Every so often a discussion ensues about compensation in the tech space. This conversation has picked up again after a tweet from Jonathan Abrams where he quoted a recent HBR piece on venture capital compensation:
You can read the litany of responses if you’d like. They are varied and worth a look.
Let’s take a look at VC compensation first. It seems like a lot of the angst comes from the idea that some VCs want founders to take relatively small salaries in favor of the upside in their businesses while some VCs (maybe the same ones, maybe not) make millions each year in management fees whether nor not they drive appropriate risk-adjusted returns for their investors (LPs). In other words, VCs are “paid like asset managers rather than investors” as the HBR article states.
I agree that VCs should make the bulk of their compensation on the returns they generate for their LPs (I’d say the same of any investor in any asset class). Large salaries can be counterproductive to the ultimate aim of venture investing. VCs should make a solid salary commensurate with some of the opportunities they could otherwise take and taking into account the large potential upside they have. This will help to ensure quality people enter in the VC business and that those people can focus on their job without having to worry about providing for their family. Given a reasonable base salary and benefits, the rest of the comp needs to come from investment returns. Carry checks need to matter for VCs in the same way exits matter to entrepreneurs.
Ultimately, LPs need to get serious about this to make it happen. The high salaries that do exist and the ability for fund managers to raise ever larger funds (even though we know it negatively impacts performance) is the result of a clearing price in the market. If LPs can get together on this things will start to change. In the meantime, some funds will do the right thing despite the clearing price in the market (a lot of firms do already) but the issue will persist.
Recently, the lens that folks have used to evaluate entrepreneur compensation is that of entrepreneur comp relative to VC comp. I am not sure the comparison is helpful given the different nature of the roles. Also, this comparison tends to focus on a small number of VC partnerships where the partners make millions in salary each year that are not tied to returns. I think those are likely outliers and that many of the seed and early stage VCs have much more reasonable salaries (e.g. see Dave McClure’s tweet in the stream linked above).
In addition, there are different choices entrepreneurs face. Entrepreneurs may want to keep their salaries low in order to reduce burn and keep their ownership in the company as high as possible. Others may need to take a little more in salary to ensure they can provide for their families as they build their companies.
Either way, it seems that we should try to find a way, if possible, to achieve a level of comp for founders that allows them to focus on building their companies rather than wasting time and energy worrying about their living expenses and that takes into account their potential upside. In my experience this is typically achievable, but it does require tradeoffs like any other decision.
(Early) Employee Compensation
While VCs and entrepreneurs discuss and debate their relative compensation I can’t help but feel that one of the most important constituents in this ecosystem is left out – employees (particularly the very early ones). Sam Altman wrote about this issue recently on his blog. He worries less about cash comp and more about stock comp, which I agree with. Stock comp for early employees is really where the issue is.
Sam lists four key issues relative to early employee stock comp:
- Employees usually don’t get enough stock.
- If an employee leaves the company, he or she often can’t afford to exercise and pay taxes on their options.
- Employee options sometimes get unfavorable tax treatment.
- Employees usually don’t have enough information about the stock or options.
I’ll focus on the first one here as I believe it is the most important at this point in time, but Sam outlines proposed solutions for all four of these issues in his post if you are interested.
The solution to the first issue is, you guessed it, give early employees more stock.* The reality is that the value of a company is built over a number of years. While the founders, who did take the most risk, should get a premium for starting the business it probably shouldn’t be, as Sam notes, “100x – 200x what employee 5 gets.”
I like Sam’s general solution that looks at the comp package in total using an expected value for the stock piece of the comp. In addition, I also like the idea of splitting distribution the equity in a tiered system like Sam suggests. I am not sure at where I would place the numbers but Sam’s suggestion is the following (and a good starting point):
As an extremely rough stab at actual numbers, I think a company ought to be giving at least 10% in total to the first 10 employees, 5% to the next 20, and 5% to the next 50.
Compensating early employees in a more appropriate manner should help to do a couple of things: 1) improve the quality of the people willing to join startups; and 2) provide more capital to early employees after exist, which should, in turn, lead to a larger group of people that can invest their capital back into the ecosystem as angels and/or start their own company now that they have some capital to see them through the lean startup phase.
Compensation in this ecosystem, as in any, will always be hotly debated, but I hope that we are in a place to start making progress on some of these ideas in the near future.
* Note: Vesting timelines should likely be elongated if employee stock compensation is increased. The typical vesting period is four years today but, as Sam states, companies typically take longer that that to exit and if more equity is going to be given out to early employees the vesting timeline should better match the time to a liquidity event.