From what I've seen, startups almost always pay less than market, but they make up for it in four different ways:
1. Quality of life and work: employees at startups get to touch more things, work on more exciting projects, eat free food, play ping pong, be a part of a tight-knit culture, etc. A lot of people highly value this, and I don't blame them!
2. Employees mistakenly overestimating the value of their options, their probability of success, and the uniqueness of the startup culture.
3. Related to both #1 and #2, hiring employees that don't care about money and/or haven't taken finance 101.
4. Related to #1, #2, and #3: hiring employees that are so excited about the startup that they don't care about the deal they're getting.
I've NEVER seen a good engineer get a better offer at a startup than he/she would've gotten at a large company, but it's certainly possible.