Startup compensation: flat salaries and equity/options work best

Earlier in my career I was a proponent of incentivising management teams with a quarterly bonus structure based on hitting KPIs that would be established at the start of each quarter. We had some success with this system, most notably at Zeus Technology, which was a good exit for my old firm Draper Esprit, but these days I recommend flat salaries with upside coming from options or founder shares. Here’s why:

  • Quarterly goal setting is still best practice (now called OKRs) but linking them to compensation creates a misalignment of objectives – the startup wants big goals, the employee wants achievable goals so he can get his bonus
  • Linking targets to compensation encourages gaming  and sometimes unethical behaviour. (This is also a danger if missing targets is perceived to damage reputation or chances of progression. Employees should be held accountable for effort and doing the right thing but not punished for failed experiments.)
  • It’s tough to define short term measures that will lead to long term success, particularly at a fast changing startup, so flexibility is important, however, It’s hard to change someone’s targets half way through a quarter when it’s linked to a bonus.

On the softer side, an increasing number of studies show that fixating on performance impinges on creativity and can weaken intrinsic motivation – and in startups you need creativity and intrinsic motivation in spades. Otherwise life gets very difficult.

The only exceptions to this flat salary rule are routine work which requires no creativity and sales where commission structures remain the best way to motivate a team.

With those caveats the best structures are flat salaries and a share of the equity. The share of equity only pays out a small percentage of the time and is far in the future which makes it imperfect as an incentive, but it is great for aligning everyone around building value and for creating a shared sense of ownership.

Finally, for those of you thinking ‘that’s all very well, but how do you motivate people without bonuses’ consider whether you are better off hiring people who are intrinsically rather than extrinsically.

Hat tip to Gail McManus of PER, a recruitment firm for private equity professionals. She stimulated this post by emailing me a link to an LBS article: Why CEO pay should be 100% fixed.