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Your startup raised a Series A 18 months ago, and you’ve been busy growing your startup and hiring great people.
You recently found a top-notch sales leader with just the background you need, but when you go to set their compensation, you realize that you’ve run out of options in your options pool.
Yikes.
Now, you’ll have to go to your board and explain to them why you need to issue more options (hopefully with a reason that’s something other than, “I didn’t plan well.”)
This is one of many compensation situations you want to avoid. Here are a few others:
Luckily, a lot of these predicaments can be avoided by tracking the right compensation metrics.
In this post, we are going to talk about:
Let’s get into it.
At a startup, your people are your most important asset and compensation is how you measure the financial cost of those people.
Additionally, for software companies compensation is often the biggest cash cost, accounting for 50%-70%+ of the total expenses.
Yet, compensation is complicated. It includes immediate cash costs like salary and benefits, but there’s also equity compensation. Equity is a big motivator for startup employees as they are likely taking a lower salary compared to larger companies. Besides the salary, benefits and equity, there are indirect costs of talent such as recruiting, onboarding and training your team.
What is it?
Monthly burn is the amount of money your company spends in a month. There are two kinds of burn: gross burn and net burn. When people talk about burn they usually are referring to net burn which is the difference between cash inflows and cash outflows. However, sometimes they may refer to gross burn which is the total amount of cash spent (not accounting for cash inflows).
Why is it important?
Monthly net burn is one of the most important KPIs for your business, and is a metric you’re likely already tracking. For compensation in particular, it’s important for a few reasons:
What is it?
The total sum of the amount of how much your startup spends on its workforce. This includes cash salaries of employees, but it also includes the cost of benefits, equity and HR operations like sourcing, interviewing, onboarding, training and development.
To calculate total cost of workforce, sum the following expenses: salaries, bonus, equity[0], benefits, HR & admin, recruiting and training.
We also recommend breaking it down by function. Generally, there are two big buckets:
Breaking it down in these two categories enables you to compare what’s required to keep the company functional to what’s required for growth.
[0] For the cost of equity, multiply the number of vested options issued by the strike price of those options. This isn’t a perfect calculation as there are many ways to estimate the value of illiquid equity. The actual cost is impacted by factors including exit price, vesting schedules, if the employees exercise their options, and other factors.
Why is it important?
You can measure how your talent costs are trending over time, and which components of them are increasing or decreasing. This can be helpful to track labor cost components and ensure they are tracking in a way that is consistent with your compensation philosophy. It’s surprisingly easy, for example, to have the cost of contractors or the benefits portion of compensation balloon higher than you intended.
What is it?
Salary bands are how you set compensation based on job function and level. For example, your engineering salary bands could be the following (these are not market rate numbers and are only used as an example):
Why is it important?
Mapping your employees based on salary bands gives you a number of benefits.
First, it gives you the ability to give pay increases part-way through a year. This incentivizes and shows them that they are valued without giving them responsibility that they can’t handle.
Second, you can track metrics like percent of employees above or below salary bands to course correct. It’s common for early employees to be paid lower salaries than later employees, even for the same job. There are also common salary discrepancies due to gender or ethnicity. These gaps can be closed by setting salary bands and making sure employees are paid accordingly.
Finally, you can track how many of your job offers fit within the compensation bands. Not every candidate can be a stretch candidate! This keeps you on track.
What is it?
Cash cost per employee is the amount of cash you are paying on average for your employees. To calculate it, take the total salary expense divided by the total number of employees to get the average.
Why is it important?
First, this is important because it allows you to benchmark your salaries against market rates. This can be a good indicator if you are executing on your compensation philosophy: if you plan to pay at the 75th percentile but your cash cost per employee benchmarks as the 50th percentile, you aren’t executing on the philosophy.
It’s also helpful for planning. If you know your full cost of employee, you can more accurately forecast expenses. Evaluating building a new product? Knowing the full cost of the product, design and engineering employee costs can help you figure out if and when you can hire them.
What is it?
The employee equity pool is the amount of shares reserved for the company to grant to employees via options or stock units. The first decision the founders need to make is how much of the shares to allocate to the pool. The industry standard is between 5%-25% of company shares (often landing at 10%), but it’s ultimately up to the founders.
Equity pool percent granted / remaining tracks how much of that employee equity pool you’ve given out compared to how much you still can give out. If you reserved 10 million shares for employees and you’ve given out 3 million options, you’ll have 70% remaining.
Why is it important?
Once you’ve allocated shares to your employee equity pool, it’s important to track how much you’ve granted to employees. It helps to make sure you have enough equity to grant to future employees.
In addition to the metrics above, investors also ask for a snapshot of the business on a monthly or quarterly basis. Below are a few ideas; work directly with your investors to learn what makes sense to report on for your specific business.
Tracking the wrong metrics can often be worse than not tracking any metrics at all. It can lead you down the wrong path and also misdiagnose the root cause of problems. Here are a few metrics you shouldn’t focus on.
Attrition is when an employee leaves your startup. And actually, you should track this metric and compare your rate to industry benchmarks to see if employees are leaving more or less often than at other startups.
You should not, however, assume that compensation is the #1—or even one of the top few—reasons that employees are leaving.
Employees join startups for a lot of reasons: impact, learning, network, mission, and yes, a small chance of a large financial outcome (among other reasons). It’s rare, however, that the compensation strategy is the reason an employee leaves.
If your employees are leaving, instead figure out if there’s another good reason for it. The most common reason is if your startup has stalled. Have you not found product-market fit yet? Has your top-line growth slowed-down? Are customers churning? There could also be other culture-related issues that cause employees to feel burnt-out or unmotivated. These are issues you should address before assuming the cause is your compensation strategy.
Finally, companies also often track regretted vs unregretted attrition. Regretted attrition is when you didn’t want the employee to leave where unregretted is if you were fine with the employee leaving. In practice, however, this metric doesn’t have much meaning. The definition of “regretted” is very subjective. If an engineer leaves to start a company is that unregretted compared to if they joined another startup as an engineer? If an average performer leaves, is that regretted or unregretted?
In 2023, inflation is on the minds of many employees. Since their dollars don’t go as far, they expect salary increases to compensate for the lost value.
However, as an employer you shouldn’t worry about these claims.
Inflation and wage growth are correlated but not the same. Inflation is driven by changes in the price of a basket of goods, while wage growth is driven by labor supply and demand. Labor supply and demand can be influenced by worker preferences, demographic trends, changes in productivity, technological advances, and the labor participation rate.
Wages often have less dramatic fluctuations, resulting in an advance to employees in low inflation years and a disadvantage in high inflation years. For example, in 2020 inflation was between 1.6% 1.8% while wages increased by between 2.6% and 3.5%.
The bottom line: compensate your employees according to your philosophy and don’t worry too much about inflation.
To get help setting your compensation philosophy and communicating it to your employees, consider Complete. We help teams improve their acceptance rates and employee retention through proactive communication. Request a demo here.
