Editor’s note: Russ McGuire is the online director of Business Reform Magazine. Each issue of Business Reform features practical advice on operating successfully in business while glorifying God.
Last week, Microsoft announced that they were changing their compensation structure to replace stock options with actual stock grants to employees. This has been heralded as a seismic shift that will send shocks through the entire tech industry. This undoubtedly is true; in fact the move could strike a devastating blow to the entire current model for technology entrepreneurship.
Thanks to increasing regulations, Microsoft’s change is extremely complex. There are myriad details surrounding what happens to current unexercised options, how and when the preferred shares given to employees convert into common shares that can be sold on the stock market, and how this new form of compensation changes regulatory financial filings made by the company. In fact, it’s so complex that Microsoft has undoubtedly deployed an army of accountants and lawyers to figure it all out.
Unfortunately, most technology companies don’t have an army of lawyers and accountants. And that’s just a small part of the problem.
But, let’s back up and consider the overall challenge of compensation within the technology industry and how we got to this mess in the first place.
Most technology companies start small with a good idea. Their greatest asset is intellectual property – those good ideas, often translated into patents or product designs or lines of software or something else that the founders believe will create great value (and wealth) over time – but that has very little tangible value today.
In short, these companies are typically short on cash and long on promise.
To grow, they need to do things. They often need to hire employees and they need to spend money on things like marketing and advertising so that potential customers will learn about their product so that promise can become reality.
To cut to the chase, what has developed in technology industries is a two-fold answer to this challenge:
- Whenever you can, pay for something with equity instead of cash.
- For all other cases, sell equity for cash so you have money to spend.
Equity is ownership in the company, or in other words, it is the opportunity to share in the future profits of the company. Equity is extremely valuable to the stakeholders who have bought into the promise embodied in intellectual property of the company. These are the kind of people that you want on your side. They will fight tooth and nail, not only because they have a financial stake in the success of the business, but also because they have almost a “spiritual” stake in the business. They believe!
Employees who believe are irreplaceable. They work with passion and they are natural “evangelists” for the company and its products. Making them co-owners in the company not only is wise stewardship of limited funds, but also wise alignment of stakeholders to common goals.
There is no better model for the employer/worker relationship than the proprietor model, where all the workers take literal ownership in the business.
However, technology entrepreneurship has also spawned another type of equity owner. Instead of “believing,” this one “figures.” This owner has calculated his rate of return on his investment (whether that investment is in dollars, time, or goods/services), taken into account the risk involved, and made a wise investment decision. Such an investor will undoubtedly be conservative in calculating a low future success and a high risk level, so he will demand a higher ownership stake for his dollar than a “believer.”
Investors who don’t “believe” can be deadly to the business. Their loyalty is to their dollars and, if given enough control over the business, they will force changes that protect their near term return but that limit the long-term potential.
Don’t misread the above paragraphs. Not all employees are “believers” and not all cash investors are “unbelievers.” In fact, the incredible wealth that has been created in the technology stock markets over the past few decades has created lots more “figurers” than “believers” and this has created a huge problem that needs fixing.
Believe it or not, Microsoft’s recent move may do more “fixing” than anyone expects.
Let me explain.
“Figurers” are more worried about the future dollar value of their investments than “believers,” so they do everything they can to protect their equity stake.
To name names, the venture capital community has become very wise in crafting the terms under which it will invest in technology startups.
Don’t get me wrong. Venture capitalists have done a great service to our economy by providing the cash investments that have enabled many tremendous companies to develop and bring to market many wonderful products and services. But, the very nature of a venture capital firm – they take the money of others and are expected to do everything they can to maximize the return on that money – means that they have got to be excellent “figurers” and can’t afford to be “believers.” Believers don’t abandon the faith. Someone entrusted with other people’s money often must sacrifice the dream and make hard decisions to protect an investment.
But, over time, as part of protecting their investments, VCs and their lawyers have created relatively complex equity structures to control who actually gets real ownership in the company in what timing and under what terms. These structures include things like “options” and “warrants” and “preferred shares” – all with lengthy legal documents explaining the terms and conditions under which these instruments can be converted into “common shares” of stock in the company. Obviously, some of these restrictions are simply the practical reality that, until a company issues an initial public stock offering (IPO), there really is no market for selling common shares of stock. But still, much of this nonsense has been driven by the self-interests of these investors.
So, what happens if the world’s biggest technology company decides to cut through most of this noise and shifts from compensating employees with options to compensating them with actual shares of stock?
Well, we’ll have to wait and see, but here are my guesses for the three biggest impacts this will have on technology entrepreneurship:
- Stock, rather than options, will become the “gold standard” for employee compensation. This should be good for technology workers, should be generally good for promoting a proprietorship model in the workplace, but could create new complexities for company founders.
- Venture capitalists will have reduced control and power. Undoubtedly, they’ll work to devise new structures to regain that power, but there will be both short-term and long-term implications in the deals that VCs will do, why they’ll do them, and under what terms.
- Entrepreneurs will likely be forced to work harder to find true “believers” to invest in their companies. This barrier likely will kill many startups (arguably, maybe the ones that have nothing worth believing in?). But those that do get funded, will have much healthier relationships on which to build.
The net short-term effect, whether Microsoft has schemed for this or not, will likely be fewer companies getting funded to create innovative solutions to challenge incumbents like Microsoft.
However, over time, Microsoft had better watch out. What is likely to develop is a totally different breed of entrepreneurial technology companies. These companies will lack the greed-driven vacillations of today’s venture-backed startups. Instead, they will be infused with teams of management, employees and investors that share a deeply-held belief in the opportunity that lies ahead of them – even if that opportunity involves challenging Microsoft.
And, as any student of history knows, an inspired army fighting for a cause in which they deeply believe can often overwhelm an opponent whose army appears vastly superior in size and strength, but whose hired soldiers lack commitment and passion.
Let the battle begin.
Russ McGuire is Online Director for Business Reform. Prior to joining Business
Reform, Mr. McGuire spent over twenty years in technology industries, performing various roles from writing mission critical software for the nuclear power and defense industries to developing core business strategies in the telecom industry. Mr. McGuire is currently focused on helping businesspeople apply God’s eternal truths to their real-world business challenges through Business Reform’s online services. He can be reached at [email protected].