Here’s a common hiring scenario at VC-backed companies: You finally find the right talent who can fill your critical needs (and more). The excitement of the perfect match quickly wanes when you realize you’ll have to stretch well beyond the role’s specified pay range, equity grant, or both to win a yes.
So, you decide to make an offer beyond your budget for the role, just this once, to add an exceptional talent to your team.
One-time, or occasional hiring exceptions like this, are common — and kind of expected — for venture-backed startups. But straying too far, too often from your pay strategy can amount to considerable cash burn and equity dilution not accounted for in your hiring plan and operating budget.
This scenario is known as compensation philosophy drift. It’s easy to do inadvertently in a tight labor market, and difficult to explain to a board who expects a company operationally execute approved operating plans and budgets.
But let’s accept it: Drift happens. By recognizing what causes drift and how to adjust when you see it, you can balance hiring top talent with protecting a company’s runway and equity burn. Here’s what you need to know.
Why Every Company Needs a Compensation Philosophy
Before we get into all things drift, let’s review what a compensation philosophy is and why it’s important. A comp philosophy is your company’s documented strategy for how it will pay and reward its employees compared to the market. It defines cash and equity ranges that HR and finance leaders use to set annual hiring, merit, and promotion budgets.
A comp philosophy is a checkpoint for all pay-related initiatives, including job architecture and career paths. It also drives consistent and equitable pay practices, and compliance with the myriad of recent transparency laws designed to drive fair pay. A well-constructed pay philosophy can save your company from the major legal and financial consequences of getting pay wrong.
How Compensation Philosophy Drift Happens
Drift occurs when companies pay significantly more than planned during hiring, merit, or promotion cycles to attract and keep top talent.
Another time companies typically see drift is when they don’t adjust pay and equity guidelines after a significant valuation shift. That means they could be overdelivering on the total value of cash and equity, driving higher dilution than needed.
Finally, as pivotal as comp philosophies are, hiring leaders often overlook or ignore them when making offers. What they ultimately pay employees is often influenced by industry trends, regions, and competitors.
Why It’s Hard to Measure Comp Philosophy Drift
Drift is measured by how much a company pays beyond a set pay range’s midpoint and by the extent to which equity compensation exceeds planned allocations. And the size and the frequency of drift is a measure of your comp philosophy’s success.
Ideally, you’d see compensation and equity data at least quarterly so you could adjust as needed throughout the year. But this information typically lives in different systems, requiring a lot of time and people with know-how to gather and make sense of it.
Companies often don’t realize they’ve drifted until it’s too late. Usually, this is at the end of the year, after the merit cycle, when they’re analyzing the performance of their comp programs.
If you’ve drifted significantly and often from your compensation philosophy, it might be time to update it.
Is it Time to Update Your Comp Philosophy?
Market, business, or employee needs are the top drivers of drift. To find out if you need to update your comp philosophy to get back on track, ask yourself these questions:
- Is our current comp philosophy still desirable and affordable for our organization considering the market and economy?
- Is our current comp philosophy still a good fit for our business stage and strategy?
- Are we attracting, motivating, and keeping the talent we need to achieve our goals?
- Are we paying within our defined pay ranges?
- Are we achieving the outcomes we wanted from our pay program?
If you answer yes to these questions, you’re likely in good shape. But if there’s “no” or hesitation, you should revisit your compensation philosophy.
How to Balance Your Compensation Philosophy
If you’ve figured out you’ve drifted too far from your comp philosophy, it’s time to reset it. Here are the general steps to follow.
Step 1: Understand your constraints
When it comes to comp, there are many things out of your control. It’s important to understand what they are before redesigning your pay philosophy. Constraints are usually related to:
- Investors
- Economy
- Regulations
- Your company’s size and scale
Step 2: Build your toolbox
To maximize the power of compensation, avoid a blanket approach to your pay elements. Salary, bonus, and equity can be used to drive behaviors and goals. They can also be tailored to who your employees are and where they’re located, so think about each as a different tool in your toolbox. How can you make the most of each? And don’t forget to consider how benefits contribute to the mix.
Step 3: Redefine your compensation philosophy
With current market data, decide on your cash and equity ranges and how you’ll target the market. An example is paying all software engineers in the 85th percentile of San Francisco market rates.
Keep in mind where you drifted previously. Was it during hiring or merit cycles? Was it for employees at certain locations? Was it by gender? Pay close attention to these areas to avoid making the same mistakes.
Step 4: Keep an eye on execution
To stay ahead of drift, regularly monitor how you’re executing on your hiring plan, including:
- Hiring and attrition trends
- Current headcount distribution
- Actual pay compared to budgeted ranges
- Compliance with regulations
Today’s investors are holding operational teams and the C-suite more accountable for managing burn and dilution, and a well-constructed compensation philosophy can help you protect your runway and make pay-related decisions that support your company’s growth and bottom line.
How Sequoia can help
Current comp and equity data are key to spotting compensation philosophy drift early and keeping your pay strategy on target. Sequoia’s tech-enabled advisory, service teams, and Sequoia Comp OS™, can provide you with total compensation and benefits expertise and real-time data in one platform. Visit Sequoia.com/Comp to learn more.
