There is both a legal and cultural shift to ensure inclusive and equitable pay. New pay transparency laws are an example of 2023 initiatives that will directly impact a company’s recruiting and retention of current employees. The fines for non-compliance are real, and the fallout from lack of planning is inevitable. All this can be avoided and starts with defining the company’s compensation philosophy. Compensation in many companies includes base salary, variable pay, equity, and benefits. The focus for this series of posts will be salary, variable pay, and equity.
What is a Compensation Philosophy?
A compensation philosophy defines how the company pays and rewards its employees and ties it to a quantitative metric. “We pay all employees at X market midpoint relative to a Y geographic location compared to other companies who are within Z revenue/capital raised/funding round ” or “We pay all employees at the 75th percentile market midpoint relative to data from Series A companies in the San Francisco Bay area”.
As part of the company’s compensation philosophy discussion, the company will want to use a tool to understand in what percentile of the market their team’s compensation falls, and in what percentile the company wants to pay its existing and future employees moving forward. Most early-stage companies aspire to fall in the 50th to 75th percentile. Since this decision directly impacts the company’s compensation budget, any decisions now should be sustainable for the company until their next fundraise.
If your company already has a compensation philosophy, it is a best practice to review it annually to ensure it still aligns with your company and the ever-changing market.
Defining Your Compensation Philosophy
If your company has not determined what its compensation philosophy is, start by identifying what kind of talent is needed to achieve the company’s business goals, factor the time it takes to fully onboard new talent to get them to full productivity, and how employee churn impacts the company’s bottom line.
Once the company knows the associated costs to hire and lose an employee, discussions can focus on how the leadership wants to incentivize and reward employees for employee performance. This is another critical conversation to have because companies applying merit-driven compensation philosophies will bonus and promote for different reasons and on different schedules. It will also promote a different culture than non-merit driven organizations.
A comprehensive compensation philosophy will address the following topics:
- What market data will be used to set compensation ranges?
- What percentile of the market is targeted (ex. 50th percentile, 75th percentile)?
- Will compensation differ based on geo-location? IE, will the team use SF Bay Area data for every US-based employee, or will they use more local data?
- How does performance factor into compensation decisions?
- How often will pay be reviewed? Annually, semi-annually? Merit-based?
- When will pay be reviewed? A fixed calendar date or based on the employee hire date? In merit environments, pay reviews are often more frequent since it is based on performance.
- How often will the company re-evaluate its compensation philosophy? Annually is optimal, but at minimum, companies should re-evaluate their compensation philosophy after a major company milestone, such as a merger, acquisition, or financing raise.
Once the company has discussed all these options and weighed the pros and cons of each decision, they are ready to formalize the company’s compensation philosophy. From there, the team can begin phase 2- defining career levels and building pay ranges for existing and expected future roles in the company.
See part-two, Pay Transparency: A Plan & Rollout Strategy Blueprint, for a step-by-step guide including defining career levels and how to build compensation bands.