We’re excited to kick off a new post series where we answer reader questions. If you have questions where you want the Stay SaaSy POV, drop us a line here.
Onto our first question:
Salary Caps at a Growing Series A Startup
I am at a Series A stage company where the first wave of hires are all on a salary cap (seed employees) and with the recent funding, new hires are coming in above the salary cap, creating disparity of pay for the same roles/ seniority. How should this be managed?
I’m not sure exactly what deal was made with your early employees, but it sounds like you’re probably paying some early employees below market rate in exchange for larger equity stakes. This seems like a modified version of salary compression, where new unproven hires are paid the same (or more) than equally qualified people who are already succeeding on the team. This could understandably cause friction, but it also doesn’t necessarily seem crazy provided that these team members also have much more equity than more recent hires.
It’s hard to answer your question without knowing more details about the situation. So I’ll propose some compensation heuristics that I think likely apply, and for each, a quick test of whether you’re on the right track strategically:
- Compensation won’t make people happy on its own
- Compensation alone can make people very upset
- Compensation helps to create owners
Compensation Won’t Make People Happy On Its Own
The first heuristic of compensation is that you’re never going to make unhappy people happy with compensation alone. The hedonic treadmill means that once new, higher compensation has sunk in, people’s happiness will tend to adjust back down to baseline, and they’ll be just as upset about their manager, the build being broken, annoying customers, or whatever else is on their mind.
As a result, it’s very rare for moderate increases in compensation to make employees permanently happy. What isn’t temporary, however, is compensating well enough that you take compensation off the table as a reason to be discontent. You can keep increasing compensation to the moon and people will still complain about their boss. But if you pay people generously, they will at least not complain about their compensation, and you can remove pay from the equation as a retention risk.
This leads us to the Thanksgiving Dinner Test. Imagine that your employees go home for Thanksgiving or Christmas, and their parents ask how work is going: Do you like your boss, do you like your team, are they paying you fairly? The situation that you want to avoid is one in which compensation causes the conversation to go downhill: It sounds like you’re underpaid, is that pay structure normal, have you brushed up your resume?
Interviewing is a pain. If things are good at a job, many people will happily remain as valuable team members for a long time. By paying your team generously before they become discontent, you can take advantage of this natural momentum and avoid a situation where compensation causes them or their loved ones to start to build a case to look elsewhere.
Compensation Alone Can Make People Very Upset
The second heuristic of compensation is that you can unfortunately make people extremely, problematically angry with compensation alone. There’s a special kind of righteous anger that people feel when they believe that they’re being treated unfairly in regards to comp. And one of the worst perceptions of unfairness comes from salary compression, where newer and less experienced hires are paid more than existing team members.
To make this even more complicated, you should assume that a significant subset of your team (say, 10-30% at minimum) will talk to one another about their compensation (even more problematically, some non-zero subset of that group may also lie). This creates a chaotic situation in which snippets of compensation information are floating around your organization without context, and tees up the awkward comp situation where someone asks why one person is making X and another is making Y, and you need to respond with a logical explanation (even if you don’t confirm the numbers).
As a result, compensation decisions should pass the All-Hands Test: If you had to publicly defend the compensation decisions that you’ve made at an All-Hands, would it cause a riot? Your compensation philosophy should be sufficiently fair and logically sound that this hypothetical nightmare All-Hands would be uncomfortable but wouldn’t end with windows smashed and fire alarms pulled.
The compensation rules you follow don’t even need to be perfect – as long as they’re logically defensible (usually via a compensation philosophy and pay bands), you’ll avoid enraging your team due to perceived injustice. Passing the All-Hands Test also inherently confirms that your compensation philosophy isn’t working solely because nobody has enough information to realize how upset they should be.
It’s also worth mentioning that compensation’s ability to cause problems is stronger than its ability to make employees happy. You can pay someone 1.5 what they would get on the market, but if someone who they don’t respect is making twice their salary, it’s still infuriating.
Compensation Helps To Create Owners
The final compensation heuristic applies to startups: The only reliable way to get people to exhibit high degrees of ownership is by giving them a realistic chance at a significant reward.
Early stage employees are looking for high upside – they’re taking on the risks of instability, long hours, and an uncertain future for the chance of financial success. They also want to act like owners – if they wanted to phone it in, they’d work at a larger, slower company. People who act like owners are the engine that creates winning companies. The real potential for upside is what motivates people to grind out unpleasant tasks late on a Friday or think about how they can help you win while they’re in the shower.
But ownership is a relative concept; owning 50% of a lemonade stand and 0.15% of Apple are very different concepts, and our emotional brains run on dollars, not percentage points. This leads to the Millionaire Test: Employees whom you want to be highly motivated should reasonably believe that they have a chance at making at least a million pre-tax dollars if the company hits ambitious targets. For example:
- Very early employees (tech team + executives in the first 10-20 hired) should all feel that they have a decent shot at a million USD if the company sells for $250M+ (a good exit for a venture-backed company)
- Moderately early employees (tech team + executives among the first 20-50 hired) should feel that they have a decent shot at a million USD if the company is worth over $1B
In my experience, a million dollars is an arbitrary emotional bar that most startup employees are looking to clear in order to feel that the long nights and existential stress of a startup were Worth It. You may not ultimately get to a good exit, but employees need to credibly feel that there is a chance. If that possibility goes away, all of the ownership and initiative that the team feels will drain away with it.
So be generous with equity, and similarly to the first heuristic, do so proactively. Try to get as many people as you can to the point where they feel truly invested in your success because they’ll participate in the upside. Without this your team will feel limited, and if they’re doing well they deserve to participate in the upside.
The art of effective compensation is largely the art of managing expectations and calibrating compensation proactively, in a world where everyone has imperfect information and the underlying topic is very important to people’s lives. To figure out if you’re on the right track, consider the following:
- The Thanksgiving Dinner Test: Is compensation likely to create upsetness?
- The All-Hands Test: Would explaining your team’s compensation publicly cause a riot?
- The Millionaire Test: Does your team feel like they could clear a million dollars if you hit it big?