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Innovation in incentives - how should startups structure salaries, bonuses, commission, stock options?

Understanding the business stage is important when trying to decide the best way to incentivise your team. Startups exist in a state of uncertainty, rapidly iterating to find product/market fit which can scale up. This is quite different from a large corporate with revenues that are likely to be sustainable for the long term.

Incentive schemes must be stage appropriate. They have to reward reaching key milestones which allow the business to transition to the next stage. So what does this actually mean for a startup? How should incentives be designed for those initial 12-18 months of the life of a startup?

Salary #

At its most basic, an incentive is a trade. You’re trading an object of value for something else of value. For employees, this starts with money being exchanged for time. The value of that time is determined by a number of factors particular to the individual - their experience and their skills - in relation to the availability of someone similar within the market. Of course it’s not quite as simple a calculation as that, but this a basic approach to thinking about salary.

But salary is just the starting point. There are many other aspects of an employment package which make up compensation, which is in turn just one part of what incentivises people to work.

This is important because incentives have to be more granular than just a salary. The salary is really there just to trade money for time in the pursuit of a goal, but it doesn’t change whether that goal is achieved or not. Indeed, it’s not supposed to - a good proportion of someone’s salary is for subsistence. It’s what they need to live. Rent/mortgage. Food. Travel. Clothes.

The only thing that salary is linked to is the survival of the business. If it fails, you’re out of a job. Certain roles tie success not to the entire business but hitting quotas or targets, such as in sales. Those who are not very good at the job quickly move on. But for most role, there’s not such a direct association between quantitative success and whether you get fired or not.

By itself, salary is therefore an insufficient incentive for most startups.

Bonuses and commission #

Bonuses and commission are the next thing which come to mind as very common options for incentives.

Commission is quite easy to deal with because it is just like linking salary/being fired to quotas. Commission is appropriate for sales based roles, whether new business or account management. It directly incentivises increasing the revenue of the business, which is the main goal for most for-profit organisations. However, it is very specific to sales roles and so isn’t helpful when considering a broader incentive scheme.

Bonuses are more challenging. The criteria which determines when a bonus is paid needs careful consideration. The goal must be clear and quantitative. It has to be achievable, but not too easily. And achieving the goal should provide more value to the business than the monetary value of the bonus (at least over the long term). Some consideration should also be paid to exceeding the goal - is it a binary state of achieved vs not, or is there a scale of achievement? In a pure sense, once the goal is achieved and bonus paid, there is no incentive to go any further even though this may be beneficial for the business. So can the bonus amount increase based on what is achieved? How high should it go?

Bonuses also have organisation-wide context. Who gets a bonus and how does it relate to the bonus structure for the rest of the team? People will compare their bonuses both in terms of the value and what they have to do to hit it. It’s very difficult to equalise all bonuses so there may be a negative incentive because someone is unhappy that their bonus is smaller or harder to hit.

Organisation wide goals #

Salary, bonuses and commission are all paid to individuals on individual success. How do we incentivise a team or the whole organisation?

Well, bonuses apply here too. Everyone should be working towards a single goal for the organisation and if the effort of the group means you hit it, the group can benefit.

All the problems of bonuses apply here though so for more mature businesses, a profit sharing scheme is a good alternative. It is not a fixed amount so aligns both the goals of achieving a profit, and growing it. With proper transparency into the spending patterns (and decisions), the team can be involved with commercial decisions about whether to increase spending and how to cut costs.

Startups usually use stock options as another form of incentive. However, these only have value if a) the business is acquired (for more than the strike price); or b) the business goes public. Both outcomes are extremely rare and so far into the future that for all incentive based discussions, their value is basically zero. There is of course some value to feeling like you own part of the business and you will benefit in those two events to which you have contributed, but that value is not quantifiable in advance.

That’s not to say stock options shouldn’t be a standard part of startup incentive plans, but for the purpose of this discussion their uncertainty means they’re not a particularly useful incentive.

More individual choice #

The problem with organisation wide incentives like profit share, bonuses and stock options is that they reward everyone regardless of effort. There should be consideration for the differences between someone who is putting in 30 hours a week vs someone putting in 60.

There is a growing movement focused around work/life balance, with schemes like 30 hour weeks and ensuring staff get proper breaks by deleting all their email when they are holiday.

Whether this new way of working is reconcilable with the level of dedication needed in the early days of a startup is something I’d like to write about further. Is the legendary worth ethic of Jeff Bezos and Elon Musk necessary for billion dollar outcomes? But for the purposes of incentives, there has to be a link between effort and reward. Effort does not necessarily = results. Working more hours doesn’t mean better outcomes. According to some recent research:

…people who sleep fewer than six hours a night are 2.4 per cent less productive than those who get between seven and nine hours. Overall, the UK loses hundreds of thousands of working days due to insufficient sleep, costing the economy £40bn each year, or almost 2 per cent of gross domestic product.

At some point, the incentives to work more generate negative outcomes. As such, the level of productivity and output must also be part of the calculation.

Why not let people choose?

If your goal is something other than more money - family time, hobbies, travelling, reading - why not opt to work less in return for a different compensation package?

Of course, another word for this is “part time” but that typically implies a proportional salary reduction which might not viable for people who need their entire salary to live. How about if you could trade fewer working hours with your bonus, or a lower commission? Indeed, this might even incentivise you to be significantly more productive to achieve the same (or more) in less time.

Amazon is piloting something similar with an experiment allowing technical teams that work 30-hour weeks for the same benefits and three-quarters the pay of 40-hour employees.

Innovation in incentives #

It seems to me that just being paid a salary is quite an inefficient way of incentivising your team.

For the business, it is a fixed overhead that has no real power to incentivise achieving company goals (neither once nor as they evolve).

For the employee, it just serves to fulfil basic security needs and has no relationship between effort or achievement. It’s a backwards looking measure of your worth in the market at the time you were hired and does nothing to link you to the success of the organisation you’re spending so much time with.

With more and more focus on work / life balance, there has to be more innovation in incentives. Bonuses and profit sharing might not sound innovative, but it’s interesting to consider how they’re applied to help encourage achieving goals for the individual and the organisation.

I think we’ll start to see more choice for employees joining new, innovative businesses that help align them much more in the short term, the long term, with financial outcomes and overall wellbeing. Compensation packages should be just that - a package selected from various options that are truly linked to outcomes and motivations. This will provide a compelling differentiator in the labour market and make success more likely overall.