Should we award equity based on specific performance metrics?


13

My team and I are nearing the launch of our initial product this August. We are wanting to develop a metrics-based system that will be implemented upon product launch that will determine founder's equity throughout the life of our company.

Relevant Company Background:

  • Organized as LLC. (Not sure if this matters)
  • There are four founders, two
    "business" guys and two "tech" guys.
  • We currently have equal equity stakes
    in the company (25%).
  • We all believe that there needs to be
    a system in place that holds us all
    accountable.
  • We all believe in the merits of
    performance-oriented, measurable
    goals and achievements.
Our Idea: "Dilute" our individual equity down to 5% and place the remaining equity in an escrow account. In order to earn our founder's equity back, we have to reach benchmarks. Since the "business" team's primary responsibility is to increase unique users, they will be able to earn equity based on the total number of unique users. Since the "tech" team's primary responsibility is to build a product that users find value in, they will be able to earn equity based on user retention. Taking into account the extended functions of both teams and their need to work together, we have also decided to implement an 80/20 split. Since the "business" team needs to deliver user feedback to the "tech" team in order to build a more valuable product, 20% of their benchmarks will be determined by retention. Since the tech team (of a small company at least) needs to help with marketing and selling, 20% of their benchmarks will be determined by unique users. By implementing this system, we ensure that we hold ourselves accountable, have measurable metrics to base performance on, and promote a performance-based atmosphere instead of an effort-based atmosphere (hours worked, lines of code, etc.)

Your Thoughts? Too ideal? Anybody have significant problems with something similar to this? As of right now the benchmarks are undetermined and the 80/20 split is more of a reference point.

Thanks in advance for your help, suggestions, and thoughts regarding our new initiative...

Equity Metrics Founders

asked Jul 6 '11 at 06:27
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Travis Truett
127 points
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9 Answers


21

One piece of advice I frequently give startup founders: don't try to invent two things at once.

You've got enough problems inventing a new product which you are trying to launch. That is the entrepreneurial risk you are taking. Don't risk the whole thing by also trying to invent a new way to allocate equity.

You're going to need every brain cell you've got making your product great. Time spent inventing, arguing about, adjusting, and implementing complicated share allocation systems is time you should be spending nurturing your product. Your product is a very, very delicate candle in the wind. With this scheme, the founders are all going to take time off of working on their great idea to argue over whether Linda met her metric and whether Frank should be compensated for the fact that his metric turned out to be impossible to reach because you had to change the business model. And while you're blowing a lot of hot air at each other over equity and targets and so forth, nobody's going to be paying attention to the candle. Which will go out. And you'll be bitterly arguing about absolutely nothing.

You're going to need every ounce of personal fortitude you've got to keep the team of four people together, on the same page, and in the same boat. The minute you invent a complicated game-like system with rules and who the hell knows what that can only serve to create inequality, you're just opening the door to fights and arguments. You've got enough fights and arguments ahead of you already. Don't invent a new system to generate more fights and arguments. It'll kill the company.

Alternative: Stick to the 25/25/25/25 system. It's awesome. It will serve you well. Everyone will feel happy. Have one CEO. If someone screws up badly enough to get fired, the CEO fires them, and their unvested stock goes into the pot. That's how everyone else does it and it's hard, but it works, and that's why everyone else does it that way.

answered Jul 6 '11 at 11:28
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Joel Spolsky
13,482 points

4

The problem I have with coming up with a system for earning (or retaining) equity is that, apart from being nearly impossible to come up with a "fair" system, it ultimately undermines the trust that you have within your team.

I really like the 37 signals analogy that "choosing co-founders is like a marriage " and what you guys are really saying with a system like this is "how do we protect ourselves from being screwed over". Essentially you're making a pre-nup and the reason you're probably struggling to get a "sweet spot", is the same reason it feels wrong when applying these principles to a marriage - because you're starting off by saying "I don't trust you"... or more accurately: "I trust you, but..."

When you co-found a business, what you are essentially doing is forming a specific type of relationship with a person, or group of people, with the intention of achieving a common goal, and just like any relationship, everyone must contribute to make it work and most importantly, there needs to be trust there. Nothing will undermine that trust quicker than putting checks and balances in place to ensure that everyone is meeting their requirements for that relationship.

If you apply your logic to marriage, suppose you work and earn money and your partner stays home and looks after the kids, how would you apply a metric and benchmarks to ensure you and your partner are both contributing and both meeting those benchmarks?

Finally, doing things like this sets the tone for your business. It basically says "we're the kind of business that is going to try and minimize risk" as opposed to "we're the kind of business that is trying to maximise rewards" and there are plenty of businesses you can work for that are in that first category without having to deal with the stress of a startup.

If you feel like you don't have the level of trust in your partners to be able to contribute fairly and equitably to your business without being hit with the "metrics" stick then I would seriously consider whether these are people that you want to be going into business with in the first place.

My advice would be to split everything 25/25/25/25 and trust your team. If someone isn't pulling their weight, you'll be able to tell pretty quickly and then you can assess the situation and try and reconcile it amicably.

answered Jul 6 '11 at 15:26
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Lomaxx
151 points
  • Thanks for the advice, 37signal's "rework" is sitting on my desk and will be read after my current book is finished. I have heard great things and am looking forward to the read. Regarding the marriage analogy, that is very true and it would be very hard to gauge metrics that would apply to both the tech/business teams. Conceptually, I figured that a unique/retained users could be viewed as a unified goal catered to both teams but it still feels "apple to oranges" in a sense. Will keep all of this in mind, thanks. – Travis Truett 9 years ago
  • Rework is a great read and I highly recommend it. I'd also look at focusing on adding value rather than using metrics. If you can honestly say "everyone in our team is adding value" then that's much more important than "are we hitting our targets" because if you're all adding value you're increasing together, but hitting metrics doesn't mean you're increasing, it just means you're focusing in hitting metrics. – Lomaxx 9 years ago

2

I like the concept and the buy in on shareholding that is a very good idea.

What you haven't said is

  • How you will set the agreed targets
  • When you will measure the targets (weekly/monthly/quarterly) or is it more "when the target is met THEN you get the shares.
  • How many shares you get back when hitting a target. Is it a buy in over 2 years and you get 1/24 of your shares for hitting you monthly target?
  • What happens when you don't hit the target, but have worked your ass off, its just the idea didn't work or it got you 1/2 way ... do you get half your share allotment.
  • Do individuals have individiual goals or metrics, business guys one is advertising and one is PR do they have different goals and ways of measuring their own impact on the stats?
  • What if the business guys are very successful at putting the WRONG people on the site ... your selling to 30-40 year olds and your getting 1000s of 15 year olds turn up ... the counter is ticked over but they don't stay around for the tech guys to earn their points.
Issues with the overall incentive scheme :

  • There are a huge range of things your reward system hasn't covered ... whos job is it to clean up, fill in the insurance forms, answer the phone, turn up to meetings ... etc. If this is detracting from your ability to earn your shares what happens?
  • What happens when people need to work together, business guys NEEDS a new feature they promised in order to sell but techs are more focused on something else ... as I just got told today ... "On the list of things todo, that one is about in spot 201"
  • Why didn't you hit your targets? I was to busy helping you hit yours ...
  • Business guys get the advertising right or spend $5,000 outsourcing it to somewhere like trada and then sit back saying "my targets are getting hit, I'm off to the beach". Devs work all night for a week and miss their targets becuase there is some performance issue with the underlying RAID array (not really any of their doing) grinding things to a halt.
  • We tried an incentive scheme with sales staff, got it wrong and had them fighting and claiming "contribution" to each other sales and therefore should have their 3% ... wrong move.
My advice is, while I like the concept, be very careful about the unintended conseqences of your incentive scheme ... it will focus people ... but it will cause people to focus on one set of things rather than on the business operating as a whole.

I think your incentive scheme should assign a large percentage of the shareholding / profit to be awarded on the collective effort and acheivement of the group OVER individuals. Infact I think most of it should be collectively "did we make it or did we not" ... "did everyone put in the hard yards" (whatever they ended up needing to be). Did everyone collectively contribute to deciding what the next steps should be, did they all contribute to nailing those next steps?

Further research needed Incetive schemes aren't new, there have been many different variations, start with googling stuff like "problems with staff incentive systems" and have a read about some of the issues that can come up.

There was a great TED talk a year or so ago about this problem by Dan Pink, where individual incentive schemes most of the time ended up with the whole performing worse because it fractured the collective drive into competing and conflicting individual objectives.

answered Jul 6 '11 at 09:17
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Robin Vessey
8,394 points
  • Thanks Joel and Richard ... that was the talk I was refering to. – Robin Vessey 9 years ago
  • Great advice. Regarding actually building out the benchmarks, we have not thought this out farther than the concept right now. I will check out the TED talk and do some more research into the subject. It sounds like while ideal, the system might be over-reaching for right now. – Travis Truett 9 years ago

1

Good points from Robin (maybe referring to the Dan Pink TED talk?). There is good and bad in this. I can't give a definitive answer, but I would ask two questions:

  • You haven't launched yet - what if you make a change like selling to advertisers (small number of large accounts) instead of users (large number of small accounts)? Are you certain enough about the direction to commit to incenting that over 2-4 years? What would happen if you had to change? Do the people involved know exactly how they're going to reach their targets or do they first need to figure out the way (which can take years longer than planned) then implement it?
  • Are you using precise rules to replace good judgement? As the saying goes, if you're getting into something that you expect to end up in court no contract will help you. An agreement works best when everyone has a shared understanding of what's unwritten and trusts each other to stick to that. Just to take one example, what if someone has to put in more time than they expected? You can write that into the contract but you can't force them to want to do it and do their best. If they believe that they will be rewarded well and fairly they're much more likely to do it.

In general if there is no clear "owner" who's making the whole thing work and there's a bit of uncertainty or people aren't fully committed yet I would think it's fair to have everyone earn their way in, and if they drop out others will get more equity. If you have four people who know each other well and just quit their jobs to do this it might come across better to get a bit more up front. Again it takes good judgement to decide if they should be there in the first place.

answered Jul 6 '11 at 11:08
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Richardg
474 points

1

Herein lies the problem.

Apples are not Oranges.

You're seeking a mathematical formula where none exists and you are forgetting the human equation.

If the four of you are compadres, then, create an LLC for the four of you that owns 100% of the primary LLC (where the IP resides). Include buy-out provisions in the management LLC (the four of you), where if three of you agree (super majority, no questions asked), then the 4th slacker can be bought out for current market value.

Keep it simple. Keep it fair.

Also, plan for success. Build a wall of protection around the management team that no one can f-with. Stick together. Sure, have a fall back if it turns to s*it. But, put the focus where it needs to be: on success.

answered Jul 6 '11 at 13:39
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Bob
11 points
  • The root of a lot of this is certainly the fact that my mind prefers mathematical formulas in almost every situation. Obviously the human element cannot be accounted for in this scenario. We are wanting to build a company culture that promotes hard-work, goals, the ability to earn part of the company that you dedicate your time to. It sounds like this is a system that works for employees but for the founding team it is solely based on trust and faith. – Travis Truett 9 years ago

1

I agree with Joel's answer. But you probably also want to consider that it's a lot easier to measure performance for business guys (just measure the money) than tech guys. I'll go as far as to say that there's NO decent scientific measure that will tell you whether a programmer has performed well. All the conventional metrics are either silly or can be gamed in some way. The only thing you'll accomplish is people slowing down their development to try and satisfy the formula they'll be judged by. Performance metrics are a terrible tragedy for a startup.

answered Jul 6 '11 at 13:56
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Andrew M
11 points
  • Agreed that it is much easier to measure business guys over tech guys. Hopefully there is a way to apply some form of performance metrics to our startup without the risk of tragedy and increased failure. I have always valued and awarded performance in previous scenarios and workplaces. In our scenario though I guess trust is more important than performance to an extent. I will keep this in mind. – Travis Truett 9 years ago

1

I'm am not experienced in this matter but I wanted to share my little experience. Not so much long ago, I had an idea, and I wanted a partner, because I like to discuss ideas, I think that it is better to discuss everything, to improve, validate and execute. It should be better right?

So I told the idea to a friend who initially seemed interested, after a couple of weeks he came up with weird performance rules for the business. It was kind of absurd for many reasons but this is what I have learned:

  • If there is no trust, you can't work with that people, no matter what is the equity distribution and performance measurements.
  • All of them need to have business mind, as some other said, willing to wear many hats. Not only willing to do their own craft, who will clean the table after the pizza?
  • Selfish people don't like to share, so get to know your partner before proposing a business.
  • Don't blame your partner for being chosen. You are responsible for partnering with someone that you should not.
  • Every single one must have the same goal, and push to the same direction, otherwise you know, you are doomed to failure.

I am glad that we didn't move forward, because it would have been a mess if later on he came with that proposal.

I would just stick to splitting on equal parts, for ownership, and then keep track of the effort spent on the business, so you are owner an a worker. You get money from working for your company and you also have equity on it.

I hope I can help someone with my xperience, for me was really useful, I ended up with a sweet and sour taste, but now i see that it was a step that i needed to go through.

Last note, finding the right partner/s it is not easy task.

answered Jul 6 '11 at 17:47
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Seba
11 points
  • I appreciate you sharing your experience. I whole-heartedly agree about the trust and that is something that we are slowly building everyday. That is probably the hardest part of the venture so far, being able to take a step back and trust that a co-founder has a role to perform and that they need the trust and independence to successfully do it. – Travis Truett 9 years ago

1

I am searching myself for good answers to this question. I have read a lot of case studies
and found, unfortunately, that most advices out there fail to address the following basic problem:

  • Problem. Life changes. People change. Their attitude, motivation, interest etc change. Their perception of the right business direction change. Their perception of fairness changes (very important!).
Failing to address this problems leads to the many disaster stories we read online. It is real!

Trust is great and important but people break trust all the time!

Yes, you can degenerate into wasting your team's brains into eternal discussions doing that. But this is just the same with anything you are doing. Just pick up any question you have to solve as startup! So what? Should you avoid solving this question in first place?

I honestly see a bar between getting into endless fights and spending a quick afternoon to try to get something. If it does not work, you can always get back to the "classical" solution, where however the above problem remains. If however it does work for you, it may save your startup from future failure! Is it worth to spend few hours time on that? I'd say yes!

Now I have to ask:

  • Why is it so important to set up the equity split up front?
Yes, people want some clarity. But is a startup really a place where you come looking for clarity? Wouldn't a regular job better serve that purpose?

Yes, people want to see that they are rewarded for their work. But does this reward really have to be a fixed percentage of number X, about which value nobody has a clue? What for? So I can say to my friends, I have 25% of X (where X is between 0 and infinity :)?

Am I competing with my co-founder? Sorry but when I see people eager to go 50/50 I have to ask - do they worry that otherwise the co-founder gets too much? Because there is simply no one else there at the moment to "compete for the pie"!
If yes - you feel to be in competition - then - where is the so-called "trust"?

So what is the solution? I am still looking for a perfect one (aren't we all?) but the best advice I have found until now is in the book of Mike Moyer Slicing Pie. It advocates dynamic approach, where each contribution is counted and only later is converted into equity. And the most important thing I learned from that book, that applies to every situation even with fixed equity split carved in stone is:

  • The most important thing in a startup is that everybody feels being treated fair, at each moment. Disregard it, and your startup is heading for failure with the best business model ever.
Now I have recently posted another answer linking to the same resource, which, sadly, generated some negativity because my answer was called "spammy" as it "did not apply the dynamic equity concept directly to the question" according to the moderator. To which I want to say the following:

  • Also here I do not apply the dynamic equity to the precise question. I believe the question asker is able to do his homework better than me who knows close to nothing about his business.
  • I believe that giving a helpful information link is still just as useful.
  • By not focusing on specific details I avoid to obscure the main point made.
  • By not focusing on the details, I make my answer more useful for readers who have similar problems but have to deal with different details.

Why I am writing it here? Because I would very much like to avoid that kind of subjective non-constructive comments here again. So before you rush to you down-vote to "save the world from undesired answers", please consider the following:

  • If you find anything bad in my answer, would you consider sending me a private message, explaining what was it and give me a chance and your help to improve it? Nothing is better than a factual honest discussion.
answered Aug 28 '13 at 14:54
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Dmitri Zaitsev
181 points
  • I'm the author of Slicing Pie and I would agree with Dmitri's sentiments even if he had not cited my book. A dynamic equity split is THE solution for bootstrapped start-ups where ideas an sweat equity are the main components. If there is a lot of cash in the start up then there may be other models, but for this particular case a dynamic split is by far the most logical solution. I would be happy to provide a copy of my book if you contact me at [email protected]. – Mike Moyer 7 years ago
  • @MikeMoyer Your book is cited in the paragraph "So what is the solution? ...", Mike :) – Dmitri Zaitsev 7 years ago

0

Ownership should be allocated based on value and risk. As far as value is concerned, you'll need to clearly define your business and identify your competitive advantage. Your competitive advantage is your core business. Once you've identified your competitive advantage, you'll see the skills needed to make your advantage sustainable. Those members that add the most value to the core function of the business should have more ownership. Every skill is not equal.

Risk is another important component. The members that have contributed the assets (which can be tangible like capital and equipment, or intangible like intellectual property as in "Who came up with the idea?") should be compensated more.

I don't like the performance metric at the ownership level. You should use value and risk to define the equity allocations. You'll need to have a system for diluting shares when other members join in, i.e. venture capitalist or talents that want a vested interest to work for the company. You should settle these issues beforehand and open up shop with a fixed allocation. Appoint a CEO and you're set! Good luck.

answered Jul 7 '11 at 02:26
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Rayce Rollins
91 points

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