Myths about startup pay

I've been collecting data about startups and compensation since 2001. Here's what entrepreneurs think they know about startup pay--and what actually happens.

Entrepreneurial decision-making is often guided by anecdotes, rules of thumb, and intuition. Sometimes that’s because entrepreneurs don’t have time to look at reams of data, sometimes it’s because they’ve learned to trust their gut, and often it’s because the data just isn’t there.

But when it comes to pay, you need data. Since 2000, I’ve been collecting information about startups, including how much founders, their lieutenants, and their employees get paid. That research forms the basis for my annual CompStudy survey, as well as the quantitative backbone for my new book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup.

The research also highlighted four myths about startups and pay. Here’s how they contrast with reality.

Myth number 1. Startup CEOs make a lot more than the rest of the executive team. It’s easy to see where this myth comes from: The average Fortune 500 CEO makes several times as much as execs just one or two levels down.

The Truth: Compared to the lowest-paid member of the executive team, non-founding startup CEOs only make 1.7 times more in cash compensation. The big difference is in equity: Startup CEOs who are not founders get 6.2 times as much equity as the lowest-paid member of their team.

Myth number 2. Founders make more than everyone else. Founders often believe that their own compensation is a ceiling beyond which they will not have to pay new hires. They try to anchor compensation packages at or below their own pay.

The Truth: Across all senior-executive positions, founders make significantly less than other similarly-qualified execs. I call this the “founder discount.” This holds true even when we adjust for differences in the amount of experience these executives have and, importantly, their equity stakes. Founders refer to their startups as their “baby” and are willing to give up some personal comfort to fund their baby’s development. They soon learn that the rest of the management team doesn’t feel the same way, and often lose their best hires when they refuse to pay market rates.

Founder-CEOs are often the most striking victims of the founder discount. In startups that are led by a founder-CEO, there is almost always at least one other non-founding executive who makes more. In our 2011 dataset, we had 283 tech companies in which the founder was still the CEO. Only 17% of those founder-CEOs were the highest-paid member of the executive team. In another 24% of the companies, someone else on the executive team made as much. In a full 59% of startups, the founder-CEO was out-earned by at least one of his or her subordinates.

Myth number 3. Vesting is a tailored way to keep execs on board. Vesting, which requires executives to earn their equity through continuing involvement in their companies, is effective at “handcuffing” the executives to the company until their contribution is less crucial.

The Truth: Of the more than 15,000 non-founding executives in our database, a stunning 77% of them had four years of vesting. Four years may be a good amount of time for some startups and executives, but blindly applying that rule of thumb so broadly doesn’t make sense. Vesting terms should be tailored to the unique needs of the startup, the time during which the executive is expected to play a key role, and the startup’s stage of development. Yet four years remains the standard.

Myth number 4. You get paid more if you live in a high-cost area. Startup compensation is proportionally higher where the cost of living is higher. Silicon Valley and New York City startups pay significantly more than startups in Austin and Washington, D.C.

The Truth: Location has relatively little impact on executive pay in startups. (One exception is the Midwest, where startups tend to strike a different balance between cash and equity compensation.) There are valid reasons to want to work in Silicon Valley or another expensive place, but fiscally, a startup exec might want to work in a low-cost metro where pay is similar to that in a Silicon Valley or New York.

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