Building companies: Incentives from first principles

Building companies: Incentives from first principles
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If you have a product or service and you're starting to build the organization that will support its growth, you've probably wondered how you should compensate the people working in it. This is what this post is about.

Don't expect specific OTE breakdowns, templates, or buzzwords; there are plenty online. Here I discuss the basic principles I've seen work when incentivizing people to do their best work and hit their goals as you build (and they help you build) an organization.

I've tried to stay on the topic of incentives, but you'll see I talk a lot about goal setting as well. Goals deserve their own post, but it's hard to discuss incentive alignment without mentioning the goals behind them.

1. You need goals.

You'd be surprised by the amount of companies that create incentive plans without actually setting goals behind them first. The reality is that without goals, incentive plans are prone to be misguided and misaligned with the rest of the company's needs. So heed my advice and learn from my mistakes: you need goals first. And the more specific and reasonable those goals are, the better. They will guide the way you actually plan incentives. Think about it from first principles: incentives are a way to compensate people for fulfilling the goals of an organization. It doesn't really get more simple than that.

Again, as I mentioned before, I'll talk about goals in a separate post because they deserve their own book. The key to creating amazing goal structures is to think about the most important metrics that make your company default alive – and if you're already default alive, congratulations –, increase revenue, reduce costs, and create long-term value.

2. Align incentives directly to company goals (and make those goals span all teams)

Well, we've covered the fact that incentive plans without goals are very difficult to guide and fulfill. Now let's talk about how to create those goals. In my opinion, the best goal structures are structures that are shared across entire companies. The art of creating team-specific goal structures is very nuanced and has to be done carefully to avoid misaligning different teams.

If you are running a mature organization with hundreds to thousands of employees, by any means, go ahead and create team-specific goals. You will need them, they're necessary. It is very, very difficult to run a big organization just on company-wide goals. However, if you are a small to medium-sized company, still probably in the hundreds of people, you need to base everything you do on dead-simple, easy to explain, easy to remember, goals.

The best company-wide goal structures are centered around revenue, customer satisfaction, and long-term value. Those goals need to be simple, easy to explain, attainable, and easy to measure.

Run the following experiment: create a goal structure, present it to your team, and three months later, ask a random member of your team to, off the cuff, say what the goals are for the year. If they don't remember, then you're making one of two mistakes. You are either making your goals too complicated, or you're making them not relatable enough to your team.

The other clear advantage of having teams share goals across the entire company is that you're never going to run into fiefdoms. Fiefdoms and small areas of privilege and power are created by small teams creating their own little goals in isolation. Forcing teams to share goals means they need to sit at the table and work together to understand how each of them can help fulfill that goal. It means everyone is bought in. It also means everyone is rallying towards the same objective.

The typical joke of sales, product, and engineering being at odds with each other is not uncommon. The only reason why this happens is because each of these teams is incentivized differently from one another and probably has different goals altogether. If you are running into this particular example, it probably means that you're incentivizing sales to push a product that is not ready yet, or that product and engineering cannot build fast enough.

Destroy misalignments by forcing people to sit at the table and work together. Destroy fiefdoms by aligning them with the same goals, even if you incentivize them slightly differently, and have them rally against the same objective. Make salespeople product experts and product and engineering people sales experts.

3. Beware of incentives based on proxy metrics: revenue is king

A lot of companies that generate revenue based on transactional value are tempted to measure their success against proxy metrics of their own choosing. Those proxy metrics are very different depending on the type of industry, but if you have worked or work currently on SaaS, marketplaces, or fintech, I'm sure you're familiar with them. You have probably seen things like gross market value, daily active users, number of users, and average session duration.

These metrics, these proxy metrics inevitably are a promise to stakeholders and investors that you will be able to convert them to revenue. However, you don't make money based on premises.

Proxy metrics are fine when you're starting out. They are a way to educate investors and other stakeholders about how you're not making much money right now and promise you will be able to convert, at some ratio, part of those metrics into revenue.

The problem with aligning incentive plans to proxy metrics is that generally incentive plans are paid in cash and proxy metrics are not cash. You may end up in a position where you're paying enormous amounts of money to your team for metrics that are actually not driving the success of the company. That's called burning money.

Generally, I recommend basing cash incentive plans on real actual revenue and when I mean real actual revenue I mean closed finalized, and paid revenue.

4. Invest in long-term value through equity

One common mistake I've seen made in sales organizations is to focus too much on cash incentives and not enough on the company's equity.

Think about it from first principles. You want this salesperson to think about not just the immediate revenue of the company, but long-term value as well. Incentivize them only with cash, and they'll focus only on making a quick buck for the company, even if it's at the expense of forcing other areas of the company to be under pressure. Incentivize them handsomely with equity, and they will, on top of generating revenue, think also about how to select the best customers and become experts to make the entire company better. Make every single person in your company an owner of that company.

5. Fulfill personal goals

Not everything is money, and a lot of what we do professionally is thinking about the long-term plan. For a lot of people, that long-term professional plan means advancing in their careers and learning new skills. Make sure that you provide the right management structure for people to feel like they're fulfilling their own personal/professional goals in a meaningful amount of time. Make sure that there are clear career ladders in your company so that you can grow people, not just hire people.

Let me insist on it one more time, the best way to ensure that you fulfill your people's career goals is to foster a company culture of growing and nurturing skill sets and professional value within your company. If you're in doubt, always grow people, not just hire people.

6. Set people up for success

Okay, so now you have a set of goals for your company, perhaps smaller goals for your team if you're mature enough. You also have an amazing incentive plan. You're ready to go. One important thing that a lot of people miss: you need to make sure that your team can fulfill those goals and they're set up for success to actually squeeze their incentive plan. You actually want to be in a position where you're paying out their full incentive plan plus extras, plus bonus, plus everything.

The best way to set people up for success is for them to have the resources they need. Make sure that your product and engineering teams have the toolset and the management structure that they need to just focus on thinking critically and build their best work. Make sure that your sales team has an amazing sales tool set with the best software, great sales enablement, and an amazing pipeline with clearly defined targets and target markets that they can actually attain.

7. Extra: Viral cultures and people actually wanting to do their best work

Finally, let's talk about company culture. The reality is that all the money in the world is not going to make someone do better work or faster work. You want to be in a place where your team members wake up in the morning actually wanting to do really, really good work.

Create a company culture where you are doing everything we discussed above. Create a company culture where people wake up in the morning and they completely understand the goals of the company. Everyone has the same goals across the entire organization. They understand exactly how their incentive plan is aligned with those goals, and they have a vested interest in the long-term value of the company. And finally, most importantly, make sure to understand that these team members are real people with real personal goals. Create a structure in your company that ensures these people are in it for the long run, that they see a career ladder, and that they see a way to learn new skills and advance.

If you have managers already, congratulations, make sure that they are bought into this company culture in a way that it becomes viral and they are stewards of this culture itself.

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