There has been a lot written on incentive-based startup employee compensation over the years from the perspective of VCs, startup founders and startup employees. What there has not been much written about is tying disincentives into startup employee compensation to protect liability exposure and limit risk.
Thoughts on the Ryan Braun PED Suspension
I started thinking about this yesterday, when MLB announced that it would be suspending the Milwaukee Brewers’ Ryan Braun for 65 games without pay for his involvement in the Biogenesis PED scandal. My first thought was: Wouldn’t it be interesting if the league allowed teams to void convicted PED users’ contracts? I know it would be a battle with the player’s union, but it would make the risk of juicing more real and something players would have to actually consider before doing.
The thing is Braun is signed through the 2020 season. He was supposed to be the face of the Brewers franchise. They are now stuck with his contract despite Braun’s marketability being a fraction of what it was, and his expected performance may be in question as well. These were all liabilities that potentially could have been accounted for via a contract if the current MLB collective bargaining agreement had allowed for it.
Why is this Relevant for Startups and Expansion-Stage Companies?
In the tech startup world, unions do not exist and disincentive contract conditions like “the PED clause” are possible.
So why are they rarely utilized?
The answer is simple — startup founders have a difficult time bringing on top talent and do not want to risk losing-out on top talent. They know committed top talent is a key determinant of success.
Startup employee contracts are lined with incentives and this is the main reason that so many talented individuals chose to forego corporate America opportunities to work for startups.
Typical Startup Employee Compensation Incentives
- Options: Startups generally set aside 15% to 20% of equity for a starting employee option pool. This is used to help recruit top talent.
- Accelerated Option Vesting Schedules: Generally, startups will tie options to a vesting schedule of three to four years. Sometimes they will offer vesting schedule accelerators to incentivize top performance.
- Performance Option Accelerators: Startups sometimes will tie part of the options to an employee’s performance. This allows the company to incentivize top performance. Just be sure to put a ceiling on the accelerator as hyper growth can get very costly.
- Free Stuff: Free lunch, beer, etc.
- Events at Milestones: Experiences after the company hits target milestones.
Startup Employee Compensation Disincentives to Consider
Startups and expansion-stage companies rarely opt to use disincentives in contracts, but here are some ideas to help avoid getting locked into a “Ryan Braun-like” contract that you may no longer want.
- Vesting Periods for Options: This is the most common disincentive that you see in startup contracts. Startup hoppers are abundant in the tech community and in order to protect your investment in this pool it is important to tie options to a longer-term vesting schedule in order to disincentivize early departures and maintain top talent. Most companies limit the first option vesting to the employee’s one year anniversary, but this is a factor you can play with, especially as a company matures a little and moves into the later startup or expansion stage.
- Decelerator on Options for Poor Performance: Another approach to controlling option liabilities is to add a decelerator clause on options whereby poor performers actually lose options. This option allows you to penalize poor performance without having to outright fire those team members, which can cause image problems in itself. Just ask Mark Pincus, the former CEO of Zynga.
- Brand Damaging Behavior Conditions: A firm can be greatly damaged by decision gaffs that are made by the startup executive team, and sometimes this can even lead to problems raising funding down the road. Startup firms may want to disincintivize bad decisions by including a contract voiding condition or an option penalty for “brand damaging behavior”.
Startup contract design is an art form and it can mean the difference in a startup or expansion-stage company’s success, so make sure to do your homework and think of the different angles you can take to help attract top talent while not exposing your firm to unnecessary risk. Below are some great resources on startup employee compensation:
- Understanding Startup Equity: Every Startups Secret Weapon
- Brad Feld’s and Jason Mendlesen’s Ask the VC
- Norm Wasserman’s Annual Compensation Study
- Wealthfront.com’s Startup Salary & Equity Compensation Tool
- Angel List’s Salary & Equity Statistics By Job Type, Region and Key Skills
I would love to hear your thought on utilizing negative incentives in startup employee contracts.