Compensation for early startup employee - what is the right balance?

It depends on your equity strategy for your company. If you do not anticipate a liquidity event in a 3 - 5 year window (merger, IPO, private equity exchange), the options may not be much of an incentive, since the options do not convey standard ownership privileges of dividends and voting rights until they are converted (requiring the options owner to pay the strike price). You can cut the ambiguity a little bit by using stock grants with vesting to make this a little simpler, it really depends on how you want to manage your equity pool.

If your strategy is to have a liquidity event, articulate this clearly to those getting the options/grants, and get everyone motivated to hit targets that are going to make that strategy a reality. Tying performance milestones to a clear path for that liquidity event makes equity incentives effective, otherwise it is not going to produce the results you desire.

I would still keep equity in the mix even if you can pay a competitive salary. Remember, people in an early stage company are taking a risk by putting their talent to work for you rather than a larger, more stable opportunity elsewhere.

It depends on your company stage:

• if you are early stage (as you mention) any options are just a risk for the employee as they have no way of knowing the real worth and the uncertainty associated with options often creates more questions than answers. I would say a fair market wage and small amount of options is most attractive
• later stage startups have a better base to say what the likley worth of the options are and the employee can equate that risk. In that case more percentage of options and lower salary is most attractive.