“But, how do I make sure that the person is a great performer before I am forced to give them equity?”
This question gets asked by nearly every Founder, Investor or Compensation Committee Member very early in the development of an equity compensation plan. Sometimes it is expressed more genuinely as, “I don’t want to give away part of my company to someone who hasn’t carried their fair share.” Either way, the concern is valid. Sometimes the answer is very simple, and sometimes it is not.
Your equity compensation plan should be aligned with the strategic needs, executable capabilities and cultural strength of your company. Clearly identifying these in any company can be tough. At a startup, it can be nearly impossible. That doesn’t mean it shouldn’t be done. Startups are used to the concept of impossible.
Performance conditions can be incorporated into nearly any type of equity, but the easiest tool is Restricted Stock Units (RSUs). Performance conditions can impact all the following: whether someone gets an award, the size of the award, the timing of vesting and the amount of vesting. This article is a bit too short to cover the details, but we can cover the key points.
What are good performance conditions for equity? Most companies want to reward results, but results in a startup are notoriously hard to predict. What will your revenue be in three or four years? How about EBITDA? What is the correct margin number and how can you predict a relatively accurate estimate of how you will get there? These are all hard, but there are more far more challenging questions.
When will you “pivot” and who will you become? Who else is building something similar and how much better or worse is their team and execution? What will your second and third round of investors want to see from you? How will those hurdles conflict with or support the goals already in place? These are impossible to predict; therefore, performance equity plan needs to be avoided or designed to evolve.
THE BEST APPROACH
Rather than focusing on the specific results associated with each metric, focus on what will need to be accomplished to drive success in each metric.
- You want revenue to hit a certain number? Then, you better make sure that the product is viable and ready on time. You also need to make sure that your go to market strategy is as bulletproof as possible. Your sales people need to have the tools and marketing collateral to be successful. This list goes on.
- You want the company value to increase by X%. You need to be willing to squash passion projects and focus on the things that your valuation professional says will increase your multiple. Your need to hone your investor pitch deck to get that extra bit of value out of each new funding round. You better be prepared to navigate your market as it sways and spins over the years.
The unpredictable nature of the issues above is why stock options, remain so popular. They have a single metric which is stock price. The have a single goal to take the stock higher in the future than it is today. They are just and fairly elegant. They can also be a crude tool for a nuanced topic. And, adding performance conditions to something that already has a stock price hurdle can end up in “hitting your performance goals” while having the stock price flat or down due to market conditions, operational errors or any number of other things.
RSUs require no stock price hurdle to create value (therefore investors increasing dislike RSUs.) But, they are far less dilutive than stock options (therefore investors increasing love RSUs.) When you add in performance conditions that can help modulate unexpected great performance and provide a softer landing to unintended underperformance (within reason), you give yourself and investors something that may be far better for your company and employees than anything else.
Of course, it takes a bit more time and effort to create, manage and evolve a plan like this. But in an age where investors are more careful and potential values are more fantastical than ever before, performance-based equity may be the solution to the question that nearly everyone has when they start their exploration process.
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