Incorporating tokens into compensation packages brings unique complexities, challenges, and opportunities. For example, there are many ways to structure compensation, and what works for one company may not work for another. So in this post, we explore how tokens fit into a larger compensation strategy, and then dive into the specifics of token awards, including vesting schedules, lock-up periods, and taxes. First, tokens are not equity While many token compensation strategies have their roots in compensation models at web2 and other traditional companies, let’s be clear: tokens are not equity. They are not even a substitute for equity, so companies should be careful about drawing that analogy when discussing it internally and explaining it to potential employees. From an employee’s perspective, receiving tokens and receiving equity are two different experiences, with different risks and rewards attached to them. For example, protocols are autonomous software, not companies — and unlike equity, there is no board or management team dedicated to maximizing the value of a token. There are many broader considerations when allocating tokens, and employees are just one part of it. To learn more about token distribution, click here. In addition, there are a number of legal and regulatory considerations related to tokens and web3 that startups need to carefully consider when developing their token strategy.
Now, let’s dive into some important principles around token compensation…
Token Compensation Structure: A Quick Start Guide
Token compensation is a balancing act within a larger compensation strategy, where the ultimate goal is to reward work and retain employees without losing their engagement or creating a distracting work environment. This involves designing a strategy that shifts the focus away from token price and toward building the future.
For talent teams managing token compensation for the first time, all this may seem like entering uncharted territory. The good news is that despite the above differences we’ve highlighted in terms of web2 and web3 compensation, there is still a lot that HR teams can learn from successful web2 models. In fact, they need to if they want to compete with traditional companies, especially in hot industries like AI.
To get started, it’s critical to build a compensation philosophy that’s well-defined, transparent, and easy to understand. These three qualities are key to any good compensation program. Transparency and fairness in compensation have been shown to have a significant impact on employee engagement—and companies can’t afford to ignore that.
Once a compensation philosophy is established, it will guide decisions about hiring, grading, and salary ranges; long-term incentives (token awards, equity, or both); promotions, performance increases, and rehiring; and more.
A good compensation philosophy also answers questions like:
What is the base salary associated with a job?
What portion of an employee’s total compensation package comes from tokens or equity?
What is the salary percentile of the company’s target market?
What is the salary percentile of the company’s target market?
What is the base salary associated with a job?
What is the base salary associated with a job?
What portion of an employee’s total compensation package comes from tokens or equity?
What is the salary percentile of the company’s target market ... base salary associated with a job?
What is the total compensation amount the company is targeting for each role?
How does the company define the market? For example, who are their benchmark companies? Which companies are they most likely to compete with for talent?
Once these questions are answered, the company can start to drill down into the specifics: How often should employees receive tokens? What is the balance between cash and tokens? And so on.
Balancing Cash Compensation with Tokens
In a traditional compensation package, base salary is an important countermeasure to balance the risks and rewards brought by equity. Likewise, token compensation is only one part of the overall "total compensation package" for full-time employees.
For web3 companies, this compensation package may include:
Base salary and performance bonuses, which make up the total cash compensation, usually paid in fiat currency
Equity, including non-qualified stock options (NSOs), incentive stock options (ISOs), employee stock purchase plans (ESPPs), etc.
Token compensation, paid in the project's tokens or other tokens (commonly Bitcoin or Ethereum) and stablecoins
A simple rule of thumb is to provide a healthy total cash compensation that is competitive with the level of peer companies. What percentage of total compensation is cash vs. tokens? We typically see structures like this:
Total Cash: 75th percentile of the market
Total Compensation (total cash plus bonuses, plus equity value): between the 75th and 90th percentile of the market. Total cash includes base salary and other cash components, such as performance bonuses
Premiums: Some teams may also explore offering “premiums” for hard-to-find skills, such as protocol or smart contract engineering, or people focused on crypto security. These premiums are reflected in higher base salaries and total compensation
A question we often hear is, “Should we give employees the freedom to choose the balance of tokens vs. cash in their compensation?” While there are no hard and fast rules, it’s generally better to cap the token portion at a specific percentage of total compensation, rather than letting employees choose a percentage.
Not only can it become confusing for finance teams to keep track of various custom arrangements, but drastic changes in token prices can disrupt a company’s overall compensation strategy. For example, a sudden drop in price could force people to renegotiate their compensation packages. And a surge in price could result in some employees suddenly becoming richer, which is wildly out of balance with the salaries of other employees—a demoralizing experience for other employees.
Choosing a Token Vesting Schedule
Just because you set a fixed percentage for tokens, it doesn’t mean that the balance of tokens versus other compensation won’t change over time.
The token portion itself can be implemented in a number of different ways, depending on when and how the tokens are distributed. Companies have a lot of options here: short-term incentive plans, long-term incentive plans, and classic mechanisms like vesting schedules and bonuses.
The best model will depend on the company’s specific circumstances and compensation philosophy: Is the token publicly available or still under development? What type of token is the team offering? Are there any restrictions on trading the tokens? The answers to these questions and more will determine a company’s approach.
Here, we outline several common timelines — and their pros and cons — to help founders who are unfamiliar with best practices. Note that these are best suited for projects that already have publicly traded tokens and have a set number of tokens reserved for ongoing employee incentives.
Founders will need to find a balance between using token reserves and structuring employee rewards and incentivizing third-party contributions to drive decentralization. It’s important to work with outside counsel to evaluate these options and their implications under applicable law.
Four-year vesting, one-year cliff
In this model, employees receive a tranche of tokens when they are hired. The first quarter of the first year vests, and the remaining tokens vest pro rata on a monthly (or quarterly or annual) basis.
Pros: Rewards employees for their work on the project.
Disadvantages: Employees hired at different times may achieve very different results in the same year, especially during periods of volatility. Long time frames can also create a distracting emotional roller coaster for employees - unless there is a renewal mechanism like an annual performance basis to balance this out.
Annual Awards
Given how much token prices change over time, some teams find that offering token awards across multiple years doesn't make sense. As a result, this model favors annual awards. Each employee is awarded a token of the annual market value. Then, after the first award, the talent team typically incorporates performance metrics into the calculation.
Pros: Token price changes don't directly affect employee income, and employees can feel they are treated fairly. Teams have more flexibility to adjust awards based on different points in token price fluctuations.
Disadvantages: The need to re-evaluate and communicate annual bonus amounts can cause employee instability.
Two-Tiered Vesting Schedule
In this model, a portion of tokens vest immediately, while the rest vest based on a longer time frame. This allows teams to reward short-term performance while still keeping employees motivated in the long term.
Pros: Incentivizes employees to reach specific goals in the short term while also keeping them engaged in the long term.
Disadvantages: This can be confusing, especially if communication is poor or goals are not clearly set.
These are some common token vesting schedule models. Companies should consider their own culture, token economics, and employee motivations when choosing which model is best for their team.
In any vesting and renewal plan, it’s a good idea to reduce the impact of the common day-to-day price fluctuations of tokens, so consider using something like a 90-day moving average when pricing vesting and renewals. Companies should also ask legal counsel to review all vesting variations they see to account for market volatility.
Finally, keep in mind that many tokens, especially those in the run-up to issuance, also need to consider lock-up periods. Token lock-up periods, the ability to “lock in” the trading or redemption value of a token for a period of time after issuance, not only helps ensure the long-term success of a project, but is also critical to aligning the interests of all stakeholders; more on lock-up periods here.
Setting and Communicating Lock-Up Periods
Founders should ensure that “insiders” (including employees, investors, advisors, partners, etc.) have the same lock-up periods and rules. If certain groups can sell earlier than others (i.e. at the first opportunity), it could engender distrust, create unpredictable incentives, violate securities laws, and negatively impact the protocol.
For US employees, companies should plan for a lockup period of at least one year (for legal reasons). A three- to four-year lockup period may be more beneficial to the long-term success of the project, as longer lockups can reduce downward price pressure and demonstrate confidence in the long-term viability of the project.
For candidates coming from Web2, this may require some education, as they may find long-term vesting schedules and periodic lockups overly burdensome. Assuming that the lockup period applies to all pre-launch token holders (which it should be!), candidates should want to see a lockup period in their offer, as it shows that the founders prioritize the stability of the protocol and believe it has real use.
Finally, as a practical matter, lockups can be managed via smart contracts and enforced by the token management provider. Once token vesting is complete and the lockup period is over, employees can send their tokens to a wallet of their choice. This ensures that token allocations are hard-coded in the smart contract and helps build greater trust with employees.
Token Grant Structures: RTAs, TPAs, and RTUs Explained
There are three main ways Web3 companies in the US structure token grants today (outlined by Toku, a comprehensive global token compensation and tax compliance solution). All of these are based on the model of equity awards, which is also the most common template for asset-based compensation - but to be clear, tokens are not equity:
Restricted Token Awards (RTAs), similar to stock options that employees of a traditional company might receive before an IPO. RTAs can be granted to employees who join after the tokens are minted but before they are available to the public.
Token Purchase Agreements (TPAs), which are another way to structure token grants before issuance, have different tax implications (see below).
Restricted Token Units (RTUs), which are similar to Restricted Stock Units (RSUs). RTUs are used after tokens have been issued and have begun trading.
RTAs and TPAs are two ways companies can offer token compensation to employees who join after the tokens have been minted but before they are issued to the public. They are often compared to stock options offered by traditional companies before an IPO.
Both RTAs and TPAs can be offered under any of the vesting plans we mentioned earlier, and typically include:
lock-up periods, during which they cannot be sold or transferred to other wallets;
and forfeiture rights, which allow the company to reclaim tokens before they vest.
The main difference between RTAs and TPAs is their tax implications, so founders should discuss this with legal counsel when evaluating which type of award is most appropriate. For example, the recipient’s tax timing is a key factor and depends on the type of tokens granted.
RTAs
RTAs allow U.S. recipients to file an “83(b) election” with the IRS to recognize income upon receipt of the tokens based on the fair market value on the grant date. This can be advantageous to employees, especially if the tokens are expected to increase in value. Additionally, filing an 83(b) election protects against the potential risk that an employee may owe taxes on tokens that they fail to sell. Note that an “83(b) election” must be filed with the IRS within 30 days of the grant date.
TPAs are similar to RTAs in that they can be granted to employees prior to issuance and allow employees to file an “83(b) election.” But unlike RTAs, they require employees to purchase the tokens at a specific price, known as the “exercise price.”
As expected, employees generally prefer RTAs, but TPAs do have some tax advantages. Unlike RTAs and RTUs, the granting of TPAs is not considered ordinary income and therefore is not immediately taxable. Taxes are deferred until the employee exercises their options and/or sells their tokens; at the time of exercise, the tokens are only considered income if they have increased in value compared to the exercise price.
RTUs
RTUs, on the other hand, are typically granted to employees who join after the tokens are issued and are similar in concept to the RSUs offered by many large companies.
RTUs are granted upon joining and are subject to one of the vesting plans we mentioned earlier. Once vesting is complete, employees can generally transfer tokens to a wallet of their choice unless subject to a lock-up period. Because tokens are considered income at their then-current fair market value upon grant, some companies choose to withhold and sell a portion of an employee's grant to cover their tax liability.
While the above discussion focuses on the recipient, companies should also consider their tax withholding obligations, which typically require payments to be made in cash.
Please note that the above should not be considered tax advice. But we hope it provides companies with some strategic overviews for token compensation. We strongly recommend that Web3 talent, legal, and tax teams work together to develop the best course of action that fits the company and strategy. If liquidity is the primary driver for the token, there are other strategies, such as conducting a secondary offering so that employees can access liquidity when the company raises more capital.
Operational Considerations: Setting Up Token Compensation
This all may seem complicated, but the good news is that more and more companies are developing products and tools to make token compensation operationally easier to manage. Generally speaking, startups will have a wallet (from a company like Coinbase, Anchorage, or BitGo) and a token management system (from a company like Toku or Pulley) to handle all the administrative work.
Employees will receive tokens through a wallet that they can access through a token management system. They should also be able to use such a system to view the progress of their vesting, or access pre-vesting staking when offered, as well as other calculators or tools.
Web3 companies are gradually maturing. By using well-tested and mature compensation strategies, they can address the challenges that may arise when attracting top talent, who may be deterred by a lack of liquidity.
The key is to ensure that tokens are part of a well-designed compensation strategy. Such a strategy should be transparent, fair, and incentivizing for employees - not only to attract and retain some of the best talent in the short term, but also to ensure that productivity is reasonably rewarded.
While companies can employ other strategies, such as offering secondary offerings to employees when raising more funds, token compensation remains an attractive lever for Web3 companies to use to level the playing field.
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