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Manage sweat equity possible pitfalls

I have spoken about the valuation on sweat equity in another post and yet an equally important question is "who should receive sweat equity?" Or better yet "what are the risks for a founder who is looking to enlarge the team in this way?".

Often enough founders find themselves obliged to onboard a new team member by promising swear equity because they don't have much choice. They need a specialist in a given field and they don't have the cash to pay for the service. Usually further development of the project seems to hinge on this as the existing team just don't have the skills. Out of desperation they might rush into jointing forces with whoever shows interest and has the skills. The risks that can arise:

  1. They fail to judge the depth of the interest of the new member; this leads to conflicts later on or an early departure as they can easily get discouraged. Points to consider are a good understanding of the company's mission and alignment with its vision and values. As Steve Jobs said “When I hire somebody really senior, competence is the ante. They have to be really smart. But the real issue for me is, Are they going to fall in love with Apple? Because if they fall in love with Apple, everything else will take care of itself. They'll want to do what's best for Apple, not what's best for them, what's best for Steve, or anybody else.”

  2. They fail to set clear objectives, responsibilities and expectations. To manage that is best to put some effort in formalising these and minimising communication shortfalls; how often have you experienced debates that started with claims such as:

  • " this is not what I said/wanted"

  • "I don't understand what exactly you want" (claiming that one is being to vague or by the contrary providing too much detail)

  • "I thought you were dealing with that"

  • Team member taking the liberty to act independently in one task without the team expecting it etc

These can all be managed by profiling team members and empowering them with communication skills that help in overcoming the differences in their thinking patterns

3. Failing to define performance expectations and avoiding "soft performance". Incentives can be adversely skewed or ineffective if the terms are not clear.

In a nutshell to manage risks consider:

  • a clear agreement

  • protection clauses, including share buyback

  • diligent profiling of the person being considered

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