10 Key Advantages of Switching to Performance-Based Equity
One of the most complicated tasks in a startup’s development is navigating the challenging conversations and decisions about splitting equity.
In many or most situations, a Founder (or Founders), begin on the road of business ownership with one great idea: a product or service that they believe will be a profitable game changer for their industry. Sound familiar?
Founders know that bringing a product or service to market will take a lot of manpower, and often a lot of money. It is at this point in time that they have to begin the challenge of recruiting teammates who will contribute a whole lot of time for the promise of a little or no money now with an upside of a lot of money later.
Equity strategy is never an easy conversation. As a mix of finance, culture, loyalty and law, most new executives struggle to create a plan that works well and makes everyone happy. This is where the case for performance equity comes in.
If possible, performance equity should be used from the beginning, especially prior to company formation. Performance equity is the fairest way to divide shares amongst founders, early employees and other valuable contributors. Performance equity, as opposed to a fixed equity model, takes into account the value of each individual’s input to assign the appropriate number of shares across the team. For example: a senior developer who provides great ideas and full-time manpower will receive more equity than a developer who provides portions of ideas but only part-time development efforts.
Below are 10 Things to Know to Become a Quick Expert on Performance Equity
1. Anything Can Be Bought with Equity
Contributors to a new start-up may include those that provide office space, business partnerships, tools like computers, even housing during the early phases of startup building. Performance equity makes it easy to thank and reward those that help founders get through the early and tough days in an appropriate fashion (think the 30% you were going to offer your friend whose couch you’ve been sleeping on – maybe not a great idea).
2. It’s Human Nature to Want the Biggest Piece of the Pie
Ever see a family with 3 kids opening Christmas presents? It is embedded in most adults to demand fairness. This is where performance equity preserves company culture. It is not unusual for each hardworking team member to believe that he or she has contributed the most and, thus, should own the most of the project. Without a model based on defined inputs, it is easy for human nature to take over and damage relationships, even ending the company. Fairness rules and most people feel and see fairness through the measured and standardized calculations of performance equity. Fixed equity is a complete guess of future value.
3. Smart Leaders Share the Wealth
Have you ever had a friend offer you a role at his startup, only to task you with 80% of the work and offer you 5% of the ownership. Many people share this experience and know where the story usually ends: failure. Smart founders who work with the best investors know that top talent who are smart and confident enough to work in a risky early stage company are also savvy enough to demand appropriate compensation for their work, especially relative to other team members. Smart leaders do not resist this, but embrace strategies to reward and retain the talented people that lift their ideas off the ground. Performance equity can also be very transparent, further inspiring the team and minimizing any stressful pay negotiations. When every team member knows each other’s hourly pay, people are less likely to advocate for a higher than reasonable pay.
4. Performance Equity Changes Over Time
In fixed models, founders often agree to an equity agreement before having a chance to experience actual contributions across the team. It is obvious why this leads to conflict and even failure in small companies as those who give a lot resent those who do not. Performance equity is smart because it changes over time as each team member contributes.
5. Team Members Have an Incentive to Work Harder for Longer
Because performance equity changes over time, this means that, up until the point that a company is acquired or goes to IPO, team members are incentivised to work hard and give more! This is a great strategy to avoid complacency and to motivate team members through the tightest financial times. An important feature of performance equity is the ability to see your ownership in a dashboard in real time. Static documents go into a drawer and are forgotten. This leaves team members uninspired because they lose touch with the value of their share… and their work.
6. Calculating Performance Equity Doesn’t Have To Be Hard
Tools exist that help you to calculate performance equity online so you do not have to go through complicated measures to figure it out. To toot our own horn: Upstock was created to help startups do just this. We even generate all of the legal documents you will need.
7. Inputs Are Not Created Equal
Your friend who provides you with the couch that we mentioned above (great guy, couldn’t do it without him) has a contribution that is not equal to your Leading Developer (and he would remind you of that). Performance equity allows for assignment of value- think weighted scores- to various inputs. This means that those that contribute seed equity, endless hours of manpower and your first 10 clients can be rewarded for their level of contribution, while those that provide less also receive an appropriate level of compensation.
8. Fixed Models are Bad
Like many old fashioned things, like rotary telephones, ROM chips and Enron stock, that once seemed like a good idea become outdated and are replaced with innovation that better solves a problem. Fixed models are archaic, yet continue to be mainstream. If fixed models are so bad why do many people continue to use them? The answer is that founders do not know a better way. But like most things, as information and technology expand awareness, the fixed model will join the likes of its peers who are now considered business shelfware and ancient history.
9. Investors Appreciate Performance Equity
Large investors like Founders Fund have gotten smart to the idea of performance equity and have even put money behind advancing the concept. Many investors are former founders who know the grief and challenges that come from fixed equity business models. For this reason, many investors will nod to startups that modernize their equity structures and demonstrate an aptitude for new concepts.
10. Companies That Are Built on Trust Perform Better
Fortune Magazine called trust “The Most Powerful Currency in Business”. Crunchbase recently said that reputation and trust will be the new currency. Do you blame them? If you’ve ever tried to work with a person who you do not trust, you can recall how quickly your motivation, creativity and dedication to the project fell to the wayside. Trust is built through transparency, communication and a sense of fairness. A trustworthy leader will identify and communicate clean, intelligent and equitable ways to reward, motivate and compensate others for their contributions. The result: a better chance at being a success story.