Partner Compensation in a Start-Up

post # 249 — November 27, 2006 — a Managing post

A reader wrote in to ask:

“What’s the best way to structure a compensation system for partners in a small startup firm? I have recently launched my own consulting practice with another partner. We also have a third minority owner (1%) and we expect to hire between 3-5 associates this year. We might even bring in a third partner if things go well. 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.”

It would seem from previous comments on this blog during the year that some of you might have been through this, or are in the business of advising start-ups . (I am not.)

But here are some of my thoughts to get your juices flowing:

(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 thi k 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.

OK everybody else — jump in. What advice do YOU have to give about structuring partnership compensation in a start-up?

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A Shakespearean Retreat

post # 247 — November 22, 2006 — a Managing post

I said in an earlier blogpost that I wanted to seek out praiseworthy things. Here’s one.

The picture above is Bryan Schwartz, Managing Partner of Levenfeld and Pearlstein, a law firm in Chicago. Let me use his own words to describe how he ran a recent partner’s retreat.

“I did a Shakespeare theme where I showed some clips from Henry V (1989) starring Kenneth Branagh , an adaptation from something I had learned from the Young Presidents Organization that I belong to. The clips made the messages powerful. The partners had to play the role of the king and determine how they would behave under the circumstances. This lead into the themes below.

“We discussed the issue of managing friendships in business and whether we would deal with those of our friends who were not living up to our firm’s standards for quality and service. Would we hang the thief who stole from the French? We decided that we would maintain our friendship but be firm about adherence to our standards and that one did not conflict with the other.

“We talked about how Henry V walked around and talked to his people to get a sense of how they were feeling the night before the big battle at Agincourt.

“We talked about being optimistic and being of the right mind when we observed Henry’s speech concerning St. Crispin’s Day. We talked about compensation and our subjective plan. You set that up beautifully. We spent 10 minutes on that – a miracle for a law firm. I believe people are realizing that in the absence of subjectivity, which we currently employ, we become a mercenary firm, which we do not desire to emulate.

“We really embraced the fact that we had choices to make. Thequestion about how much of our work fell into the category of “God, we love this”! really hit home with many and we all discussed this at dinner on Saturday night. We discussed the power of change at the dinner on Saturday and weaved it in on Sunday. We viewed the battle scene at Agincourt, where the smaller English forces were highly focused and fought the battle on their terms against the arrogant but larger and better equipped French. We talked about the distinctive weapons that were created and the use of strategy to win that battle. I made the analogy of big firm vs.. small firm and focus.

“We incorporated the scene where Henry is trying to woo Princess Katherine even though he could grab her by the hair and say do what I tell you to do because I am the king. We made that analogy to our associates and also our clients. We focused winning the hearts and minds of people we deal with, not just telling them what to do and avoiding intimacy. I think intimacy is the right word by the way.

“We went through various tensions that exist in the firm and spoke about those tensions out loud. We had a great deal of honest and worthwhile discussion.

“It was probably our best retreat.”

Has anyone else been using Shakespeare or other authors to form the basis for real, substantive discussions at business meetings?

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Are We ON The Same Side?

post # 242 — November 17, 2006 — a Managing post

What follows began as a piece that I wrote for PSVillage.com (a great location for IT professionals), and I plan to expand it into a longer article if you all find it interesting and worth commenting on. Here it is:

In the November 6 issue of The Wall Street Journal (page B1) there was an article by Erin White and Gregory Zuckerman entitled The Private Equity CEO, which explored how life for a CEO changed when a company went from being publicly-held to being owned by private equity investors.

What caught my attention was this excerpt:

“Mr. Bilborough (the CEO of privately-held Generation Brands) says one of his biggest challenges is motivating employees amid uncertainty. Most companies controlled by private equity are sold within three to seven years. Senior executives receive equity, which can be lucrative. But middle managers and lower-level staffers typically don’t get stock. ‘You’re trying to lead an organization where everybody knows we’re going to be sold, said Mr. Bilborough. ‘It just hangs over them like a cloud as a constant distraction for people.’”

Exactly!

When management and employees have very different vested interests and incentives, employees really begin to question whether everyone’s on the same side. They begin to ask “Is management doing this because it’s good for the company, or because it’s good for them?” People begin to wonder: “Are we in this together or not?”

By the way, before you get too far in reading this, don’t think I’m only talking about “THEM” — the top people in large companies. These tensions apply to all of us, even if we manage only a small project team — or even if we don’t manage anybody, but just have to collaborate with others on a project or across departments.

People will always be asking:

a) What time-frame are you using for your decisions; and

b) Are we in this together or not?

We are all tempted by (and seek) immediate gratification, and doing things that pay-off in the short term. Underinvesting in our future is something we all due as individuals and human beings, not just as organizations. And we’ve all probably done something, sometime, where we were seen as looking out for ourselves rather than the team.

The timeframe issue is crucial, because it’s hard to get your team to accomplish things that take time if they think that you, their manager, is acting with a shorter —term horizon.

This is not a matter of morality (like some Animal Farm chant of “long-term good, short-term bad”). It’s OK to be either at different times, but you need to be honest and self-aware about which game you’re playing. Managers need to learn that they rarely fool anyone else about their timeframe, and it’s dangerous to try and fool yourself!

So, putting all this together, there could be four outcomes of how people view you:

1. You’re in it for yourself and want a quick payback for your efforts.
2. You’ll ‘play ball’ as a team player as long as the team is working, but will bail out if it stops working for you.
3. You’re in it for the longer term, but you’re still primarily focused on yourself.
4. You’re both a team player and in it for the long haul.

Which way do your people see you?

Note that these questions don’t necessarily have to have permanent answers. People will come to a judgement about which game you are playing THIS TIME.

In my latest article called “Accountability: Effective Managers Go First” I argued that the best managers work hard to remove the distance between themselves and those they manage. By this phrase, I don’t mean you have to get “buddy, buddy” with those you manage, but, if you DO want them to pull out all the stops on behalf of you team, then those being managed need to feel that the manager is part of the team, not separate from it. Managers and managed need to be “on the same side.” All too often they are not.

If the people you are trying to manage think you’re not on their side, or are only trying to meet short-term goals, you’ll have a lot less ability to influence them. You’ll be able to manage them because they (temporarily) want to keep their job, but its unlikely they are going to put their hearts and minds into your team’s activities. You’ll get today’s sausages made and shipped, but you won’t be going anywhere new as an organization.

So, those are my thoughts. Your reactions, please?

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Wise words

post # 241 — November 16, 2006 — a Managing post

After a speech I gave, Francis Sheridan, whose title is Resource Efficiency Manager at 3 CES/CEOEE, sent in this comment:

“About ten years ago, while still a manager for Washington State, I took a week’s class from a person considered, at the time, maybe the most talented and accomplished person in Washington State governement, Dick Thomas. He’d been Chief of Staff for the Governor, house majority leader, president of Evergreen State College, etc., and a very cool guy to boot. When I took that class, he said two things over and over until I, for one, wanted to kill him—-figuratively, of course. Long after the class ended I finally began to understand the wisdom of these two simple thoughts:

1. Policy is what happens.
2. Peoples’ feelings about the process largely determine their feelings about the outcome of the process.”

If only more managers understood those two lessons!

Policy isn’t goals, visions, missions, values, principles, etc. It’s what happens around here. Manage that!

Don’t just manage the goals, mange the process. Simple!

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