Facing a Cash Crunch, European Startups Rethink Their Approach to Equity Compensation

Published: June 2020

 

European startups have relied heavily on cash compensation to attract key talent, but in the current environment, this approach is unsustainable. To conserve cash, some firms are initiating exchange programs and exploring greater use of equity incentives.


Before the COVID-19 pandemic reached Europe, startup companies had never been better funded. According to Crunchbase, European startups raised $36 billion in 2019, a 25% increase from the prior year and the highest level in a decade. Fast forward three months and startups are struggling to stay afloat, even as government-mandated lockdowns are starting to ease across much of Europe.

Although most startups utilise technology in various ways and are well-positioned to take advantage of a more virtual society, businesses are adversely impacted by the current economic slowdown and uncertainty. Across Europe, startups are relying heavily on government social insurance programmes and furlough schemes (e.g., chômage partiel in France and kurzabeit in Germany) in order to prop up wages and avoid layoffs. In the UK, Chancellor Rishi Sunak has put forward a £1.25 billion package largely made up of convertible loans to bridge funding support to UK startups excluded from other government schemes due to lack of profitability. But these schemes won’t last forever, and startups need to begin preparing for when government funding subsides.

The massive transformation in funding status raises the question of how startups went from record levels of funding to such a devastating cash crunch. For most companies, payroll is their biggest expense and the same is true for startups. However, our analysis of compensation and pay mix among startups compared to the broader technology market finds that startups may have been overly reliant on cash compensation, which could be exacerbating the cash crunch these firms are currently experiencing.

Cash Compensation at Startups

Using our survey database, we find that startups are making big bets on their people when it comes to key executive talent and critical engineering and business development roles — debunking the stereotype that startups are cash starved and, therefore, pay lower salaries. On average, salaries at startups are 1.1% higher than the broader technology sector (including public companies), even after controlling for factors such as employee location, industry, job function and level (see Figure 1).

The raw base pay premium (i.e., the average pay for an employee at a startup vs. an employee in the broader technology sector) is 22.2%. Much of this premium is accounted for when controlling for region, as startups tend to cluster in high-cost urban centres, such as London, Munich or Paris. Our previous analysis finds that salaries at technology firms in inner London are 15% higher than the national average. (For more information on geographic pay differentials in the UK, see our article: Technology Wage Growth in Other Regions of the UK is Catching Up to London. Why It Matters.)

Employee level also plays a key part in the salary premium at startups, which have a greater percentage of employees with more senior titles that are considered the head of a team or department, as well as fewer new graduate programmes.

Whilst we see a premium for base salaries, target total cash is, on average, 2.0% lower at startups compared to the broader technology sector. This is driven by the relative lack of bonus plans at startup organisations, which often have less rigorous annual performance management systems in place. According to Radford’s 2020 Overall Practice Report for the UK, for example, over three quarters of technology companies reported having a formal bonus programme, whereas only 65% of private companies operated a formal plan.

Despite the lack of a formal bonus plan, it’s clear that, to attract talent, startups must come close to matching cash compensation levels for public technology firms. Put another way, public and private technology firms are increasingly competing for the same talent and include both types of firms when benchmarking pay.

In order to conserve cash during the current climate and continue to attract top talent, startups could rely more heavily on equity compensation. Compared to the United States (U.S.), European startups have historically offered lower equity awards, both in terms of overall value and eligibility levels. Employee perceptions are also at play. With fewer flashy exits in Europe compared to the U.S., startup employees in this region are more likely to undervalue equity compensation. This also means that HR often struggles to clearly communicate the value proposition of equity awards to mid-level staff.

However, the culture around equity compensation in the startup world is slowly changing. Many European startups are using equity compensation as an important differentiator as they stake out their employee value proposition vis-à-vis larger traditional technology organisations. We’ve seen global venture capital firms in recent years pour money into the European market, and reciprocally, high-profile European technology companies (e.g., Spotify, Yandex and Farfetch) have gone public in the U.S. As a result, the geographic lines are blurring between U.S. and European equity practices.

Next Steps

We are already seeing some private companies begin to offer cash-for-equity exchanges to preserve limited cash. In mid-April, Revolut announced a firmwide scheme to offer employees the option to exchange £1 in salary for £2 in stock. Before engaging in this kind of arrangement or taking other difficult cash conservation measures, it’s important for companies to understand where they sit today against the market with both cash and equity compensation.

To support companies in making these decisions, Aon is launching our first private company survey in Europe to capture cash compensation, new-hire equity grants and equity ownership levels for local European technology companies. As part of this inaugural study, results are complimentary for participating companies. For more information about the survey or to inquire about participation, please write to rewards-solutions@aon.com