Luke, you are the motivator, stop whining.
Using equity to motivate startup founders and early employees is a bad idea. Yep, I said it: equity is a bad motivator. I’m sure there are plenty of smart, successful, experienced people who would vehemently disagree with me, but I stand by my opinion.
Too many founders think that giving equity to an employee is going to magically transform their rag-tag team of renegade entrepreneurs into a well-oiled, money-making machine. I wish it was that easy!
At best, equity is a blunt instrument for creating incentives. There is simply too much uncertainty, volatility and misconceptions about what it’s going to be worth and what an individual can actually do to impact its value. In a startup, the equity could ultimately be worth $0.00 (most likely) to unicorn billions (least likely, unless your name is Elon Musk). When things are going well, owning equity is fun. When bumps in the road to success arise—and they always do—owning equity is pointless and even demoralizing. Watching your employee share value lose thousands or even millions of dollars doesn’t cultivate strong company-employee relationships. Trust me, I’ve been there and it sucks.
Interest in Equity = Interest in Company
Think about your own thought process when it comes to how you might invest in a publicly traded stock. You would be attracted to the investment if you believed in the company’s product, mission, vision, management team, financial performance and whatever other ways you measure potential. The more you believe in the company, the more you will invest. Furthermore, you will retain the investment if you continue to believe that the value of holding it is worth more than the value of selling it. So, your willingness to invest reflects your belief in the future potential of the business.
Now, think about how much owning stock in a public company influences your personal behavior? Sure, if you own Coca Cola stock (KO) you might pick Coke vs. Pepsi (if there is a choice) at a restaurant, but you’re probably not going to start drinking daily 12 packs of Coke, getting the Coca Cola logo tattooed to your forehead, or holding “Drink Coke” rallies. At best, you will probably get a warm fuzzy feeling when you order a Coke knowing that you’re supporting your investing in your own little way. And that is okay. Your ownership doesn’t have to turn you into a full-time fan. Yes, people who are full-time fans are likely to own Coke stock. But owning stock reflects their fandom, it’s not the reason. I like Coke, so I own Coke stock not I own Coke stock, so I like Coke.
Still unmotivated.
The Believers and Non-Believers
Investing in stock, therefore, separates the believers from the non-believers. If you do not believe in the future potential of a business owning shares in it is pointless. Most founders want to surround themselves with co-founders, employees and other participants who believe in the business which is why Slicing Pie works so well. Slicing Pie reflects their belief in the company relative to each other. The biggest believers get the biggest share.
Similarly, when you are part of a Pie, your willingness to forgo all or part of your fair market compensation reflects your belief in the future potential of the startup. If you stop believing, you can quit and relinquish your slices which is fine because why would you care about owning shares in a company if you don’t believe in the future payoff? Sure, you may want to keep them “just in case,” but that’s a far cry from being a true believer. You can’t have your Pie and eat it too!
Slicing Pie ends when everybody is getting paid at fair market rates. If someone is getting paid his fair market rate, that person owes the company his full commitment and should perform to the best of his abilities. Given this, how could giving him shares possibly motivate him to do a better job? In reality, if you’re paying a fair market rate you should be getting a person’s best work whether they own equity or not.
Attract and Retain
My distaste for equity as a motivational tool does not mean I don’t think equity isn’t an incredibly valuable and essentially tool for attracting and retaining employees. Because the act of investing in or otherwise acquiring ownership in lieu of cash compensation separates the believers from the non-believers it will ensure that your startup team is filled with people who have an aligned vision and passion for the company mission. First, because the opportunity to attain an equity position in the business will help you attract the right people. And second, because their interest in maintaining their ownership will help you retain the right people.
It is highly beneficial, therefore, to give employees or other participants, the opportunity to acquire equity in the company. You can achieve this in the early days using the Slicing Pie model and later through employee stock purchase programs.
But, just don’t give away equity. That would be simply dilute the ownership of the people who actually care.
A Person’s Best Work
This brings us to another problem: If throwing equity at them doesn’t work to motivate employees what does? How do managers ensure that a person is, indeed, doing their best? In startups, you may not have a clear picture of a person’s potential, especially in a new job at a new company. You never know what is going to happen in a startup and this applies to the people working in the startup. They all made promises of what they are going to do, but you need a way of not only ensuring that they deliver, but also that you don’t wind up wasting your money if they don’t (or, at least conserve as much as you can).
Getting What You Pay For
So, once you have the right people (the believers) on the team you need to make sure they are living up to the expectations you had when you hired them and set their fair market salaries. A good employee who is underpaid will get lured away by the competition. A bad employee who is overpaid will drain the company resources.
Similarly, a good employee who is overpaid will unnecessarily infringe on company profits. Some companies like to boast that they pay above-market salaries and bonuses to keep good people. As admirable as this sounds, it is done at the expense of the shareholder. (Which, in a Slicing Pie company is you!) In basic economic theory, the act of overpaying isn’t a rational. Sure, you might say, “I pay a premium to get the freshest vegetables at the grocery store.” Yes, the best tomatoes cost more than the regular boring tomatoes and you may have to bribe the grocer or the farmer to be first in line, but you wouldn’t throw in extra cash just for fun. The bribe reflects the additional cost.
YES: Cost of Tomato Cost of Quality + Cost of Bribe
NO: Cost of Tomato + Cost of Quality + Cost of Bribe + Extra Cash for No Reason
Get a premium product, pay a premium price. But why pay more than what it’s worth?
A bad employee who is underpaid is a waste of space and time. You need to move these people off the team without paying extra for the right to terminate. A bad employee, underpaid or overpaid, simply needs to be removed. Many bad employees have a knack for blaming others or making excuses. Most entreprenuers and managers live in fear that they might hire and have to live with deadbeats.
Header | OVERPAID | UNDERPAID |
|---|---|---|
GOOD EMPLOYEE | Cuts into profits | Will leave to join competition |
BAD EMPLOYEE | Drains resources | Waste of time and space |
Ideally, we want people who perform at their best and paying them exactly what they deserve for that performance. People who perform better than others will be paid more than others. In order to do this, however, we need a way to monitor performance and make it obvious to everyone involved.
Creating a Lens for Performance and Pay
In the USA, and many other countries, it is not customary for companies to be transparent regarding salaries and bonus payments to employees. Benefit packages are fairly standard and well known, but other compensation is obscure. Slicing Pie implies a certain level of transparency that people sometimes find uncomfortable, but once people see the value and importance of this kind of openness extending into performance and compensation isn’t a big leap.
Lacking a logical structure, however, will make compensation decisions seem arbitrary and unfair. If coworkers can’t define, monitor, and assess performance they will be skeptical of the outcomes. So, confidentiality is a good defense against a poorly designed or lazy compensation structure. You can do better!
In some positions, like sales, the top salespeople make the most money and everybody understands why. In fact, the high performers are often celebrated in their companies. In other positions, like product management, performance is less clear.
Implementing a Logical Performance Structure
In order to get what you pay for (meaning people who perform at their best and paying them exactly what they deserve for that performance) you will need to implement a program that provides visibility into performance and adjusts compensation to reflect performance.
Bonus Programs
Many companies implement bonus programs to reward high performers. This is certainly a step in the right direction but be careful not to confuse a bonus program with motivational programs. Remember, people who are paid a fair market salary should be performing at their best, so implementing additional incentive bonus programs shouldn’t be necessary.
Yet, we are drawn to them nevertheless and we they may feel like they work. However, I think the more pragmatic view of these programs is that they allow managers to get closer to the right compensation given the potential variability in performance. In other words, because we have to set fair market values in advance of work being performed, we can’t be sure we are paying the right price unless we can adjust the amount we pay to match the performance we get.
A basic foundation of Slincing Pie is that nobody can predict future events so it's impossible to predict a fair equity split. Similarly, we can't predict how a person will perform in a job so we need to be able to understand a person's performance in the context of the goals of the startup.
If you want to learn more about how to to this, I have outlined a performance program that provides not only incentives for those who go above an beyond expectations, but also provides consequences for those who fall short of expectations in my Slicing Pie folllow up book called Will Work for Pie. You can buy the book here.
