A few years ago, I provided a link to a post on partner compensation in a start-up that David Maister (author of the seminal book on consulting, The Trusted Advisor) had on his now-retired blog. While never claiming to be a compensation expert or someone in the business of advising start-ups, David shared some wonderful points and principles around structuring partner rewards in emerging organizations - a challenging area to navigate without a lot of best principles or practices. I've sent links to this post out many times. It occurred to me, after sending it out for the second time this week, that it might be worth featuring here again for the benefit of those who might have trouble finding it otherwise.
A reader wrote in to ask David: What's the best way to structure a compensation system for partners in a small startup firm? ...Should it be simply a division of retained earnings by ownership share? A formula that builds in factors such as total sales, revenue managed, etc? Obviously, fairness and trust among the partners is critical.
Here, in their entirety (something I don't normally do), are the thoughts that David shares:
(i) I always like "look ahead" systems, not "look back" systems. In other words, let's discuss how we are going to allocate next year's profits. Once we've agreed on that, and each have our shares, we can move together during the year aligned in our interests, focusing on making the whole enterprise successful. If that proves to be a little unbalanced, then we'll tackle it at year end when we plan the division for the year after that. However, if we have a system whereby you're always looking back - trying to allocate funds based on performance that has already taken place - you'll always be fighting over differing interpretations of history.
(ii) Stay away from formulas based on origination or anything else. In a start-up there are just too many things that need to get done to allocate incomes on a few measures.
(iii) Recognize that, even in a tiny partnership, it's possible to invent a system that has different categories of splitting available cash. For example, you could begin by saying "tranche" number one of any end-of-year cash is to be split by ownership shares, while tranche number two is to be split on some other "performance" basis. The weighting between these two might vary over time. Initially, to encourage a focus on overall success, you could say "Let's allocate 80% to reward for ownership" which gets everyone focusing on the firmwide result & allocating only, say, 20% to be divided to the basis of performance. As the years go by and you add more people, you will then have choice as to the weighting between the reward for ownership and the reward for performance.
(iv) In general, I like systems where everybody shares in the overall performance (relatively fixed shares, adjusted only infrequently), but that can only be sustained if your "system" is good at addressing performance issues, so that you tackle performance problems by talking to each other during the year, not trying to invent crazy formulae. So, how well can you and your partners talk with each other? Are you the type of people who are comfortable addressing issues during the year and commenting if you think the burdens are not being equally shared? If so, you won't need the comp system to do it for you.
(v) What you REALLY have to ask yourself is: do I want to be partners with this person? With these people? Am I prepared to trust that we can work it out? IF yes, then any scheme will get you through the first couple of years, and you can re-examine it later. If the answer is no, then no comp scheme will cover up that lack of trust.
A number of people added their comments and thoughts to David's. Here's what I said...
I strongly second your preference for "look ahead" rather than "look back" systems (i). Then everyone involved is free to move forward and act based on a shared understanding of the "rules", rather than being forced to negotiate them after the fact.
I also appreciate your thoughts on establishing an agreed-upon approach to allocating available cash (different "tranches"), and distinguishing between what earns based on ownership and what one earns based on contribution or performance. The tricky thing, at least in my experience, is defining and getting agreement on what is meant by performance and how it is measured. In response to your comment in (ii) about using "origination" to allocate income, I find that it is difficult to avoid business development (what I believe you mean by origination) as part of the income equation. The business owners I have worked with in these circumstances typically feel very strongly about motivating and rewarding the hard work of business development as a critical component of their initial compensation approach.
Finally, I echo your sentiments about ensuring that a good share of the income allocation or compensation approach focuses on collective performance, to reinforce the spirit of shared destiny that is so important in the early days of an organization.
Thanks again for a helpful and thought provoking post!
Got your own wisdom, advice or information on compensating partners in a start-up? Please share it with us here!
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