Startups · Compensation

Pros/cons of deferred compensation (back-pay, cash bonus, future salary vs. equity pay)?

Dawn Jolly Executive Operations - Global Vaccines, Oncology & Consumer Healthcare

March 8th, 2016

Often times, start-up founders don't have cash flow to hire/retain employees. What are the pros and cons of the various delayed compensation plans (deferred cash bonuses, back-pay, proposed salary increases in line with business progress and employee achievement, etc.) as compared to equity pay?What is the best way to structure these types of deals?

Feel free to speak to your experiences or observations of hiring interns as well. Thanks in advance!

Rob Enderle Owner, Enderle Group

March 8th, 2016

This is an interesting question. Both Maslow and Hertzberg teach us that monetary compensation, in any form, isn't a good motivator and if we add a non-performance related risk factor that should further reduce its effectiveness. However, an asset coupled with some form of recognition, particularly if that outcome is more likely, should have a higher impact because it is tied to status and status is a higher motivator. That suggests that equity compensation, where the employee is more certain to get something (even though that something may be worthless) in terms of stock coupled with some form of recognition should have the greater impact on their desire to perform (being an owner potentially conveys status). But, to be clear, it is the recognition component coupled with the reduction in risk that makes this more powerful. You remove either or both and there likely is no significant difference in performance but equity has been tied to higher retention if the employee doesn't believe it is and will be worthless.

Conversely equity grants can dilute ownership and complicate the IPO while reserves have to be maintained to cover deferred financial compensation which can weaken the perceived financial performance of the company. Both problems can be addressed reasonably well by a good launch team but the cash path is likely simpler. So it depends on the overarching goal. Do you want higher performance/retention or an easier path to IPO? I'd recommend the former because it better assures the firm will be successful. So, were it me, I'd go with equity and not deferred compensation.

Thomas Kaled Business Development Consultant @

March 8th, 2016

@ThomasJay sorry however the math is incorrect. 1% of $1 Billion is $10 Million. Doesn't detract from your point so beyond the comment I agree with all else in your statement...sorry it's my OCD.

Folks have described lots of options. I agree the cash bonus option can be dangerous for the founder...or person doing the hiring since I think if the employee reaches whatever the negotiated goals are you owe them the money whether you have it or not.

In so far as tax implications if it is closely held in most states, non marginable, "legend" stock it is typically a 60% discount to market value if there is one beyond par which typically there will not be until someone adds in the capital.. The best way to diminish any exposure is to grant options at a nominal conversion which then does not become taxable until purchased.

However in this discussion we are absent an important issue which is what the key employee can virtually deed your entire company to someone but if they have need for cash beyond what you can afford perhaps you can contract with them or make some alternative (part time) arrangement.

Just additional considerations that do not negate any of the previous contributions.

Joe Albano, PhD Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.

March 8th, 2016

Like so many things - founder and early stage compensation is not a one-size-fits-all proposition. Bothe deferred compensation and equity arrangements depend on at least three things: 
  • The future value of the organization. In the case of equity - it's only worth what someone is willing to pay for it. For future comp, the company needs to be able to afford to pay what is ultimately subordinated debt. 
  • A very clear articulation of expectations and terms. Both equity and future comp. have inherent risk which must be priced appropriately. 
  • Trust. More often than not, things don't go according to plan. In addition to a strong agreement - you need to trust each other.
You need to figure out what everyone needs. If your "employee" needs to pay rent, mortgages, and living expenses soon, equity is not really helpful. Assembling the resources you need to launch your startup is challenging (stating the obvious). Don't take shortcuts and don't get ahead of yourself. 

Lawrence Ham

March 8th, 2016

There can be substantial differences in tax ramifications/liabilities (for both startup and employee), but I'll leave that to the accounting/legal/tax planning folks. As such, I'd say (arbitrarily) it's a 40% ops/hr decision, 30% tax, and 30% legal.

Since your objective is to hire + retain (aka induce), it really comes down to understanding what your potential employee wants. Some people have been burned by the equity option and only want to see cash (deferred or as earned) while others are adventurous or truly believe in the startup. Some have families and are looking for 9 to 5. Others are willing to do 8 to midnight. Some just want the chill culture with ping pong tables and dart boards, and other the immersive small team experience with rapid potential for climbing the ranks, scaling the startup, and contributing substantially. Some just want a voice, rather easily lost even in a 20 person team. One things is consistent across the board - most people don't know what equity truly entails let alone liquidation prefs.

To oversimplify this mathematically, the equity option, E, can be weighted by 0.05 as only 5% of startups succeed. So a 50/50 salary/equity compensation is now worth 50/2.5. However, the 2.5 can be reweighted possibly by average exit/valuation multiple multiplicatively or adjusted exponentially. Ben West does a better job of number crunching here.

I've been told a hundred times that cash is expensive upfront, yet equity is expensive later on. Having seen equity go to zero, it's really only worth what you and the team make it worth + investment trends and hype cycle + round valuation + product market fit + some luck. To put this all into perspective, we're in a period where we've had absurd valuations and we're seeing downrounds of unicorns and plebeians. As a decision scientist, I'd suggest taking 25 use cases to see how valuations, markets, liquidation preferences, dilution, and a number of other factors play out.

But theory aside, empirically, I've seen a greater draw to workplace culture, innovation, and cross-training + immersion at a sacrifice to pay and corporate lifestyle, so it ultimately comes down to the people you're looking for and what they want.

Having been brainwashed in clarity --> objectives --> execution, I find it difficult to put together a compensation plan without knowing what the target demographic wants. A better offer can easily be the latter of camaraderie and flexibility over heaps of deferred compensation and equity.

Personally, it would be tough to induce me with a seven-figure equity plan ever again, but then again, I just jumped on a riveting new project without discussing any form of equity or compensation despite constantly advising others to settle the details early.

Joe Albano, PhD Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.

March 8th, 2016

Actually Thomas, that was kind of my point when I said "You need to figure out what everyone needs. If your "employee" needs to pay rent, mortgages, and living expenses soon, equity is not really helpful."

But it's worth repeating. 

Tom Jay

March 8th, 2016

There are lots of legal issues with this so you need to be careful, try not to pay or offer deferred comp. these things are trouble in my mind.

Normally people offer me stock to create an MVP, 1% appears to be the common offer for a mobile app and back end system that fully represents an entire product.

If you value the business idea at $1B then 1% is $100M which is pretty interesting to any developer.

Most people feel that the idea is worth 99% of the company and that the technical and execution is not worth very much, any one can create a mobile app and servers for what you want, its all about the idea and how to market it. You might also want to make sure that you have an agreement with your developers that they need to be part of the business for 4 years before they actually get any stock, have a solid agreement so if they leave at some point they do not own anything and you always have ownership of all work from day one. You can get lots of work done from people this way and then just let them go when you feel your done with them. It appears to be a pretty common way of working in startups.

Always promise above average compensation when you get funding, people are generally willing to work for a good wage as long as they know they will be getting paid well when you get funding, there is so much money for startups these days I can not imagine anyone not getting funding, maybe you need to create the product first but then once you show it you will get suite cases of cash being thrown at you to spend as you want.

William Agush Founder and CEO at Shuttersong Incorporated

March 8th, 2016

I'm sure there are whole books and consultancy engagements on exactly this subject. Equity is good but watch out for tax implications on the recipient and make sure it's more than equal to the dollars replaced - in other words equity on it's face has to be a better deal if you're trying to replace dollars. As for all the other complex comp deals just make sure they are transparent and mutually beneficial.

Finally, on the subject of interns - interns MUST always be under qualified for a full time entry level role - otherwise they should be a full time fully benefited person. Internships are not "pre-employment" or for 26 year olds that haven't been able to land a job because the economy is bad. In my view they are also ONLY pre-graduation roles.

They are to give the intern a taste of the business, some experience to aggregate into a real job at some point. Have I hired interns - yes - and 100% of them have gone on to Director and VP level. But then YMMV.


March 8th, 2016

It depends on how your business structure is in place and if the founders are set up with a guaranteed draw. We are and LLC and any deferred comp went into our capital accounts. I will let the tax accountants weigh in here. If it is compensation with employees that don't have equity, you can offer equity in place of cash but that can get sticky. I suggest you have open communication about your timeline and cash flow, even with non equity owners. You are all in this together and some pay is better than none in some cases. I found that we had a couple of customers that we could "rent" our employees for project work to cover salary costs. We love interns, however, the old saying you get what you pay for can be true. I have found that if you work with a co-op program through a university or the career placement. You can sometimes get good talent part time for free if you can show value or even class credit. Best of luck.

Andrew Lockley Investments & consulting for tech startups

March 8th, 2016

The advantage of such deals is that the employee bears a huge amount of risk for a tiny reward, if any. A