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HR & Finance
Jenny Kang, Conrad Lee  |  October 28, 2022
The Three-Part, Startup-Compensation Conundrum Keeping CEOs Up at Night

CEOs of private technology companies are dealing with a perfect storm of economic and market issues today complicating their core compensation philosophies and programs–and the stakes for their companies couldn’t be higher.

The first compensation headache for CEOs is the high-profile, ongoing war for talent—at least at the industry’s best-performing companies–that is fueling record employee turnover and pushing salaries ever-higher, despite the market downturn. A study released in September by Aon found, not surprisingly, that corporate budgets for employee salary increases rose to 5.0% in the U.S. this year, up from 4.6% in June and up from 4.0% in 2021. Meanwhile, median turnover among technology companies clocked in at 21.1% and up from 19% in June.

At the same time, the pandemic has forced an end to the traditional in-office culture for many companies and prompted a significant shift toward hybrid and even all-remote workforces, particularly in the technology industry. This has created a slew of complications for companies trying to fairly compensate workers in far-flung locations, as well as for those forced to continue living near headquarters for family or other reasons.

Finally, there’s the broader economic environment: With inflation at record levels, new geopolitical issues popping up left and right and access to private and public capital tightening, private-tech CEOs are facing enormous pressure to slow burn rates and get profitable. Many are being asked to keep enough cash on hand to fund operations for 24 to 36 months, instead of 12 to 18 months. It can all be tough to do when leaders’ single biggest budget item, labor, keeps increasing, and it’s harder to find top-quality engineering and other talent to fill critical open roles.

As one talent professional told the tech publication Protocol earlier this year: “The days of ‘I’m so lucky to have a job’ are now a case of, ‘We are so lucky to have these employees.’” And companies are paying more and more for the privilege.

There are no easy answers. But here are three steps CEOs can take to get a handle on compensation questions during this tumultuous time.

1. Assess each job function.

How essential are all of your current positions to the functioning of your business? Which positions are most critical and need to be protected or expanded? A careful evaluation of all of your current job functions can help you figure this out. Our advice is to start fresh and create a hierarchy of critical functions and roles. Then, you can sort them by factors such as productivity, profitability, sales numbers (if applicable), specific expertise and seniority.

This exercise can help you hire for future roles more strategically and judiciously. You should also consider the next key milestone or revenue target your company needs to hit and how to get there—and which specific classes of employees need to drive that effort. Maybe you are banking on a big new product launch to take your company to the next level, for example, and a unique marketing campaign is essential to its success. That might argue for more investments in product or brand marketing. Or maybe you need to add specific new features to a product to reach a new audience, which could mean leaning on critical software developers or certain types of salespeople.

Put another way, as startups transition from a “growth at all costs” mindset to one of efficient and sustainable growth, they should think hard about where they see areas of future investment. In programs or functions that are not core to future investments, companies may find opportunities to freeze hiring or not backfill open positions.

But if you determine that you absolutely need to let go of some employees—never an easy decision, obviously—this process will help you as well.

2. Figure out your in-office vs. remote work policy, and how that affects compensation.

Plenty of ink has been spilled on the contortions companies are going through now to bring employees back to the office, at least some of the time—and the decision by others to go all-remote. But this decision also impacts a number of critical compensation issues that could be deal-killers for some employees.

One is the issue of geography-based pay. Traditionally, companies with offices in multiple locations have tiered salaries so that employees in higher-cost locations—say, San Francisco or New York—are paid more than those living in Nashville or Kansas City. But how does this work in a hybrid or all-remote world? If a San Francisco employee relocates to Boise, does he/she get a pay cut? And how much? In our experience, some companies have adjusted pay downward in these situations by 10% to 15%. While many employees are fine with this policy, as long as they’re experiencing a net financial gain, such reductions can be risky given the continuing hot job market and employees’ ability to find other, high-paying positions.

And what about hybrid employees? Generally, they remain tied to the pay policies of their local company office (more pay for New York, less for Cleveland). But we’ve also seen some resentment build up at companies between employees who choose a hybrid setup because of childcare or other personal responsibilities, while more unencumbered folks are expected to come into the office. Then, they’re irked when many of their meetings are still on Zoom. Companies should set firm policies on work-from-home eligibility and also consider providing in-office perks for those making the trek in, such as childcare stipends. They should also think about creating opportunities for in-office employees to gather for periodic in-office lunches, happy hours and other events—paid for by the company—to build cohesive culture.

To be sure, some companies like Airbnb have successfully managed fully remote and geo-agnostic pay. Depending on the company’s culture and philosophy, that approach can be highly effective. But companies that have chosen a different tact should think about the factors discussed here.

Finally, there are the considerations around equity compensation, which has traditionally been the most highly valued component of startup comp packages. While earlier-stage companies may have an easier time justifying cash and equity compensation without geographic differentials, scaling companies often turn to cash-based geographic differentials. This makes sense as these companies hire in multiple regions and from more diverse candidate pools. But how should you handle equity?

The answer depends on how the company considers equity compensation, its culture and pay philosophy. Historically equity is considered a long-term incentive aligning corporate and employee goals with value outcomes. Shifting your equity program policy to reflect different geographies or an employee’s work status (hybrid/remote/office) may send the wrong signal to employees: it makes equity seem equivalent to annual cash compensation, instead of what it really is, a retention and alignment tool.

Deciding how an organization considers equity value is also critical. Value-based equity programs have gained traction with earlier-stage private companies lately, even though they’re traditionally associated with later-stage companies. Value-based equity programs calculate the amount of value delivered to an employee based on the company’s current or future valuation.

But there’s a real catch: Value-based equity programs may hinder CEOs’ goals of creating a true culture of ownership at a startup.

3. Work with your finance team to determine your cash runway.

Access to capital, of course, makes all these decisions easier. You should be working closely with your finance team to determine your specific cash runway—given anticipated fundraises–and then taking those forecasts into account to make ongoing changes to your compensation practices. Remember, your investors are now likely preaching the gospel of “sustainable” or “efficient” growth, because of the more-difficult exit market for private companies. And that means keeping a closer tab on all spending with an eye toward getting profitable sooner rather than later.

Being more judicious with cash is really not optional for companies today: Many companies are faced with the prospect of raising “down rounds” at valuations lower than their previous valuations, given the worrisome state of the financial markets. In a September report, Pitchbook found that only 6% of venture capital financing rounds thus far in 2022 have been down rounds, but more are expected as the IPO market continues to be difficult.

Being a startup tech CEO has never been easy, and today’s complex compensation challenges are making the job even more stressful. But CEOs who can remain nimble and adjust employment policies, headcount and spending in light of changing market conditions will be the ones who come out on top.

The information contained herein is based solely on the opinions of Jenny Kang and Conrad Lee and nothing should be construed as investment advice. This material is provided for informational purposes, and it is not, and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any fund or investment vehicle managed by Battery Ventures or any other Battery entity.

This information covers investment and market activity, industry or sector trends, or other broad-based economic or market conditions and is for educational purposes. The anecdotal examples throughout are intended for an audience of entrepreneurs in their attempt to build their businesses and not recommendations or endorsements of any particular business.

Content obtained from third-party sources, although believed to be reliable, has not been independently verified as to its accuracy or completeness and cannot be guaranteed. Battery Ventures has no obligation to update, modify or amend the content of this post nor notify its readers in the event that any information, opinion, projection, forecast or estimate included, changes or subsequently becomes inaccurate.

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