Beyond Benchmarking: A Guide to Structuring Compensation

Nov 18, 2019
Structuring Compensation Featured Image

8-min read

In this interview, Katelyn Dennis, Head of Customer Success at Advanced-HR, explains the importance of creating a plan for paying your people fairly. This involves referencing the right data, matching internal jobs to external data points, creating salary ranges (or "bands") for each company position and then assigning your employees to those compensation levels. From there, you build your compensation packagesusing a blend of cash, equity, and benefits. In this way, you can attract and retain top talent.

With so many factors at play in hiring top talent, compensating employees with consistent practices can easily be overlooked. But if you want your startup to succeed, it’s vital to have a plan in place for paying your people fairly. 

“Employees are typically the largest operating expense for each company,” explains Katelyn Dennis, Head of Customer Success at Advanced-HR. “And if there’s not enough time and thought put into how you’re going to pay them, then you run the risk of being over budget, experiencing turnover, or failing completely!”

Creating a thoughtful compensation strategy takes a lot more than just benchmarking salaries. It requires you to use market data as a guide rather than a rule of thumb and create compensation bands that fit your company. 

An important step to take before you start building out your compensation structure is to make sure you’ve thought through your long-term compensation philosophy first. 

Step 1: Choosing the Right Data Points 

The first thing founders need to do when creating a compensation strategy is determine which data points are relevant to their company. This can include anything from base salary ranges and incentive pay to total equity percentages and total target pay.

At the same time, founders also need to decide where this data set will come from. For companies with employees concentrated in one region—like the Bay Area or the Midwest—this might mean creating location-specific data sets. And for companies in up-and-coming areas or with fully-distributed teams this may mean casting a wide net to get a complete picture of the market. 

Ideally—Katelyn points out—seed stage startups should focus on collecting data points from companies with similar growth and resources. She suggests looking at companies with similar capital raised. 

When you do this planning correctly, the market data will provide the foundation for a scalable framework on which to build your compensation structure.

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Step 2: Matching Internal Jobs to External Data Points

Not all job titles line up perfectly with the market data. For example, the “Dream Alchemist” at your company may just be a kitschy startup title for a Head of Creative, Chief Creative Officer, or Creative Director, but it’s unlikely to show up in a database. Even if it does, it’s doubtful that the database will have enough specific points for the search to be useful. In these cases, Katelyn advises founders to look at job families and job levels. 

“Sometimes private companies use creative job titles to attract talent and motivate their employees,” says Katelyn. “but those titles are unique to their company. That’s why it’s so valuable to look at job families—like marketing or sales—and job levels to get your data points. Ultimately, these are the factors that tie data together from company to company.”

Returning to the example of Dream Alchemist versus Head of Creative, founders could instead search for data across the full marketing job family, and narrow the scope to include only data points in the high to executive levels. This would enable them to grab data on all relevant job titles—both creative and traditional. 

While benchmarking and market analysis are the first steps to creating a successful compensation strategy, Katelyn cautions founders to take all of it with a grain of salt. 

“Market data is really cool. Market data is better than nothing. But market data does not at all speak to the uniqueness of your company,” she explains. “It doesn’t consider the fact that if you have a company that’s highly valued, you can reduce your equity ranges because each share is worth a lot more. It doesn’t speak to the fact that if you have a dwindling option pool and you want to create an ongoing retention strategy, you need to reduce your new hire ranges. The point of using market data is to see the culmination of what a bunch of other companies are doing. What you need to do is figure out how you can leverage it in your company to support your decisions.”

Step 3: Creating “Bands”

Once you’ve successfully chosen, matched, and analyzed your data points, it’s time to build your forward-looking compensation strategy. This starts with creating “bands,” or salary ranges, for each job. 

Katelyn explains how they work:  “The idea behind ‘bands’ is that you’re creating a set of ranges to inform employee compensation. For example, you could say: ‘Here’s my engineering department, and here are the ranges. I pay my Managers between $150,000 and $200,000. I pay my Directors between $175,000 and $210,000. And so on and so forth.’ 

Visually, a set of bands looks a lot like a floating staircase. You can see an example below for what this might look like across a 50-person company. Each step balances on the step below and supports the step above. The overlap between levels creates a logical sequence to the movement of employees between levels.  

When individual employees are added to the model, they're represented as dots--each dot showcasing the position of an employee in relation to the salary range at a specific band level. 

Viewed as a whole, this model enables founders to see the spread of salaries and make better informed decisions regarding raises and promotions. 

“You want to have a logical progression,” says Katelyn. “That way, as someone gets a raise or a promotion, they move seamlessly into the next band and start making more money. It creates a sort of upward and onward progression that makes sense.”

Once you’ve mapped out the bands and pinpointed where each employee falls, it’s likely that some employees will be outliers. This could indicate that that employee is mis-titled, meaning they are at a level above where you’ve placed them, or it could mean that they are over-compensated. In the case of over-compensation (when an employee is leveled correctly but their compensation is above that salary band), that employee might not be ready for a promotion, so you will be in a tough spot when end of year raises come around. In that scenario, you can consider several options, like delaying their next raise but continuing to pay out their bonuses, or being transparent that they are at level-X and they won't receive an increase until they hit level-Y, and that future increases will be more modest to get them back into the right band. On the other side, you might have some people that are being under-compensated but you can't afford to give them a $20K raise right now. One option is to market-adjust their salary by $10K and give them larger raises over time to get them back into the right compensation band. The bottom line is that you might have outliers when you first do this exercise, and that's okay—it takes time to get everyone into the bands you've created.

Because of its simplicity, founders may be tempted to put off creating bands until their team has grown to include several people at every level, but as Katelyn warns: “It’s important to have someone come in and create these bands early on. You might be able to benchmark and follow the market data fairly easily when you have 30 employees, but think about what your company will look like when you reach 100 or 500 employees. If your data points are all over the map, it’ll be a nightmare.”

Step 4: Placing Employees in ‘Bands’

Building ‘bands’ is one thing, but knowing where to place employees in the bands can be much more difficult for founders to tackle. Not only are there level differences between employees—for example between a Sales Director and a member of the Sales team—but there is also parity between employees in the same band. In both cases, Katelyn explains that compensation decisions should come down to value. 

“Not all employees are created equal,” Katelyn explains. “Say you have someone that is mission critical to the success of your company. If they leave, you’re going to be screwed. So, you want to make sure you’re paying that person more than someone who just started and doesn’t have the same skill set. Because even though they might be at the same level in the same department, those two people are not the same value to your company.”

“The bottom line: you want to allocate resources toward the retention of top talent.”

Step 5: Building Compensation Packages

From here, Katelyn explains that founders need to focus on creating compensation packages for employees, using a blend of cash, equity, and benefits. These packages can vary from level to level and employee to employee, based on the stage they’re at in their career and the things they value. 

“It’s important to consider whether or not equity is going to resonate with certain employees before you offer it,” Katelyn says. “Typically executives and senior team members are working at a private company because they want that equity. They have money and they can pay their bills. They’re working for you because they want the long-haul payoff.” In these cases, equity is very important. “On the flip side, a lower level employee—maybe someone right out of college—is likely working for you because they need to eat and they need to pay their rent. For them, cash is much more motivating because they need money today.” In both instances, you have something valuable to offer in your compensation package, but it really boils down to what they value, and what’s going to help them reach their goals. 

Ultimately, Katelyn says: “there are a lot of levers that make your cash and equity mix fluctuate. So you need to be thinking about the best offer you can make your employees with the resources at your fingertips.”