The Pitfalls of Deferred Compensation

I have recently been asked if I would "jump-in" to a start-up for 100% "deferred compensation" or equity. My answer was a definitive "NO".

My experience (on both sides of the coin) is what drives my agreements for "jumping in". I have found that unless there is at least minimal salary paid ($2k-$4K month) plus long-term, success-driven compensation (stock, equity, profit sharing, etc.), one or more of the following things WILL happen (usually all of these to some degree):

1. The company will not fully value the energy and investment the individual puts in (particularly before it creates revenue, when all the hardest work happens).

2. The individual will not full value the company and invest their time and energy fully (driving the company to revenue as rapidly as possible). This is inevitable and can kill a company (I don't care how motivated either is).

3. The company will probably lose a key individual at a critical moment because they got a great offer from a later stage company that brings their personal finance to a high cash flow positive (instead of cash flow negative). As a result, the company could lose the contract (or investor).

4. The company founder gets tired and folds. The partner/employee is left with nothing.

You could get lucky and find someone with great personal resources that will work for deferred salary/equity. In fact, it happens often. See number 2 again. It will happen. Let's say I have $7 million in the bank, but I like work, so I get involved with you. Then my daughter gets married. And I invest in an exotic resort in the Caribbean that I like to visit. I buy a new boat to play with. My energy involvement in the company slows; the company's growth slows. You may find a capable executive that has a reserve of cash or a severance agreement. See number 3. The chance of one of these two being the case is about 90%.

A minimum salary creates commitment and loyalty between the company its contributors that an equity stake just can't create. I have seen this happen both ways time and again.

I've been the start up guy with "my" company. On the part of the company, we want to take the smallest risk possible. We want our employees to take that risk with us, though they will not reap nearly the reward we will when success is reached. (Their ROI is not as high for the risk) In doing so, we create more risk around our success. With limited resources this seems necessary, but there are often ways to create a little cash flow to create this commitment. The key is to make the commitment in the right areas first.

A better path for business/corporate development is to allocate a small salary for that individual to pay their household bills (hence creating loyalty). Compliment this with significant bonuses associated with sales/investment milestones. Then ice the cake with a long-term vesting equity stake. This would interest me, and I could bring some a great wealth of experience and talent to bear on both business development and corporate development.

I am so clear on this that I won't get involved any other way. This may be tough for a founder to hear, but any talent looking for a great opportunity will probably say the same.

If the time to grow your business is right now, you may also look to your board of directors for help. At this stage, you should have picked board members that can provide limited resources part time, but can commit to a number of years. This is significant talent. These people will be contributors of one or more primary pieces of success. They will be strategic partners, possible clients, or experts. They will bring resources to the table. Standard practice for board members of a start-up is to compensate these board members with vesting equity. However, if you need someone to hit the phones, visit clients, or create documentation- you will need to hire.

Entrepreneurs are brave and courageous. They deserve respect and loyalty. But they must also grant this to those that help them realize their dreams. Properly executed this will pay dividends to the success of the business over the years.

The 2nd Component of Entrepreneurial Manifestation: Time

In the first article on this site, I wrote "Energy can be defined as four things in this case (and in most cases): time, money, action, and commitment.... A successful entrepreneurial enterprise needs high levels of all four components. With these investments- and a decent idea- any business can be Manifested."

Let's talk about time. Time is the one thing that is finite. We can't make more of it. We can make more time available by a variety of time a management methods or simply by paying others to do things for you, hence "freeing" your time. We can not, however, add more time to the overall pool. Time is perhaps the only real direct, flexible expense.

The hard truth in entrepreneurship is also that you may not be able to pay someone else to do what you do. Someone with your expertise may be exceedingly difficult to find. Once you find that person, they may not be able to make the logical leaps you have to get to the right ideas. Or keep those idea secret may be part of your intellectual property. Once you solve all those problems, you could find that another person simply does not fit well in the scenario- they are the wrong person for that "seat on the bus".

Entrepreneurship will take time, and a ton of it. To best ensure the success of the venture, key personnel must be able to commit to the venture full-time. They must clear their time of other things to create as much "free time" as possible. This free time is then "occupied" by the new venture. This takes on a number of strategic advantages. First, the key personnel will not be distracted by other things. This is very important to maximize productivity within the chronological parameters. Second, you will be able to commit the most actual production time within a set quantity of hours. In other words, you will get the most work out of the most time by your key personnel. This moves the venture along as quickly as possible, which is often critical to its success. We will talk more about this when we talk about "action" in the next article.

A talk about investing time energy would not be complete without a discussion of money. Time inevitably costs money. If key personnel are worried about how their mortgage is going to be paid, they can not maximize productivity. And they must be rewarded for their innovation. Reward can be delayed with stock options, and even some salaries can be deferred, but an understanding of compensation must be agreed upon early to ensure that time can be absolutely focused on success.

The 1st Component of Entrepreneurial Manifestation: Comittment

In the first article on this site, I wrote "Energy can be defined as four things in this case (and in most cases): time, money, action, and commitment.... A successful entrepreneurial enterprise needs high levels of all four components. With these investments- and a decent idea- any business can be Manifested."

The first and most important of these is Commitment. Commitment is the basis upon which the other three components can grow and flourish. Commitment is the driving force. And entrepreneurship needs a driving force, for it is a path full of obstacles, hurdles, challenges, doubts, nay-sayers, and do-nothings. It is only with commitment that time, action, and money can maintain momentum in the face of these fantastic foes.

Commitment can be defined very simply as consistent and imperturbable motivation to achieve a defined outcome. This is best identified in the face of adversity, but it can also be equally recognized in the face of prosperity. As individuals, we are equally likely to "slack off" during good times, as we are to be disheartened during bad. Commitment never wavers from the defined outcome, even in the midst of extraordinary middle success. And need it be said that they exhibit the same steadfast character in the face of failure?

Consistent: firm, coherent; steadfast
Imperturbable: not easily excited or upset; marked by extreme calm and composure
Achieve: obtain, attain; perform, accomplish; succeed.
Define: explain, clarify; limit, set boundaries.
Outcome: consequence, effect, result, event, materialization

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Manifestation and the Entrepreneur

So often, entrepreneurs have the wrong results at the forefront of their mind. They are focused on the wrong things. There is a reason, but before we talk about results, let's talk about focus. Most of us by now have seen The Secret or heard the cliff notes on it. Very simply the Secret talks about Manifestation, which I may talk about often here as well. What the Secret teaches is nothing new. I can cite countless texts back to the beginning of time that talk about it. It is simple, what you focus your energy on, you Manifest into reality. So it is with entrepreneurship. The aspect of your business that you focus on is the part that is most successful.

Let me clarify a point about Manifestation. Manifestation is the investment of energy to create an outcome. This energy must talk more than one form. It must take all forms in order for the outcome to be achieved. Let's take the lottery example that most people use to dispute the Secret. The argument is that just by thinking about winning the lottery, I will not win it. No, that's true. You have not invested much energy into it. You focused your thoughts on it, for 15 minutes. But did you buy a ticket? Did you buy ten tickets? Did you buy 10,000 tickets? What is the level of your energetic investment? Buying 1 million tickets would surely increase the chances of winning the lottery significantly, would it not? Ah, I see. You wanted to get a huge return on a very small investment. Manifestation does not work that way. Sorry.

Entrepreneurship does not work that way either. Entrepreneurship requires a huge investment of energy. Energy can be defined as four things in this case (and in most cases): time, money, action, and commitment. Sometimes more of one will compensate for less of another, but to best guarantee success, all must be present, in abundance. This often means a partnership. Those with abundant money can not always invest time and action. Those with available time and action may not be able to invest money. Those that are capable of action, through experience and education, do not always have the time or money. And so on. A successful entrepreneurial enterprise needs high levels of all four components. With these investments- and a decent idea- any business can be Manifested. The abundance of those investment determines the level of manifestation.

Future blogs will discuss the four components of Manifestation in more depth. We will also discuss investing in the right results, outcomes, and ideas. These ideas will focus on the creation and growth of business, but I also hope that my few readers can see the application of these principals to their personal lives. For how your business is a reflection and hence, a manifestation, of your person. Initially, this blog will be about the philosophy of entrepreneurship, however, I will try to include some valuable resources and systems to help you on your way. However, the philosphy of entrepreneurship is the cornerstone of successful ventures, and most often missing entirely from the equation.