Holistic Compensation [Barry]

Source: Nathan Barry

Stumbling upon Nathan Barry’s piece, which was referenced in one of the various newsletters that I’m subscribed to, was such a pleasant surprise!

Why I changed my mind on team stock options

 Note that I’ve picked a very different title to my own post, because I’m taking his content in a different direction. But first, a bit of context. 

Compensation matters

Compensation in my mind represents a core attribute of the professional collaboration effort that we call work. The fact that we’re not only trying to do something together, but we’re also trying to distribute the benefits of doing so in a fair way adds a massive amount of complexity to the effort. The thought exercise I always like to go through when thinking about large-scale collaboration efforts (aka work) is “would this still be a problem on an open-source project?”. Open-source projects are massive collaboration efforts in which the primary value that contributors expect out of the effort is the work product itself, which in economic speak is “non-rivalrous”: its use by one contributor does not prevent its simultaneous use by another contributor. Revenue, on the other hand, is a perfect example of a rivalrous good: if I take a dollar out of the pile, it’s one less dollar that can be distributed to anyone else. And that makes things, well… complex. 

Which is why I’ve spent several posts writing about it covering aspects such as the foundations of a good compensation philosophy, the implications of pay-for-performance, the tension between internal and external fairness, the varying levels of transparency around comp, the challenges with equity, and several others. The latter in particular is a good jumping off point to Nathan’s post. 

A holistic approach 

Recognizing similar challenges in the use of equity to the ones I (and Henry Ward of Carta) called out, Nathan initially decided to avoid using equity grants altogether in his startup, ConvertKit, and instead implemented a revenue/profit-sharing system, which we’ll dive deeper into in a moment. Nathan’s post, however, covers his decision to supplement the profit-sharing program with some old skool equity grants. His decision was primarily driven by fairness, recognizing that company value appreciates faster than profits and therefore withholding equity grants leaves his team significantly worse off in the long-term. Nathan’s new and holistic approach, beautifully captured in the 2×2 at the top of this post is in my mind the biggest generalizable lesson from his experience: recognizing the fair compensation needs to span to distinct dimensions, the long-term/short-term and the guaranteed/success-based leads to the conclusion that a different compensation instrument is needed in each quadrant. 

I believe this 2×2 is a great blueprint for other organizations as well, with a couple of tweaks, one mechanical and one philosophical. 

The mechanical tweak has to do with venture-backed companies, who tend to not turn a profit for quite some time. Without fully opening pandora’s box on that matter, profit in Nathan’s framework is simply a proxy for the company’s success. So in situations where it’s not a good proxy, a portion of revenues can be allocated proportionally to a more adequate success metric (revenue target, user growth, margin improvement, etc.). 

The more philosophical tweak has to do with “performance-based” which I’ve replaced with “success-based” since performance is also one of the key challenges in my mind, with ConvertKit’s specific profit-sharing implementation. 

Profit-sharing

In its latest iteration ConvertKit’s profit-sharing system works as follows: 

A fixed % of profits is distributed to the team every 6 months (the remainder goes to taxes and reinvested back in the business). 

That pool is distributed across 3 categories: 

  • 52% — Team profit sharing
  • 8% — Leadership bonuses
  • 40% —Ownership distributions

Team profit sharing is further allocated as follows: 

  • 25% (13% of total) is allocated based on tenure: your share = your tenure/sum of all tenures
  • 75% (39% of total) is allocated based on individual 0–4 performance rating: your share = your score/sum of all scores

The payout for new hires who started in the last 6 month is pro-rated to the portion of the period they’ve been with the company (3 months = 50% of your share). 

There are no details on the “ownership distributions” so I won’t engage on that. 

But both the “leadership bonuses” and the performance component of the team-profit sharing don’t sit well with me as I strongly believe that rewarding short-term performance does more harm than good (more on that here and here). Furthermore, I don’t think that “leadership”/execs are special snowflakes that require special treatment more than engineers are. They just have a proportionally higher impact on the success of the business, just like a tech lead will have proportionally more impact than an entry-level engineer, and that needs to be baked into the allocation. This is also where the logic behind the decision to ignore salaries, because “salary is a reflection of your market value and not exactly your value to the company”, breaks. While potentially correct looking cross-functionally, there is proportionality between salary and value to the company within a given function. 

Better aligning the allocation with my own compensation philosophy is pretty straight forward. First, eliminate “leadership bonuses”. Second, replace the performance component with a factor that’s proportional to salary. A more egalitarian alternative would be a factor proportional to level, and somewhere in between is applying role-specific factor (a-la Buffer) on top of the component proportional to salary. Further carve-outs to either company value or personal needs drivers can be done similar to the way tenure is handled. 

In Sum 

ConvertKit’s holistic compensation approach represents an important step-function improvement to the default compensation schemes that are out there, and with a few tweaks to the profit-sharing mechanics can be aligned with everything science tells us about the connections between compensation, fairness, and motivation. 

Holistic Compensation [Barry]

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