On Startup Engineer Compensation

February 18, 2014

tl; dr;

There isn't an engineer crunch, only a shortage of good engineers who are willing to take significant risks while being inadequately compensated. Startups are too stingy, both in equity and in salary, and they worry too much about hiring and not enough about retention. Hire better, but hire less, be generous with equity, be generous with salary. Sam is right, but he didn't take it far enough.


The discussion below is all about compensation and only about that; however, compensation is not the only thing that matters when it comes to hiring and retaining employees, it is just one important dimension of it. For example, having a certain type of technological challenge or being a distributed team may make up for some salary.


Working at a startup, especially one with fewer than 5 employees in addition to the founders, is a huge risk. Not only financially – that part is well understood – but also because a lot of startups are terribly managed and the job often requires lifestyle adjustments. The startup may be so badly managed that working there may burn employees out for a significant amount of time after quitting or have similarly negative effects in other areas of life. Just like ascertaining the competence and quality of the employee is a non-trivial problem for the company, ascertaining the ability of the company to manage is a non-trivial problem for the employee.

The first 5 or so employees are more like founders than employees. Their equity should reflect that fact. However, their salary probably shouldn't. The reason is not too obvious, but the short version is that it is incredibly difficult to do a good job of building an uncertain product (what startups do) under the psychology of a “limited personal runway” and a lot of ROI evaporates if an employee leaves. If the employee has to cut into savings or not save enough relative to their risk appetite, it becomes very hard to perform due to money-worries creeping up too often. This is even more stark for employees with significant others or families and it is particularly damning during high-stress times for the startup (e.g. while raising money). The difference between feeling underpaid (salary) during good times and bad times is night and day. A high-enough salary is minimal insurance against bad morale.

A startup should only hire people who can be trusted to advocate for the interests of the company and to align those with their own as much as possible. All the discussion below assumes that one of the first exercises the early-stage employee will do with the founders is decide an adequate compensation and both parties are trying to align interests while keeping the other's interest in mind. Good outcomes are only likely when both parties are seeking to align incentives. (In this kind of a situation, it is easy for the psychological frame to be “us vs them” ie one where the employee is trying to maximize his benefits while the company is trying to do the same)

Retention is More Important Than Recruiting

It is better to spend $200k/yr to have a single happy employee who sticks around for as long as the founders than it is to spend $100k/yr on two employees that will leave shortly after their vesting cliff or before. There are compound-interest effects and management costs at play.

The ROI on an employee working for a healthy startup is way better than linear over time. The reason is that the employee gains knowledge about the company and the company gains knowledge about how to effectively use the employee. This effect is stronger for early employees, since in addition to all that, they also shape the company.

As for management, which is often just another word for communication, it is ~4 times harder to manage 2N people than it is to manage N people. So, it is cheaper to hire only one employee than two at half the price.

Not only is giving a good employee a 20% raise cheaper than hiring a new employee, but it is also way less of a gamble.

So, when it comes to compensation, a good startup will constantly be aware of which employees may feel under-compensated and fix that. A good startup should choose to spend money on retaining existing employees before choosing to bring new people on board. (Note that there are a lot of other facets to retention, but this discussion is only about compensation)


Salary

The simplest heuristic to figure out an employee's salary is to ask, or otherwise ascertain, what is a reasonable amount of money to satisfy the financial needs of the employee. Things to consider: Family? Planning on starting one? Lifestyle? Recent changes? Risk aversion? The first and last of these are particularly important.

In the bay area, companies and the broader culture seem to have deemed $150k/yr to be “a lot of money”. And that may be so, for a young employee or for someone in a variety of situations; but, given the cost of living, it can also be not very much money. In the end, the person who is the best gauge for what really is “a lot of money” and what is a reasonable amount is the employee. This is when being able to trust that the employee is trying to align incentives instead of maximizing short-term benefit is important.

Another useful heuristic, when it comes to early employees, is what is the minimum amount of money that will allow the employee not to think about money? Be sure to land a bit above the minimum.

These numbers very well may come out higher than what google and facebook offer as salaries. That is fine so long the startup can afford it. Keep in mind that BigCos also give compensation in the form of big benefits and bonuses, which an early stage startup probably doesn't do above the bare minimum (e.g. health insurance, nice-enough office, etc).


Equity

The right amount of equity is the least amount that makes the employee feel like they are in a position to capture value in proportion to the value they create. Or, another way to put it, the least amount of equity that the employee needs to feels ownership. From my annecdata, startups often miss the mark by about an order of magnitude and even two. It is common to try to optimize “for the long term” by keeping equity grants small. This can easily filter out the very best candidates for early employees.

One important fact to consider when it comes to equity is that for most people who make good employees 1 through 5, starting a company is a very realistic option, so working for a startup has to be comparable to that. Preferably, employees 1 through 5 would like to start a company similar to the startup and are so impressed that they'd rather join forces than compete.


The Elephant In The Haystack

Where does one find these mythical employees that are so good and want to start the same company? It is very difficult. There aren't very many of them to begin with. This is one reason why it is important that when one does turn up the company does not implicitly pass on them by failing to make a compelling compensation offer.

Secondly, even deciding whether someone may be such a good fit is very time consuming and difficult.

These two put together suggest that a good strategy for an early-stage startup (especially one without previously-successful founders) is to operate as if they weren't going to hire anybody and only consider candidates who are so strong that even before starting to evaluate them there is a very good chance that they will be a remarkably strong fit.

I don't mean to advocate that startups ignore hiring altogether, only that they should operate as if nobody was going to make it through the hiring pipeline. If someone seems so promising that they may get somewhere in the hiring process, the company should also feel like it is worth its while to compensate them amply, erring on the side of too much.

Discussion on Hacker News. I'll be reading and responding to comments there.

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