How do you Determine Proper Compensation for Startup CEOs and Early Employees?
For first-time founders and leaders of early-stage startups, determining compensation for the CEO and early employees can be tough. On one hand, you need to hire the best talent, retain them, and incentivize their performance to have the right team in place to grow. As a founder and/or CEO, you also want to pay yourself enough to get by and prevent money from being an unnecessary distraction. On the other hand, you need to keep cash in the bank and appease your investors and board members that you’re extending responsible offers.
How do you determine what’s best? The right approach won’t include a one-size-fits-all answer for every business. However, successful founders do tend to establish consistent tactics early on and lean on research to find their solution. It includes understanding the competitive compensation you can afford, the value of your business, and the sum total of benefits available to you and your employees. Here are some of the best practices and advice on approaching your boards with proposed plans once you’ve determined the right way forward.
How much money is in the bank?
This is an especially important question to answer when you’re trying to hire your first employees. You have to be able to afford the talent you’re recruiting without cutting your financial runway unnecessarily fast for some quick-to-compete cash package. If the CEO is also a founder, it will be much easier to manage their salary because the value of their compensation package will likely lean much heavier toward equity than cash. But bringing in non-founders takes actual dollars and requires confronting these tough questions: how much money do we have? How long will this last us? How does a cash package for X employee change this?
What’s your current valuation?
Next, it’s time to determine what your business is worth so the value of equity can be established. For venture-backed companies, you can find this answer through an official 409A process or less formally (as Fred Wilson proposed in 2010) by using the valuation of your last financing round or the most recent offer you received to purchase your business. The value you settle on will matter a great deal to your first employees and and as it changes, so will the process in how you doll equity in the future.
What’s the competitive salary for this position and experience?
The reality is most venture-backed startup CEOs typically make somewhere between $75,000-250,000. This has long been an acceptable salary range depending on cost of living adjustments and the value of the business, and as long as the fledgling business isn’t truly desperate for cash. As noted in Business Insider here, Seth Levine’s observation on CEO salary in 2012 still holds true: early on companies that have raised $500,000 or less cap out at $75,000, companies that have raised $1 million or less pay between $75,000-$125,000, companies that have raised between $1-$2.5 million pay closer to $125,000. The greater the fundraising numbers are from there, the more likely the CEO pay climbs closer to $250,000.
As for your early employees, salary for their positions won’t be as closely tied to fundraising numbers. Some competitive research is needed. Luckily, there are countless online calculators like this one that can provide you with a solid idea of your target range – all benefits included.
How much common stock will you issue an employee?
Your employees have options for where they work. Many of those options will offer greater short-term rewards, while you are likely to offer below market value in cash compensation. But early employees will be attracted to your business in part because of the long-term payoff. “When someone works for less salary than they deserve (meaning: what they could make elsewhere), I think of that as a cash investment they’re making in your company,” Jason Cohen writes. That comes in the form of common stock.
Paul Graham has put together some valuable formulas for determining the equity of your first few dozen employees based on the expected value they bring to your business. That said, it’s unlikely in most cases for non-founders to receive more than 5% of the business (bringing on a CTO can be the one common example of exceeding this mark). Previously Brad Feld has argued that a founder CEO will be in the 5-20% range, a founder CTO in the 2-10% range, other co-founders between 3-7% and non-founder early employees between 0.5-5%. Market value for equity is dynamic though and the necessary points to attract an individual employee can vary.
Are you issuing stock options or restricted stock to your first employees?
In their helpful guide on employee equity, Gusto evaluates the decision to issue stock options, the chance to buy stock at a certain price, and restricted options, the right to buy stock under specified restrictions. The distinction between the two may impact early employee decisions on how they personally value their stock. You will want your boards input on this process early on.
What motivates your early hires?
Now comes the really hard part. “For your first key hires, three, five, maybe as much as ten, you will probably not be able to use any kind of formula,” Fred Wilson writes. “Getting someone to join your dream before it is much of anything is an art not a science.”
You’ve got a package in mind that includes a salary you can afford and an equity stake that makes the offer competitive if your company grows as expected. But you’re hiring unusual people to take this ride with you and understanding the package that will satisfy their ambition will also likely require rounds of negotiations and probing questions from you about their true motivations.
Are your investors on board?
Much like a competitive package for an employee, a CEO’s compensation and equity stake will require negotiations – this time with your investors. Having the above questions answered will help. Staying within a competitive range is needed to appease your current board and attract new investors (for example Peter Thiel has publicly stated he passes on any startup paying it’s CEO more than $150,000). As a CEO, you also want to examine your own motivations in a negotiation, especially if you are attempting to increase your salary or equity stake. “When two sides in a negotiation can’t come to a deal, it’s often because the two sides don’t have a clear enough view of what each other’s alternatives are if they can’t agree,” Tim Jackson writes.
You don’t want to walk away from a tough negotiation having damaged your relationship with investors on your own compensation or shown irresponsibility when proposing packages for early employees. A well-researched proposal that clearly assesses your company’s current financials, demonstrates the expected impact fairly compensating an early employee or CEO will have, and honors your commitment to deliver the return they expect on their investment will get you to reach mutually agreeable terms. Transparency and preparation are key.