Should we award equity based on specific performance metrics?

The problem I have with coming up with a system for earning (or retaining) equity is that, apart from being nearly impossible to come up with a "fair" system, it ultimately undermines the trust that you have within your team.

I really like the 37 signals analogy that "choosing co-founders is like a marriage" and what you guys are really saying with a system like this is "how do we protect ourselves from being screwed over". Essentially you're making a pre-nup and the reason you're probably struggling to get a "sweet spot", is the same reason it feels wrong when applying these principles to a marriage - because you're starting off by saying "I don't trust you"... or more accurately: "I trust you, but..."

When you co-found a business, what you are essentially doing is forming a specific type of relationship with a person, or group of people, with the intention of achieving a common goal, and just like any relationship, everyone must contribute to make it work and most importantly, there needs to be trust there. Nothing will undermine that trust quicker than putting checks and balances in place to ensure that everyone is meeting their requirements for that relationship.

If you apply your logic to marriage, suppose you work and earn money and your partner stays home and looks after the kids, how would you apply a metric and benchmarks to ensure you and your partner are both contributing and both meeting those benchmarks?

Finally, doing things like this sets the tone for your business. It basically says "we're the kind of business that is going to try and minimize risk" as opposed to "we're the kind of business that is trying to maximise rewards" and there are plenty of businesses you can work for that are in that first category without having to deal with the stress of a startup.

If you feel like you don't have the level of trust in your partners to be able to contribute fairly and equitably to your business without being hit with the "metrics" stick then I would seriously consider whether these are people that you want to be going into business with in the first place.

My advice would be to split everything 25/25/25/25 and trust your team. If someone isn't pulling their weight, you'll be able to tell pretty quickly and then you can assess the situation and try and reconcile it amicably.

I like the concept and the buy in on shareholding that is a very good idea.

What you haven't said is

• How you will set the agreed targets
• When you will measure the targets (weekly/monthly/quarterly) or is it more "when the target is met THEN you get the shares.
• How many shares you get back when hitting a target. Is it a buy in over 2 years and you get 1/24 of your shares for hitting you monthly target?
• What happens when you don't hit the target, but have worked your ass off, its just the idea didn't work or it got you 1/2 way ... do you get half your share allotment.
• Do individuals have individiual goals or metrics, business guys one is advertising and one is PR do they have different goals and ways of measuring their own impact on the stats?
• What if the business guys are very successful at putting the WRONG people on the site ... your selling to 30-40 year olds and your getting 1000s of 15 year olds turn up ... the counter is ticked over but they don't stay around for the tech guys to earn their points.

Issues with the overall incentive scheme:

• There are a huge range of things your reward system hasn't covered ... whos job is it to clean up, fill in the insurance forms, answer the phone, turn up to meetings ... etc. If this is detracting from your ability to earn your shares what happens?
• What happens when people need to work together, business guys NEEDS a new feature they promised in order to sell but techs are more focused on something else ... as I just got told today ... "On the list of things todo, that one is about in spot 201"
• Why didn't you hit your targets? I was to busy helping you hit yours ...
• Business guys get the advertising right or spend $5,000 outsourcing it to somewhere like trada and then sit back saying "my targets are getting hit, I'm off to the beach". Devs work all night for a week and miss their targets becuase there is some performance issue with the underlying RAID array (not really any of their doing) grinding things to a halt.
• We tried an incentive scheme with sales staff, got it wrong and had them fighting and claiming "contribution" to each other sales and therefore should have their 3% ... wrong move.

My advice is, while I like the concept, be very careful about the unintended conseqences of your incentive scheme ... it will focus people ... but it will cause people to focus on one set of things rather than on the business operating as a whole.

I think your incentive scheme should assign a large percentage of the shareholding / profit to be awarded on the collective effort and acheivement of the group OVER individuals. Infact I think most of it should be collectively "did we make it or did we not" ... "did everyone put in the hard yards" (whatever they ended up needing to be). Did everyone collectively contribute to deciding what the next steps should be, did they all contribute to nailing those next steps?

Further research needed

Incetive schemes aren't new, there have been many different variations, start with googling stuff like "problems with staff incentive systems" and have a read about some of the issues that can come up.

There was a great TED talk a year or so ago about this problem by Dan Pink, where individual incentive schemes most of the time ended up with the whole performing worse because it fractured the collective drive into competing and conflicting individual objectives.

Good points from Robin (maybe referring to the Dan Pink TED talk?). There is good and bad in this. I can't give a definitive answer, but I would ask two questions:

• You haven't launched yet - what if you make a change like selling to advertisers (small number of large accounts) instead of users (large number of small accounts)? Are you certain enough about the direction to commit to incenting that over 2-4 years? What would happen if you had to change? Do the people involved know exactly how they're going to reach their targets or do they first need to figure out the way (which can take years longer than planned) then implement it?

• Are you using precise rules to replace good judgement? As the saying goes, if you're getting into something that you expect to end up in court no contract will help you. An agreement works best when everyone has a shared understanding of what's unwritten and trusts each other to stick to that. Just to take one example, what if someone has to put in more time than they expected? You can write that into the contract but you can't force them to want to do it and do their best. If they believe that they will be rewarded well and fairly they're much more likely to do it.

In general if there is no clear "owner" who's making the whole thing work and there's a bit of uncertainty or people aren't fully committed yet I would think it's fair to have everyone earn their way in, and if they drop out others will get more equity. If you have four people who know each other well and just quit their jobs to do this it might come across better to get a bit more up front. Again it takes good judgement to decide if they should be there in the first place.

Herein lies the problem.

Apples are not Oranges.

You're seeking a mathematical formula where none exists and you are forgetting the human equation.

If the four of you are compadres, then, create an LLC for the four of you that owns 100% of the primary LLC (where the IP resides). Include buy-out provisions in the management LLC (the four of you), where if three of you agree (super majority, no questions asked), then the 4th slacker can be bought out for current market value.

Keep it simple. Keep it fair.

Also, plan for success. Build a wall of protection around the management team that no one can f-with. Stick together. Sure, have a fall back if it turns to s*it. But, put the focus where it needs to be: on success.

I agree with Joel's answer. But you probably also want to consider that it's a lot easier to measure performance for business guys (just measure the money) than tech guys. I'll go as far as to say that there's NO decent scientific measure that will tell you whether a programmer has performed well. All the conventional metrics are either silly or can be gamed in some way. The only thing you'll accomplish is people slowing down their development to try and satisfy the formula they'll be judged by. Performance metrics are a terrible tragedy for a startup.

I'm am not experienced in this matter but I wanted to share my little experience. Not so much long ago, I had an idea, and I wanted a partner, because I like to discuss ideas, I think that it is better to discuss everything, to improve, validate and execute. It should be better right?

So I told the idea to a friend who initially seemed interested, after a couple of weeks he came up with weird performance rules for the business. It was kind of absurd for many reasons but this is what I have learned:

• If there is no trust, you can't work with that people, no matter what is the equity distribution and performance measurements.
• All of them need to have business mind, as some other said, willing to wear many hats. Not only willing to do their own craft, who will clean the table after the pizza?
• Selfish people don't like to share, so get to know your partner before proposing a business.
• Don't blame your partner for being chosen. You are responsible for partnering with someone that you should not.
• Every single one must have the same goal, and push to the same direction, otherwise you know, you are doomed to failure.

I am glad that we didn't move forward, because it would have been a mess if later on he came with that proposal.

I would just stick to splitting on equal parts, for ownership, and then keep track of the effort spent on the business, so you are owner an a worker. You get money from working for your company and you also have equity on it.

I hope I can help someone with my xperience, for me was really useful, I ended up with a sweet and sour taste, but now i see that it was a step that i needed to go through.

Last note, finding the right partner/s it is not easy task.

Ownership should be allocated based on value and risk. As far as value is concerned, you'll need to clearly define your business and identify your competitive advantage. Your competitive advantage is your core business. Once you've identified your competitive advantage, you'll see the skills needed to make your advantage sustainable. Those members that add the most value to the core function of the business should have more ownership. Every skill is not equal.

Risk is another important component. The members that have contributed the assets (which can be tangible like capital and equipment, or intangible like intellectual property as in "Who came up with the idea?") should be compensated more.

I don't like the performance metric at the ownership level. You should use value and risk to define the equity allocations. You'll need to have a system for diluting shares when other members join in, i.e. venture capitalist or talents that want a vested interest to work for the company. You should settle these issues beforehand and open up shop with a fixed allocation. Appoint a CEO and you're set! Good luck.