Incentives Drive Behavior

One of the most important Fundera board meetings I ever participated in took place in 2016. We were reviewing sales productivity metrics and one of our independent board members, Phillip Riese, asked about our compensation plan. When we explained that everyone was paid a healthy base salary and that we didn’t need a bonus plan because everyone was super sharp, talented, mission-driven and cut from a different cloth, jaws hit the floor. I was promptly reprimanded and then pat on the head for my naivety. It was then that I learned a critical lesson: incentives drive behavior.

It’s a phrase I find myself repeating over and over again. I learned it well while building Fundera. Need to solve a problem? Hit a target? Do something spectacular? Incentives work wonders. Incentives are one of the most powerful tools people have to inspire the behaviors needed to drive desired results. They are deeply embedded in virtually all systems: political, economic, social, environmental, etc. Sometimes incentives produce phenomenal outcomes, and sometimes they create havoc. They are a double edged sword as too much focus on driving short and medium-term results can come at the expense of long-term mission and vision. For operators, a balanced scorecard can help to mitigate detrimental effects.

One industry where incentives can create misalignment between businesses and customers is venture capital. This thread by Rob Go does an excellent job illustrating the point.

And this Dan Primack observation succinctly explains the oppositional dynamics.

The fundamental interests of most founders are oftentimes directly at odds with those of their investors. It’s worth stating that I am huge fan of venture capital. I’ve worked with many firms and partners across GroupMe and Fundera that I deeply respect. It’s a remarkable tool to create something out of nothing and build and scale businesses. That said, for most founders and employees, optionality is an important thing to preserve in order to optimize for beneficial financial outcomes. But VC makes almost all of its economic returns on a handful of outlier grand slams. 3-5x returns on any individual company are nice, but they do not make or break an individual fund. They’re rounding errors at the end of the day. But a $50-$100 million outcome can be economically life changing for founders and employees that haven’t over-capitalized and own a meaningful percentage of their companies. This is a unique friction that exists in the industry, and it’s critical that founders are cognizant of its existence.

Once you fully grasp the concept you begin to notice how incentives influence virtually every institution in our society. For instance, this insight from Palmer Lucky will make your head spin.

When you’re frustrated with the way something works, this realization helps you get to the bottom of why things are the way they are in the first place. For people who like to reason in first principles, it’s a powerful tool to get to Why.

Now when I set out to build something or tackle a problem that’s loaded with complexity, one of the first things I try to understand is the role and influence of incentive structures.