From equity to ESOP: a guide to incentivizing founders

Samuel Hall is the CEO of venture studio Rainmaking APAC.

Through our venture studio, Rainmaking APAC, I have helped build and scale hundreds of startups across the region.

Working with so many founders has helped me to understand and empathize with what matters most in terms of the incentives that drive them – both for the founder and for the success of the startup overall. When we work with corporate partners to launch their own venture studios, we have found that it is critical to port across comparable incentivization models to the corporate venture build context.

Image credit: Timmy Loen

Doing so has proved to be enormously beneficial in how they approach venture creation and founding teams. Here are some of the principles that we apply:

Equity over salaries

Founder compensation should be structured to enable entrepreneurs to obsess about outsized value creation. They need to know that they will share in that if they achieve it.

Founders who prefer equity-based compensation to large salaries are typically the kind who are dedicated to creating long-term value.

In addition, to build high-impact, innovative companies that can deliver outsized value, founders have to take significant risks. Entrepreneurs who are satisfied with eschewing the large salary today in favor of a bigger payoff down the road typically have higher risk appetites.

This is important because to achieve enormous success, a startup must be hugely ambitious and its founders both ready and willing to play in areas of enormous uncertainty. A high-risk appetite is critical.

Another benefit of founders being equity-focused is that without drawing high salaries, they consume less of the startup’s funding. This allows the company to spend more to move faster, as well as reduce the burn rate and extend the runway.

Startups typically operate in unpredictable, uncertain environments, so for a company to have the chance of hitting it big, it needs to remain alive for as long as possible. Having a longer runway is a big help in this regard.

All that said, it should be noted that if your only focus is on equity share, you will miss out on great founders who need a certain baseline in terms of salary. Investors should work with the founders of a startup to determine the right split instead of dictating terms to them. Remember, this should be a partnership.

A marathon, not a sprint

Since no one can predict how a company’s evolutionary and funding journey will turn out, ensuring that the founders hold a significant stake in the venture means they will likely remain committed and motivated even as their holding dilutes down over future funding rounds.

Most VCs and external investors that might invest at a later round will expect the founders to have material equity shares, which indicate that they are deeply incentivized to drive the venture forward to successful value creation and exit.

ESOP war chest