably their lowest survivable number. (See the discussion about metric three below.) If we can’t get it down, then no hard feelings, it’s just that they’re not in a position to pursue this particular opportunity at this particular time.
    I’ve found the following three metrics useful when pushing the compensation down to the right level of pain:
    1) Their wife/husband/partner should be pushing back, but should neither prohibit, nor become upset about the lowered salary.
    2) They should not be tempted to moonlight. And,
    3) They should not plan on building up their nest egg, nor should they plan on depleting it.
    The first metric is one of the best because it provides input from an (rational?) agent with full visibility into the individual’s finances (hopefully). ;o) On the downside, it typically means their financial needs will be greater than if they were single. At the risk of being redundant, the spouse/SO should *not* be happy with the salary, but they should not be upset either.
    Another way to get at this metric is to explore whether they would feel ripped off if they had the chance to pursue the opportunity for a year, it didn’t pan out at the end, and *all* they ended up with was their salary. They should feel disappointed if this is the outcome, but not ripped off.
    The second metric is great because it’s just so objective. Note, this metric works equally well for you yourself as founder/executive at a startup. If you’re tempted to pick up side jobs, you’re not paying yourself enough. Now, I’m not saying moonlighting will never be required when getting through the lean times. Just that it’s *always* a signal you’re paying yourself or your employees too little, and you should seriously consider how to fix the situation at its root if it persists. You need your employees focused on creating investor value, not on how they’re going to pay rent.
    In fact, this is another way to get at this metric. I tell the prospective employee to watch for stress about paying bills. If they’re feeling stressed, it’s not that they’re doing something wrong. It’s most likely that we’ve negotiated a salary that’s a little too low.
    The third metric is the least valuable, but I still find it important to cover especially when hiring single people, or people that are eager to join the team. There is a tendency for these individuals to believe they should subsidize part of their salary in order to make their financial needs fit the startup’s cashflow. They think they can get by with less than they actually can. This situation is seductive, and yet *exceptionally* dangerous because it tends to go unnoticed until the individual has exhausted their reserves (usually with little or no notice) at which point, there may be no time as well as no ability to adapt since you’ve worked an entire plan against the (falsely) lower burn rate. I’ve seen this blow up more than once, so you can’t say you weren’t warned.
    In exchange for the employee voluntarily dictating their own paycut, or at least by definition their own sub-standard salary, I believe you owe the employee three things: a reasonable (even generous) chunk of equity – in writing, a clear definition of when the “restricted salary” period applies, and a periodic review to re-evaluate whether the metrics are still signaling the right pay level.
    You need to get clear with yourself and with your employees where you’re trying to get – whether it’s a certain level of funding, or a certain level of revenue. And, you owe telling them where they will be once you get there. I believe you owe them an objective goal and I further believe you owe it to them to continue to make progress towards that goal. As an example, I promised to bring them from the “minimal” salary they’ve agreed to to a “fair” salary with respect to their position in their industry (not just within startups) once we’ve achieved a major financing ($1M+).
    It’s important if you use this approach to remain vigilant about the metrics, especially the spouse metric. You’ll be surprised how effective this technique is, and my experience is that almost universally, the negotiated salaries are slightly below the true “absolute minimum”, so they’ll need to be revised (only slightly) upward to keep your employees happy, motivated, and focused. (You’ve been warned. Again.)