Compensation in early-stage teams

TL;DR

According to Research from the Standish Group, 40% of startups fail due to lack of funding and the impossibility of keeping their teams. 30% of funded projects will get canceled prior to completion due to misalignments in the team, and lack of motivation.

Over the past three months, I conducted research on the topic of compensation, talking to DAO contributors, core teams, startup founders and thought leaders in the DAO space.

The problem I explore in this paper is how compensation, co-ownership, and collaboration influence worker motivation and team harmony. I also explore how compensation beyond money, and motivation beyond extrinsic factors (vs intrinsic, which I will later define) play critical roles in the success of the team.

Furthermore, I aim to outline the characteristics of a compensation model that balances all the stakeholders in the project to ensure its longevity and sustainability. This includes a focus on maximizing runway, which is essential for early-stage startups. The longer an organization can operate before running out of capital, the better its chance of building a sustainable income stream. It is also critical that all contributors feel fairly compensated for their work, or they lose motivation and leave the project which jeopardizes its success.

In order to do this, I investigated the different types of contributors and stakeholders in a project, exploring their different needs and motivations. The financial stability and commitment of contributors vary based on their individual circumstances. For this reason, I specify what contributor inputs need to be taken into consideration for a sustainable compensation model.

I also explore the correlation between the motivation and the commitment of the contributors, as well as the role of transparency in compensation and how it affects fairness.

Finally, I provide recommendations for better compensation structures, which include:

• leveraging transparency in compensation for fostering trust and equality
• harnessing collective intelligence through peer-to-peer assessment
• implementing a Minimum Viable Salary for meeting contributors' needs
• embracing co-ownership to align incentives
• leveraging Web3 technology for enhanced trust and fairness

Introduction: The problem statement as I see it today

The problem statement as of today is as follows:

I am a founder of an initiative/company/campaign
I am trying to form a strong team to build our project
But I can’t reward the contributors fairly
Because I can’t measure the value created
Which makes me feel blocked.

Early-stage projects have the challenge of motivating and rewarding contributors, especially if the project is running on a limited budget. The founders struggle to find an appropriate way to compensate the teams fairly as they don’t have the resources to give competitive salaries. At the same time, in order for an early-stage project to become sustainable, the project needs a committed and motivated team. The contributors need to be confident that even with limited capital, they will be rewarded fairly.

Understanding the problem

Why is this problem important?

I’ve been actively contributing to a handful of communities and early-stage projects with little to no investment or revenue. The challenge I see all of these projects facing is how to engage and maintain a committed team to build an MVP (Minimum Viable Product) so that the project can become profitable. According to CB Insights, the top reason for failure, cited by 23% of founders, was "not having the right team". A Harvard Business School study found that 65% to 75% of startups fail due to problems with team dynamics, rather than issues with the product or market. For these reasons, many investors prioritize the quality of the founding team when making investment decisions. A survey by TechCrunch found that only 42% of investors consider team strength the most important factor when evaluating startup pitches.

The paper explores the problem of compensation in early-stage teams, as a foundation of a highly motivated and committed team, with mission, values and goal alignment, as well as building a culture of collaboration, respect, and appreciation in a flexible and accessible way.

What you should know?

1. Motivation

Intrinsic motivation refers to the internal drive or desire to engage in an activity for its own sake, deriving satisfaction and enjoyment directly from the activity itself. On the other hand, extrinsic motivation involves engaging in an activity as a means to an end, driven by external rewards or consequences such as money, praise, or avoiding punishment.

Understanding the distinction between intrinsic and extrinsic motivation is crucial in an early-stage team for several reasons. Firstly, it helps leaders design effective reward systems and incentives that align with the team members' motivations, fostering productivity and engagement. Secondly, it enables leaders to cultivate a positive work culture that nurtures intrinsic motivation, leading to higher levels of creativity, innovation, and job satisfaction among team members. Lastly, recognizing the balance between intrinsic and extrinsic motivations allows for a more holistic approach to talent management and employee development, ensuring that the team's diverse needs and preferences are adequately addressed.

In his book "Drive," Dan Pink demonstrates that as work becomes more intricate and reliant on creativity, traditional extrinsic motivations, such as financial rewards or punishments, become less effective in driving performance and satisfaction. Pink argues that autonomy, mastery, and purpose have a greater impact on motivating individuals for cognitively engaging tasks. He suggests that while extrinsic rewards may initially incentivize simple, mechanical tasks, they can actually hinder performance and innovation in more complex, creative endeavors. Pink's research underscores the importance of intrinsic motivators in fostering meaningful engagement and productivity, particularly in domains where creativity and complexity are paramount.

Aspects of intrinsic motivation

To motivate employees who work beyond basic tasks, Pink believes that supporting employees in the following areas will result in increased performance and satisfaction:

1. Autonomy - the urge to direct our own lives; In the context of a project/work, having a sufficient level of independence and feeling acknowledged.
2. Mastery - the desire to get better at something that matters; in the context of a project/work, have the space to develop new skills, opportunities to change roles, and improve  every day.
3. Purpose - to do what we do in the service of something larger than ourselves; in the context of a project/work, to be value-aligned and truly believe in the mission of the project.

Pink’s book is based on the Self-Determination theory that defines the basic psychological needs of any human. They are autonomy, competence, and relatedness. While autonomy is the same as Pink’s, mastery largely covers competence, the relatedness is not fully covered. It is, however, crucial for team dynamics and harmony, especially in the more and more decentralized world. Relatedness is defined as the will to interact with, be connected to, and experience caring for others. Simply put - it’s a sense of belonging. An essential element of the theory is that optimal development and actions are inherent in humans but they do not happen automatically. The fulfillment or dissatisfaction of relatedness either promotes necessary psychological functioning or undermines developmental growth through deprivation.

It is important to see what  the incentive mechanisms that satisfy both extrinsic and intrinsic motivations are. The diagram below shows that the overlap between intrinsic and extrinsic motivation are recognition and appreciation, ownership (can be done via equity, revenue sharing, governance tokens, etc) and training and growth within the organization. Those are crucial to any compensation package and company culture, for better team harmony.

A 2013 study conducted by researchers from MIT's Sloan School of Management found that equity can be a powerful tool for attracting and retaining employees in a startup.

The study, titled "Equity vesting and investment", analyzed data from more than 4,000 companies and found that when employees are offered vested equity (stock that they receive gradually over time), they tend to stay with the company longer and show increased productivity. It found that startups that offered employees equity saw a 4-5% increase in company value.

2. Assessment and Evaluation

An integral part of compensation involves how organizations retrospectively assess the value brought by individuals to distribute bonuses, salaries, or raises. Conversations with founders often highlight challenges such as competitive cultures and mistrust. This is why many traditional tech companies opt for transparent compensation structures with formulas, aiming to eliminate potential unfairness and subjectivity. In the Web3 landscape, characterized by a decentralized culture, numerous projects utilize peer-to-peer assessment to distribute bonuses among their teams. This approach empowers the entire team to collectively measure value, sharing the responsibility and power, thereby fostering a more equitable environment.

Aspects of Compensation

1. Commitment & Motivations

Understanding the different actors and their needs and desires is crucial to grasping the overall picture of the problem.

It’s important to acknowledge that not all contributors in a project have the same level of dedication and needs. Talking to over 15 starting projects, it was evident that the first contributors are financially stable people with high seniority levels, who want to contribute from a place of deep belief in both the founders and the project.

On the other side of the spectrum, we have bounty hunters, who want to do task-based work, paid immediately in cash. Those people might evolve into committed contributors with time.

There is a direct correlation between the motivation and the commitment of the contributors. The more committed they are, the more intrinsically motivated they are.

As the image below suggests, we can see commitment levels increasing with increasing motivation and vice versa.

2. Needs & Financial Stability

Interviewing active contributors in the DAO space, one thing that I noticed is that people tend to get involved by contributing for at least 6 months without compensation. Noting that there’s definitely a learning curve and building reputation takes time, in order to grow the DAO space there’s a need for solidarity when onboarding new members. Most people can’t afford to work for 6 months for free. This conversation is often described with the metaphor of the Missionaries and Mercenaries. While we can see that as bounty hunters (“mercenaries” with high extrinsic motivation) vs core team members (“missionaries” with low extrinsic motivation), it extends beyond this.

One of the contributors I interviewed confirmed that a large part of the reason why they contribute to their DAO is because they managed to secure monetary compensation- and they needed it, considering they’ve been contributing for free for over 9 months.

It’s important for the compensation model to acknowledge that ensuring each individual has their base needs covered is essential for fostering creativity and that this monetary compensation depends on their location, personal obligations, and wealth.

Map of the Space

Personas

Three different personas are impacted by this problem - founder, core contributors and bounty hunters.

In this paper the focus is on Alice (founder) and Bob (core contributor), however, it is crucial to point out that bounties are extremely effective in talent acquisition and onboarding of new core contributors, especially in Web3.

How do people do it now?

The common practice to incentivize contributors in an early-stage team with no sufficient funding is through vested equity. From talking to founders in this situation, I found a few pain points:

1. Legal fees and admin: The first problem is that this requires the project to have all the legal structures already in place, before they can involve contributors. And even if this is done, this solution requires a lot of bureaucracy, to set up equity allocation pools, vesting schedules, etc. Each adjustment to equity grants requires legal action. This can also be a very expensive and time-consuming process.
2. Rewarding future potential, not current input: Whether it's through set formulas or negotiation, equity distribution focuses on what someone could bring to the table in the future, rather than what they're doing right now.
3. Rigidity: In early projects, it's important to stay flexible. Giving out equity suggests a long-term commitment, but setting up stock options for short-term work can be too much of a hassle.

The next level of that problem is how organizations define compensation packages. The most common ways of compensation are the following:

1. Salary based on Negotiation

The most common way of coming up with a compensation package is through negotiation between the contributor and the managers/founders. The organization's willingness to reward them depends on the negotiation skill and confidence of the contributor, as well as urgency.

In many cases,  we can also see issues such as inequality arising, as compensation is affected by gender, nationality, race, etc., which can  open the doors for unfairness which, ultimately,  leads to team conflict and misalignment.

2. Salary based on Formula

Teams that embrace a transparent compensation model, do that using a formula, where the parameters are:

1. hours committed
2. location
3. market rate
4. experience and seniority
5. equity

In many cases in the past years, projects (for example: BetterUp, Bridgewater Associates) that use formulas for their compensation model, do that using a publicly known formula. This gives a sense of fairness, because the same formula applies to all contributors, and it’s shown to improve team harmony.

The still unresolved problem with formula-based compensation is that it comes top-down, leaving little space for contributors to give their input. Secondly, the formulae have missing parameters - team alignment, peers appreciation and the invisible value brought to the team, that usually can’t even be properly pinpointed by the team members.

3. Bounty Systems

In the context of DAOs, there’s a mindset of compensating specific contributions via bounty systems or grant proposals. Bounty systems are built for short-term relationships in a risk-free environment. These contributions are crucial for onboarding new members to the DAO, as it is expected for newcomers to be extrinsically motivated, not very committed, and looking for risk-free interactions.

4. Slicing Pie (Grunt Fund)

Slicing Pie is a universal, one-size-fits-all model that creates a fair equity split in an early-stage, bootstrapped startup company. All, monetary and not, contributions are added to the Slicing Pie Software, and the equity split is then recalculated, which provides a dynamic equity split.

5. Distributing Rewards using Peer-To-Peer Assessment

There are different solutions for peer-to-peer assessment.

1. Praise

Praise is the token of appreciation. Its best use is for individual encouragement and community building. Community members interact with a Discord Praise bot to acknowledge each other's contributions. This bottom-up approach to value recognition keeps the community engaged and invested.

      2. Coordinape

Coordinape is a system that provides peer-to-peer assessment for measuring the value brought by contributors in DAOs. Contributors allocate GIVE to each other based on the value they see being created. The simple premise is that if you ask everyone in the community who is doing good work, their collective answers will give a better sense of where the value is and who should be rewarded.

Diagram

Below is a diagram illustrating various approaches to defining compensation. The red boxes highlight problems along with potential solutions. For a more detailed exploration of the diagram, please refer to the accompanying article and video walkthrough.

Seeing the Market

The market potential here is significant, especially for early-stage companies across different sectors. The Total Addressable Market (TAM) for these projects is substantial, estimated at $13.8 billion.

Recent data from GetApp shows that there are about 150 million startups worldwide. On average, these startups spend around $460 monthly on software tools to boost productivity, covering areas like project management, collaboration, communication, and time tracking. Roughly 20% of this spending is on tools for time tracking, management, and collaboration—areas where a Compensation System could bring notable improvements.

Focusing on the Serviceable Available Market (SAM), we zoom in on distributed startups, a sizable and increasingly relevant segment in today's business world.

In the initial two years, the solution targets the Web3 space. As of January 2024, data from Crunchbase indicates around 23,155 Web3 startups. With their cultural alignment and familiarity with tokenized systems, these projects are ideal for the initial deployment phase.

Estimating the Serviceable Obtainable Market (SOM) based on these figures suggests a potential market value of approximately $2.13 million, marking the first step toward broader adoption.

During this phase of onboarding Web3 startups, emphasis will also be placed on ensuring a user-friendly experience, usability, and feature completeness, preparing the solution for the wider market of all early-stage companies.

Why it hasn’t been solved yet?

Cultural Shift

We are witnessing a significant cultural shift in how people collaborate and undertake projects. This transition towards a more decentralized and distributed mode of operation requires the development of models that align with this evolving culture. In the evolution of the internet, Web1 facilitated information consumption, offering read functionality in online interactions. With Web2, the ability to input data into the internet was introduced, enabling interaction beyond mere consumption. Now, with Web3, ownership of assets online has become a reality, presenting opportunities to create adaptable ownership systems that promote collaboration.

Moreover, the world today is changing faster and that requires more agility. Long-term careers in the same company have been progressively replaced by short-term gigs.

Tokenized projects and the allocation of decision-making power through governance tokens represent a crucial step in this direction. However, while governance tokens allow for the acquisition of a stake in a community and project decision-making processes, they open a new class of problems. They add legal complexity that early-stage teams don’t know how to address and often need to pay a substantial amount of their funds for legal advice.

Tools & Mechanics

1. Traditional Compensation with Monthly Salary and Equity

Traditional compensation is not relevant to the new shift of the culture, because it lacks flexibility, and requires a lot of admin and legal work. The new wave of organizations like DAOs or traditional startups require agility.

2. Bounties

While bounties have been proven to be a great solution to compensating a specific contribution, they do not cover the needs of the founders to build a long-lasting and committed team. On the other hand, bounty platforms do not accommodate the need for security of core contributors.

3. Pie Slicer

While Pie Slicer provides technology for dynamic equity, its use case is limited to

keeping track of contributions in the company. It is an incomplete solution to a big problem. One of the trickiest pieces of the problem is actually measuring the value brought. Pie Slicer does not offer a solution to that other than tracking hours.

4. Compensation using Coordinape

It’s common in Web3 projects to use Coordinape to reward contributors working in the team, especially when it comes to bonuses and additional rewards.

It can definitely boost team harmony and trust, as all contributors have a space to feel heard and acknowledged. On the other hand, founders are happy that the team rewards itself, as the founders do not always have the full picture of everyone's contributions.

These are the problems I found interviewing projects that use Coordinape:

• Heavy Admin

It requires a lot of admin work to do compensation with Coordinape. The output of each Coordinape round is a CSV (Common separated file), then someone from the core team needs to handle the conversion from GIVE to rewards and execute them. This is a painful process for a small team trying to optimize their time and runway. Interestingly enough - contributors also see the peer-to-peer assessment process as admin work and feel like a painful process. In order to keep the team engaged in the assessment process, there’s a need for easy, gamified, and aesthetically pleasing UI/UX.

• Missing Feedback Functionality

    The most important aspect of assessment is also receiving feedback so the contributors can learn and do better in the future. However, largely due to UI/UX, none of the organizations I talked to see contributors leaving notes as feedback. Most contributors don’t use notes at all, and those who do use it to show appreciation. While the assessment should be fairly simple and fast to ensure it doesn’t feel like an overwhelming administrative burden, integrating feedback seamlessly into the process is crucial.

• People forget what they have done

    Coordinape doesn’t allow users to write throughout the month what their contributions are. From my interviews, I noticed that many users say that they forget and then give incomplete information about their work, which affects the GIVE they get from their team members.

• Power-dynamics

I continuously heard that founders usually get more points than the rest of the team, because of the reluctance of the team to give them low points. During an interview, the founder and core member of a DAO revealed that even though they express a desire for the team to evaluate them on equal footing, they consistently receive more points than deserved, often surpassing others in the process.

The discrepancy arises from the social dynamics inherent in peer-to-peer assessment. Despite efforts to foster equality, a lingering hierarchical culture makes it challenging for team members to provide entirely objective reviews for founders.

• Algorithm based on Average

Another thing to consider is that Coordinape uses averages to create the score of each peer. In one of the startups I interviewed, I observed a big team problem arising from one of the peers, forgetting to give points to another. They were a relatively small team of 8 people. This mistake affected the score of the peer significantly. The average can be heavily influenced by missing data or errors, leading to potential unfairness or inaccuracies.

5. Compensation using Praise

Praise also requires a lot of admin work, because in order to ensure fairness it has the concept of Quantifiers. They are trusted community members who independently review praise statements and score them on a predefined scale.

Moreover, what we see socially is that there are community members who are very engaged with Praise and show their appreciation a lot and others who are not engaged at all. This creates a subjective environment for evaluating contributions. Praise doesn’t have cycles, and praises are given on demand. In order for the project to collect enough feedback and assessments they repeatedly invite contributors to give praises in community calls and such. Praise is not a structured enough way to be considered a solution suitable for compensation.

What success will look like?

Solving the problem of early-stage compensation will ensure:

1. Sustainability: Inadequate compensation can lead to dissatisfaction and decreased productivity among contributors, risking the loss of valuable team members.
2. Longevity: Early-stage startups must maximize their operational time with available capital to establish sustainable income streams.
3. Fairness: Equitable recognition and compensation of all contributors are crucial for fostering a solid and stable team environment.
4. Empowered and Engaged Teams: Addressing this challenge ensures that early-stage teams can acquire the talent necessary for the project's success. Adequate compensation fosters a sense of security and motivation among team members, leading to higher performance. Moreover, by meeting their basic needs, team members can operate at a higher level, enhancing overall productivity and efficiency.
5. Higher Collaboration and Cooperation: Implementing solutions to this problem promotes a culture of co-ownership and incentivizes increased collaboration and cooperation among team members. Fair compensation and recognition of contributions create a conducive environment for teamwork and shared responsibility. This collaborative spirit enhances problem-solving, innovation, and overall project success.

Recommendations

The solution I’ve found is a user-friendly, admin-light, Web3-based, transparent compensation system. It utilizes peer-to-peer assessment for measuring contributions and handles the split of monetary and ownership compensation, which covers the immediate needs of the contributors so that they can be motivated and safe to deliver the best possible results to the organization.

In the section below, I lay out the Hows and Whys of all mentioned above.

1. Transparency

Transparency implies openness, communication, and accountability. That makes it the main weapon against unfairness.

We’ve seen many great examples in the last 10 years of how transparent compensation brings team harmony to the next level, boosting trust, fairness, and equality.

According to the GD Survey, 71% of employees are willing to disclose their pay within the organization and believe that transparency in compensation will increase satisfaction and fairness.

Ray Dalio advocates for radical transparency to enhance decision-making, accountability, trust, and innovation. He believes open communication leads to informed decisions by embracing diverse perspectives. It also fosters accountability, as roles are clearly defined, and builds trust by eliminating hidden agendas. This approach, which encourages idea sharing and aligns with human desires for honesty and fairness, promotes an innovative, productive work environment.

2. Peer-to-Peer assessment based on Mean

In order to create an environment of transparent, and feedback-based compensation, the contributors need to have the autonomy to self-assess. More than that, there’s lots of subjectivity when it comes to defining value. “The Wisdom of Crowds” can help here. This book, written by James Surowiecki about the aggregation of information in groups, resulting in decisions that, he argues, are often better than could have been made by any single member of the group or...

    💡 The error of the average is smaller than the average error.

That being said, this is where peer-to-peer assessment kicks in. However, as shown earlier, there are problems with the solutions we have available today.

The characteristics of a sufficient peer-to-peer assessment system for compensation are:

      1. Transparent, but Anonymous

In order to have trust as shown in the previous point, transparency is essential. However, in order to avoid power dynamics and social hierarchies, it is essential that the scores are anonymous. This way contributors will feel more secure to assess their managers or founders.

      2. Mean to calculate scores

The median (average) is not appropriate for skewed or non-normally distributed data, as it may not represent the majority of contributions accurately. Mean provides a more stable measure of central tendency, making it less sensitive to errors or missing data points. This is essential for a monthly recurring process.

      3. Easy to use and administrate

One of the main problems of early-stage teams is that they are overwhelmed with work. Systems used from startups need to be easy to use and not feel like admin work, but rather an experience. The solution should implement both the assessment, distribution and calculation of funds. Another important aspect of the UX is to have integrations with systems that contributors often use for their task management such as Jira, Trello, DeWork or, Crew3, as well as giving the possibility to add contributions throughout the month, so that users don’t forget.

3. Minimal Viable Salary

As described earlier, contributors have different needs based on their motivation and commitment. Moreover, contributors, no matter their skillset, have different financial contexts. If contributors can’t cover their basic needs, they are not going to be effective, or motivated. Daniel Ospina defines Minimum Viable Salary as “a small, recurring sum that covers basic expenses”.

One of the projects that I interviewed had already tried a similar approach in their team. They, however, had the assumption that the same amount of funds per month should be sufficient for all contributors, as initially they were based in the same region (Western Europe). What they found out was that many of their contributors had alternative income streams, and didn’t really need the monetary reward. They experienced problems when they onboarded people from different locations. Not having an alternative, they got back to the initial negotiation-based compensation. Location and financial context are crucial for fairness. My research shows that the Minimum Viable Salary should be self-stated and approved by the whole team, so that there’s trust, transparency, and also financial safety.

4. Co-ownership

As suggested earlier, ownership is essential for aligning incentives. Minimal Viable Salary covers the essential needs of each contributor, regardless of their location and financial context, however they need to be fairly rewarded for their contributions. Ownership is a common and proven practice to achieve that.

The way to do that is to establish a fair total compensation for contributors' work based on their committed time and market rate. AI can be used to simplifying this process. This results in a proposal that needs to be approved by the other team members.

Each month, a peer-to-peer assessment round is done and points are allocated to all team members. These points first get allocated to cover the Minimum Viable Salary of the contributor, and the rest goes into ownership points, stored on-chain and can further be exchanged for profit-distribution, governance token or, equity, depending on the strategy of the organization.

This way each contributor covers their basic needs, and also gets the rest of the value of their contribution in ownership.

5. Use of Web3

A system with the characteristics described, requires trust, traceability, and security. Web3 opens the possibility of true ownership of assets online. A web3 solution that has an easy to use peer-to-peer assessment system for measuring contributions, as well as Minimum Viable Salary for ensuring that the basic needs of the contributors are covered, alongside co-ownership as a compensation, can significantly boost longevity, sustainability, and fairness in early stage teams.

How would it change the world?

By resolving the challenge of early-stage team compensation, we'll create a fairer work environment where every member feels valued and rewarded. This will inspire creativity and attract top talent to collaborative workplaces built on trust. With fair compensation practices in place, innovation will thrive, and equality issues will be addressed. All team members will operate at higher levels, fueled by the assurance that their basic needs are met, leading to increased productivity and personal fulfillment. Moreover, shifting from being employees to co-owners of projects will change how we work and the companies we build. People will seek out ventures that aim to make a positive impact on the world, solving real problems.

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See Milena's presentation at our Co.Lab Fellowship Demo Day on April 4th here

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