The Shifting Incentives of Startups
By Michael Burke
Mr. H asked a few startup CEOs to give his readers an “inside baseball view into a world that a lot of us will never see as employees” — the world of starting and running a startup company. In this post, I’ll try to honor the spirit of that request by describing how incentives in an early-stage startup create an environment that is simultaneously thrilling, rewarding, and terrifying. We’ll then discuss the challenge of maintaining a startup’s culture while these incentives change.
I’ll start first with a sweeping generalization:
An early-stage startup company’s incentives are more purely aligned with their customers’ incentives than any other size, stage, or structure of business.
Think about it. At this stage, it really doesn’t matter whether the founders want to build a great company, make the world a better place, or make a big pile of cash. They can’t do any of these things if they don’t focus exclusively on the success of their early customers. This singular focus is a luxury not afforded to companies of other stages. These purely aligned incentives create an environment of productivity and creativity like no other.
Does this alignment of incentives guarantee success? Absolutely not. I’ve noted in an earlier article that the odds of success for a startup are low. There are a million things that can go wrong. The alignment of incentives does, however, mitigate the risks to some degree.
Now I know that most companies of various stages consider their customers important and would assume on the surface that their interests are aligned with those of their customers. But until they’ve pledged their house and savings to guarantee a loan for working capital, they don’t know what a real incentive feels like. That’s the terrifying part.
Shifting Incentives and OPM
Incentives often change as a startup grows. The really great companies find a way to maintain the positive elements of their culture during these periods of change. It’s not easy to do.
There’s a phenomenon in the startup world that is repeated time and time again. A scrappy startup that was efficient with the little bit of capital it had gets a big chunk of money from a VC. Then they start to suffer from OPM (Other People’s Money) syndrome. They start to think that they really need those golf bags emblazoned with the company logo. They over-hire. They move away from making small, responsible bets to Vegas-style gambles. It’s not entirely their fault. Their incentives have shifted.
Because of their new outside investors (who may now have a controlling interest but almost certainly have preferential exit terms), they now have to hit a grand slam. The fund needs to generate a 10X return in 3-5 years. A base hit, double, or triple might cover the VC’s vig, but it won’t put any money in the founders’ pockets.
In order to generate this sort of return, companies are strongly incented to focus exclusively on short-term revenue growth and ignore long-term investments in people, product, and process. In a parallel universe, big public corporations often find that their incentives diverge with those of their customers when it comes to the obsession with quarterly earnings, sometimes at the expense of similarly necessary investments in people, product, or process.
Some companies manage to maintain their focus and keep their culture intact through these and other changes. As a result, they often deliver exceptional value to their customers.
Freedom and Responsibility
Most successful startups are usually characterized by a culture with freedom and responsibility at its foundation. The freedom isn’t just a cultural choice; it’s a requirement. Top-down management structures just don’t work in a startup. The glacial speed of command and control environments is absent the requisite flexibility, productivity, and creativity. Distributed, self-organizing environments are required in the early stages to learn quickly, fail quickly, and adapt quickly.
Responsibility is the opposite side of the freedom coin in a startup. It makes the selection of the startup team absolutely critical. Folks who are attracted to working in an early-stage startup seem energized by this environment of responsibility. There’s just no place to hide in a startup, and nearly every decision is important. You need folks who are willing to act and to take responsibility for their actions.
In the early days, this culture of freedom and responsibility often emerges organically as a byproduct of the nature of the work and the requirements placed on the team. As a company grows, however, it needs to be much more intentional if it wants to keep the magic going. When we were a few founders in a room, we didn’t have to worry about vacation policy. No one planned to go anywhere until the work was done anyway. Now, when we hire a new employee, we need to have an intelligent answer to the question. So our answer is: take whatever time you want. We care about results, not about punching the clock.
One of the really great things about a startup is that you get to collectively define a culture with a relatively small group of folks. That’s a very exciting and fulfilling process. Contrary to popular belief, this definition of culture doesn’t come from the top down. Don’t get me wrong — a founder/CEO can single-handedly screw up a company’s culture, but the CEO can’t define it unilaterally. A founder/CEO can be a part of the process of a company’s emerging culture, but only a part. In my view, the most influential part a CEO can play in the intentional cultivation of culture is in hiring decisions. Secondarily, a CEO can make sure the policies of the company appropriately support the required culture of freedom and responsibility. Policies are fine, but in a startup, it matters much more what you do than what you say.
The bottom line is that startups can’t focus on the finish line if they want to be successful. They have to find a way to set aside the numerous distractions and shifting incentives of fund raises and exit strategies and simply focus on building a great company that delivers great value to customers. Protecting their company’s culture is a big part of this. If they can maintain this focus, they increase their odds of long-term success dramatically.
Michael Burke is an Atlanta-based healthcare technology entrepreneur. He previously founded Dialog Medical and formed Lightshed Health (which offers Clockwise.MD) in September 2012.