The Hidden Benefits (and Costs) of Compensation Levers for Innovation Teams (Part 2 of 3)

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One of the biggest perceived barriers to corporations innovating at the speed of startups is compensation. Entrepreneurs have the promise of a highly profitable exit to motivate them, whereas Corporate Explorers and their innovation teams can hope for no more than a good annual bonus.

In Part 1 of the series, we discussed the importance of compensation and how to link compensation to your team’s objectives and structure. Here in Part 2, we’ll deep dive on the different compensation levers–exploring the pros and cons of how each may have intended and unintended consequences.

As covered in Part 1, the connection of your growth strategy and objectives to your compensation it vitally important. More specifically, it is useful to think of the desired behaviors you would like to see your team exhibit and aligning compensation levers that promote those behaviors (or disincentivize undesired behaviors).

Conversely and not surprisingly, there are unintended consequences that exist with compensation levers. For example, if you operate a venture studio where Entrepreneurs-in-Residence (EIRs) are compensated based on equity alone, an unintended consequence is that they may not collaborate to help an overall strategy succeed. Their goal is to increase the valuation of their own venture, even if that’s not in the interests of their corporate investors.
So, although mimicking startup incentives makes sense on the surface, in practice, it could frustrate achieving the long-term goal. That’s why compensation design needs careful attention.
There are three major groups of compensation lever to play with: fixed, variable, and non-cash.

Fixed Compensation

The usual major components of fixed compensation are salary and benefits. This is usually tied to a standard market rate based on talent and industry. For venture studios, innovation units, or accelerators, this usually is a given and does not provide too much differentiation. Ultra-high salaries have other consequences I’ll cover later.

Variable Compensation (short-mid term, cash based)

Variable compensation is where compensation levers start to become more interesting. I define ‘variable compensation’ as paying out in cash within 0-18 months. There are several variants.

  • Performance bonus: Like fixed compensation, this is familiar for most corporate workers. An annual performance bonus is tied to completion of key objectives for individual, group, or organization. Usually, this is in the 10-30% range of the base salary for non-executives. This is typically the lever used most by corporates to drive key behaviors within traditional business units.
  • One-time bonus: Ad-hoc bonus programs are becoming more popular as recognition for employees showcasing the intended values or behaviors resulting in a positive impact on the organization. This lever is commonly used when a team member outperforms on a project or steps up above their responsibilities on the team. Usually this is in the $1,000-$15,000 range and reserved for non-executives.
  • Revenue sharing: Most organizations pay a revenue share but use the term ‘sales commission’ instead. For new venture teams, offering a small portion of revenue share is useful to drive aligned focus on revenue growth. The primary caution would be to attach a profitability hurdle for that revenue to ensure deep discounts are not being applied.

Non-cash Compensation

Many organizations use non-cash compensation to provide a long-term incentive. The intention is to motivate executives and team members to be invested in the future success of the company. While there are many varieties of non-cash compensation, below are three that are most used for venture studios and innovation labs:

  • RSUs (Registered Stock Units): This is a stock offering to employees of the parent company’s public stock. Usual terms are 3-4 years with a 1-year vesting cliff with monthly or quarterly vesting after the first year. RSUs are excellent for retention and long-term motivation, but often have challenges with motivation for venture studio or innovation teams.
  • Venture Equity: Offering a percentage or stock options in a venture can be extremely effective in tying the success of the organization to each individual’s long-term success. Like RSUs, venture equity is usually vested in a similar manner. This lever is useful for venture teams but does carry the risk of silo’ing ventures and venture teams from each other. In addition, the ventures usually need to be spun off to realize the value of the equity.
  • Phantom Equity: Phantom equity is the promise of the equivalent of shares in a venture without the actual issuance of the shares. This is usually useful for ventures that are not intended to spin out, but rather spin back into the organization. The challenge with this is the exit valuation – what is the fair value of a venture that is spun into the business unit and who calculates that?

Assessing Compensation Levers

Now that we understand the compensation levers a bit more, we’ll focus on what to think about when building a compensation strategy. Remember, your strategy should be a combination of short-, mid-, and long-term compensation levers that are easy to understand AND align to your team’s objectives.

The below chart provides pros and cons of each compensation lever along with intended and unintended behaviors. The intended and unintended behaviors should be carefully considered when building your compensation strategy. Navigating around the pitfalls of unintended behaviors are as important as selecting the right intended behaviors.

Compensation LeverPros / Intended behaviorCons / Unintended behavior
Salary– Provide stable, consistent market rate pay– Not usually attractive unless extremely over market rate.
– Does not motivate to generate rapid growth
Performance Bonus– Ties directly to team objectives – Motivates team to outperform key objectives– Usually is a blend with the larger organization
– Incentivizes short-term wins over long-term value
Onetime bonus– Directly reinforces behavior from top talent– Ambiguous and subjective issuance dependent on the executive
– Promotes individualism
Revenue share-Ties midterm individual earnings directly to the growth of the organization (unlimited upside)
– Promotes teamwork
– Creates potential for short term focus over long term growth (revenue vs profitability)
RSUs– Provides a moderate upside to employees over a long period
– Promotes long term thinking
– Incentivizes tenure, not performance
– Tied back to parent organization, not the venture unit
Equity– Ties long term individual earnings directly to the growth of the organization (unlimited upside)
– Promotes team work
– Creates venture silo’ing
– Promotes valuation growth, not venture growth
Phantom equity– Provides opportunity to participate in the ‘upside’ of a venture
– Clean documentation for the parent company – Promotes commitment on increasing the value of the venture
– Unclear on how and when a liquidation event may occur
– Limited legal ability to control the valuation procedure
– May appear ‘too good to be true’”

Designing compensation

There are lots of options to consider. Which is the right one and how do you avoid some of these traps? I talked about linking compensation to objectives in Part 1, now in Part 2, I reviewed the different compensation levers and what to consider when selecting each for your compensation strategy.In the last part, I’ll bring together building a strategy discussing which levers work best for which types of structures (e.g., venture studio vs. innovation lab vs. accelerator). We’ll provide examples of teams that have successfully (and unsuccessfully) deployed compensation strategies.