Compensation philosophy 101: A guide for pre-IPO companies

What is a compensation philosophy?

Your compensation philosophy is the “why” behind your employee pay decisions. When looking at the rationale behind all of your compensation decisions, you should be able to identify the influence of your comp philosophy. In many ways, your pay philosophy is the uniting thread that will ultimately run through your entire compensation program.

What is a compensation philosophy?

A compensation philosophy is a formal statement that explains how your company plans to pay and reward employees based on its culture, mission, values, and financials. Rather than a standalone part of your compensation program, your pay philosophy is a critical component of your company’s total compensation framework. Once you have collected fresh, relevant market data from a reliable source, your compensation philosophy guides your subsequent actions in creating pay structures, pay cycles, and individual comp packages.

In a World at Work study, 62 percent of surveyed employers said they had a written compensation philosophy in place. Compensation philosophy can take many different forms, depending on a company’s needs. It can be short and provide a high-level view of a company’s pay strategy, or longer and with a detailed view of desired market positioning and targeted pay percentiles. Regardless of length, the important thing is that your philosophy truly reflects your goals for rewarding employees and attracting new talent.

Why is a compensation philosophy essential for your business?

Without a compensation philosophy, the decisions you make about employee pay will lack consistency and data-based rationale. Instead of making pay decisions that link back to a guiding philosophy, you can get stuck using guesswork and anecdotal knowledge. As a result, your comp program can easily veer off track, leading you to overspend in some areas and underspend in others.

Conversely, with a well-thought-out compensation philosophy, you can:

• Effectively manage your budget and spending: Manage your burn rate by determining the right balance of cash and equity.
• Build transparency and trust among employees and candidates: Demonstrate that your company pays fairly by building consistency into pay practices.
• Build a compensation program that supports your diversity, equity, and inclusion (DEI) goals: Proactively pinpoint and address any pay inequities in your comp program.
• Create an organized pay and reward process: Empower your HR and comp teams so they can ensure clarity in pay conversations and job offers.

Your compensation philosophy provides a solid and consistent structure for your compensation practices. With a clear understanding of how it affects your growth and talent management capabilities, you’re ready to start creating a comp philosophy for your organization.

The 4 strategic pillars of a compensation philosophy

Developing your compensation philosophy can be a daunting prospect when you consider all the components of employee pay and the many internal and external factors impacting pay decisions. However, when you break it down into smaller parts, it’s easier to craft a philosophy that is comprehensive and applicable to all employee roles.

To help you get started, consider the key areas your philosophy should address:

Market Position

To achieve an optimal balance between attracting top talent and managing your budget, you will need to determine how you will pay (i.e., at what percentile) compared to the overall market. Although it’s often wise to pay at the median, you should consider if another strategy suits your organization better.

Pay Mix

You will need to balance compensation package variables, such as cash, equity, and variable incentives like bonuses and commissions. Depending on your growth stage, you may offer more or less cash or equity to manage your burn rate and avoid equity over-dilution.

Segmentation

To ensure fairness when considering pay requirements for all levels and functions, you need to determine the pay strategy you want to apply to the workforce. You may decide on a single strategy for all employees or have varied strategies dependent on employee level or job type.

Geographic Strategy

In the current work-from-home environment, some or all of your employees may be working remotely, including in different time zones. You will need to decide how to pay employees across locations.

By taking the time to consider these four pillars of compensation philosophy, you can take a proactive approach to compensation decision-making. You can also reduce the chance of overlooking critical variables when drafting your pay philosophy.

How to write and communicate your compensation philosophy

No two compensation philosophies are the same. Your pay philosophy will be unique to your stage of growth, culture, and overall company goals.

Writing a compensation philosophy is easier when it fits your company’s communication style. In general, there are two key ways to write your philosophy:

Short and to the Point

If your company prefers short and sweet communications, it may make sense to have a concise compensation philosophy. With this approach, you describe in a paragraph or two how your company approaches pay and then communicate it throughout your workforce.

Long and Detailed

A longer compensation philosophy goes into greater detail about the percentile you aim to pay relative to the market. It may also include information about your desired pay mix, segmentation, and geographic strategy.

You may choose to share the detailed statement with the executive team, HR, and other decision makers instead of the entire company. The philosophy is subject to change as market conditions and finances change, so you don’t want to be boxed in by the details of your statement.

Compensation best practices & evaluation checklist

When managing your company’s largest expense—people costs—you can’t afford to make compensation decisions that put your financials at risk. Regardless of your funding stage, you want to incorporate best practices into your compensation program that help you avoid waste and put compensation dollars where they have the greatest impact.

In addition to managing the impact of compensation on company finances, you also need to establish consistent and equitable pay practices that your candidates and employees trust.

To ensure your compensation philosophy is positioned to help you achieve the best results when paying your people, incorporate the following best practices:

1. Begin with fresh, relevant market data.

To avoid making decisions in the dark, you need to understand how the market influences your compensation philosophy. By conducting market analysis and benchmarking against other pre-IPO organizations, you will gain insights to help you design and apply your compensation philosophy.

2. Prioritize clarity and consistency.

Your compensation philosophy should help you explain policies throughout every stage of the employee lifecycle journey, including hiring, promotion, relocation, and breakthrough performance. Consistency will help you build trust among candidates and employees.

3. Lead with data rather than feelings.

Compensation can be an emotional topic because it affects employees’ livelihoods. However, it’s critical not to make pay decisions based on how you feel. Rather, your compensation decisions should be based on what the data tells you.

4. Beware of exceptions.

Operating a compensation program based on exceptions erodes transparency and consistency. Instead of letting too many exceptions creep into your decision-making, set criteria for special situations that require a departure from usual practices.

5. Periodically reevaluate your compensation philosophy.

As your organization grows, your compensation philosophy may also need a refresh. Reassess your compensation philosophy from time to time to ensure it continues to align with your goals, organization profile, and external market conditions.

Compensation Philosophy Evaluation Checklist

As you incorporate best practices into the creation and communication of your compensation philosophy, it’s helpful to take steps to determine whether you have included all the elements you need.

To see if you’re on track, ask yourself the following questions about your draft:

• Does it reflect the mission, values, and culture of our company?
• Does it align with our current financials and company goals?
• Does it help us encourage the employee behaviors we seek to reward?
• Is every compensation decision backed by reliable data?
• Will it help us structure new job offers post-financing?
• Does it have a clear strategy for pay equity and DEI?
• Does it help us address how we compensate employees working in different locations?
• Can I use it to address common pay questions from employees and candidates?

Your answers to these questions will help you determine if you need to make changes or if you’re ready to finalize and share your compensation philosophy.

Compensation philosophy examples

Although every company’s compensation philosophy is different, it can be beneficial to check out what other companies are doing. Seeing how others align a compensation philosophy to their mission, goals, and culture can not only offer useful ideas, but also show you the real-world applications of salary philosophy and various approaches to employee pay.

Sample Compensation Philosophy Statements

Your compensation philosophy can take the format, length, and tone that fits your organizational culture and values. Here are some examples:

1. Equity is your most powerful compensation.

The problems we are trying to solve are complex. However, if we solve them, the value will be enormous. Equity allows everyone on the team to share in this value, so we emphasize equity over cash.

2. Rewarding excellence.

We reward employees who deliver value. Outsized results from you will result in outsized compensation.

3. Pay for performance is about what you do and how you get it done.

Our top individual contributors make a massive impact and put our customers first. Our best people managers lead impactful and healthy teams. Our compensation programs are focused on delivering rewards to high performers, those who enable high performance, and great teammates.

4. Recognition should be equitable and meaningful.

In a world of apathy and indifference, caring is an act of rebellion. We care about the cause, the art, the details, and one another. We strive to provide meaningful recognition and support to all contributors.

How Other Companies Put Compensation Philosophy into Practice

Every company’s compensation philosophy is unique. Here are three examples from Amazon, Coinbase, and Netflix to give you an idea of real-world compensation programs.

Amazon

One of the world’s largest brands bases its compensation philosophy on the following goals:

• Invest for the long term by focusing on the customer experience and the technology required to innovate.
• Attract and retain employees who act like owners.

Additionally, Amazon’s market positioning focuses on paying above the market median, with a pay mix centered on equity and a salary cap. The company reinforces its compensation philosophy through the following programs:

• Longer-than-normal vesting schedules (5-6 years) with back-weighted amounts
• A rigorous performance review process to ensure there are no overpayments in “mega grants”
• Equity grants on a differentiated and episodic basis to those who have demonstrated valuable performance and future potential

Coinbase

The country’s largest cryptocurrency exchange has two concise goals at the foundation of its compensation philosophy:

• Provide equal pay for equal work.
• Attract and retain top talent from top companies considered to be competitors.

From a market positioning and pay mix perspective, the company has a target total cash model for base salaries. That means it pays what other companies pay for base and bonus, but keeps it primarily in the base salary. Virtually all employees receive equity.

Some of the notable elements in Coinbase’s compensation program include:

• A narrow peer group: The company’s peer group includes only the top 18 technology and financial services companies it competes with for talent.
• Limited to no exceptions: Every role and level has a set pay target, with no base salary negotiations during the hiring or promotion process.
• Pay transparency: Employees see salary ranges for their level and the level above.
• Regular benchmarking: Market reviews ensure that pay targets are pegged at market rates.

Netflix

One of the largest independent filmmaking and streaming services aims to pay each employee at the top of their market. Each year, employees choose how much of their compensation they want in salary versus stock options. Like Coinbase, Netflix pays on a target total cash model for base salaries. Additionally, every employee receives equity in the form of fully vested 10-year grants.

Netflix’s compensation activities closely follow the market. Instead of establishing a salary range, the company calibrates the overall compensation program to the market annually and reviews it regularly to ensure pay targets are at market rates. In support of transparency, the company also shares employee salary ranges for each level and the level above.

Conclusion

As one of the critical pillars of a well-designed compensation program, your compensation philosophy can help you attract and retain talent. By forming your decisions around job offers, salary adjustments, cash awards, and equity, your pay philosophy can also help ensure you stay within the bounds of your budget.

By building a compensation strategy that supports the growth of your business, you can effectively leverage market compensation data and create pay structures that promote more consistency, transparency, and fairness in employee pay. For more insights, read our guide to compensation philosophy for pre-IPO companies, Compensation Philosophy 101, by filling out the form below.