The Equity Incentive Paradox: The disconnect that’s bleeding your best talent
- Jennifer Azapian
- Jun 4
- 5 min read
Updated: Aug 28
The Equity Incentive Paradox: The disconnect that’s bleeding your best talent
Picture this: You are the Founder of a ~100 person company that is scaling to raise Series C. Your star engineer just shipped a feature that increased conversion rates by 40%. Your marketing team launched a campaign that cut customer acquisition costs in half. Your product manager identified a critical user flow issue that was silently killing 20% of potential signups.
How do you reward them? If you're like most VC-backed startups and scaleups, you find a way to thank them and hope that this will translate into continued motivation and company growth. You’re relying on equity—stock options that vest over four years and may pay out over 5-10 years—assuming your company hopefully gets acquired or goes public.
These same employees can join a major tech company and receive immediate salary bumps, cash bonuses, RSUs with guaranteed minimum value and annual cash value, and regular merit increases for creating less individual impact given the scale of those organizations.
This creates a paradox: Startups demand immediate results but seem to reward with distant promises.
The Evolution That Left Startups Behind
Over the last 20 years, startup and scaleup compensation has changed dramatically. Salaries soared to compete with major tech companies. Generous benefits and perks became standard. But while startups worked to match big tech base pay and some perks, compensation for performance never developed sophistication beyond the annual target bonus (and annual bonus plans are the norm only at 100-200+ employee organizations).
At the same time, Google popularized OKRs (Objectives and Key Results). John Doerr, who developed the process (see "Measure What Matters"), specifically recommends NOT tying OKRs to compensation—because transparency around metrics creates performance pressure to excel without added cost. However, winning at metrics alone without any variable cash component isn't so effective in the long-term when employees have near-term financial needs like home purchases or family support.
The RSU Revolution Changed Everything
Microsoft pioneered broad-based RSUs when stock options proved too risky and complex for employees to understand:
"When you win [with options], you win the lottery. And when you don't win, you still want it... So what we do now is give shares, not options." — Bill Gates, 2003
Apple eventually followed suit:
"This new program extends eligibility to everyone... effectively making everyone who works at Apple eligible for an RSU grant." — Tim Cook, 2015
This enhanced form of long-term incentive created a scramble for startups limited to illiquid stock options. The focus shifted from finding talent with the right risk profile to matching public company compensation, promising "unicorn" valuations, and making unrealistic statements about potential stock value.
During the ZIRP (zero interest rate policy) era peaking in 2021, pressure on Silicon Valley startups intensified:
Companies of all stages moved to 75th-90th percentile pay philosophies, thus ratcheting up benchmarks across the industry
Sign-on bonuses became the norm and reached 30-50% of first-year salary
RSUs began vesting quarterly/monthly, essentially acting more like short term cash
Startups began exceeding public company base salaries in many cases
Emerging companies promised excessive future valuations, selling employees on theoretical VC valuations and not common stock exit potential
Another ZIRP-era shift: average employee tenure dropped from 4 to 2 years. Savvy startup talent began treating job changes as portfolio diversification—collecting stock options across multiple companies to reduce financial risk. And at its peak, the economic and social climate, spurred in part by the covid pandemic, created “The Great Resignation” (see “The unseen consequences of the Great Resignation’s hiring frenzy”).
The Broken Promise of Equity-Only Compensation
The fact is, focusing only on potential equity value when you communicate to the majority of employees fundamentally can be risky or misinterpreted, and misaligns with startup reality:
What startups need: Scrappiness, creativity, urgency. Quick wins, rapid iteration, immediate problem-solving. Long hours and intense sprints.
How startups pay: Four-year vesting in illiquid instruments tied to uncertain outcomes the majority of employees can't directly influence or access for years.
This creates costly problems:
Performance goes unrecognized in real-time. That 40% conversion improvement? It gets lost in annual performance reviews and merit increases. By recognition time, the moment has passed, behavior hasn't effectively been reinforced, and employees question whether exceptional work matters.
The feedback loop breaks down. Equity value fluctuates based on market conditions and factors outside an individual’s control. When an engineer saves $50K annually in server costs, they see no connection between that contribution and their immediate compensation.
Retention becomes the only metric. Equity grants become blunt instruments preventing departures, not celebrating excellence. This shifts conversations from "How do we reward great work?" to "How do we prevent departures?"
Early liquidity pressure intensifies. Managing buybacks or secondary sales to appease employees creates governance hazards, cap table complications, and fairness issues that distract from business building.
Option pool depletion limits strategic hiring flexibility. Many founders deplete option pools faster than anticipated by using equity grants for high performers without adequate planning or realistic benchmarking, limiting flexibility when recruiting senior executives who require meaningful grants.
The High-Performer Problem
Your highest-performing employees—those you can least afford to lose—are obviously the most at risk. They have the strongest market alternatives and clearest sense of their impact. When exceptional contributions are treated identically to average performance, they face a fundamental attribution problem. This creates frustration and can actually decrease performance levels and lead to burnout.
The most effective performance motivators and recognition are: immediate, emotionally meaningful, and planned for (not reactive).
High performers create massively more value than average performers (see Laszlo Bock's "Work Rules!" on the power law distribution observed during his tenure at Google). And they're most likely to explore opportunities providing immediate recognition while only early or senior hires with large equity grants - or worse, average performers may remain satisfied with equity-only incentive models.
The Current Market Reality
Startups and scaleups have tried to compete where major tech companies offer immediate cash bonuses, annual merit increases, and lush benefits and perks.
However, in the current economic market environment, mass layoffs and reorganizations still continue as companies look for ways to cut costs, become more efficient, and maintain shareholder value. With more talent on the market, emerging companies may find they are able to better compete – assuming that their target pool of talent is also willing to work in an even higher risk environment.
The Path Forward
I'm obviously not advocating abandoning stock options as the primary form of incentive and wealth creator for emerging company employees. That would be considered heresy in the eyes of Founders and VC's.
Many early startup employees have benefited tremendously from stock options they earned at companies they helped build, and it was the foundation of the venture ecosystem in Silicon Valley. Stock options are still the most meaningful and fair way to recognize and reward employees who have a part in long-term value creation.
Rather, for companies with traction and scale, comprehensive compensation strategies need multiple instruments working at different time horizons. Once a company reaches 100+ employees, simply stating "we offer equity upside" without additional reinforcement rings hollow when that upside is distant, uncertain, and seems disconnected from individual performance.
The most innovative scaleups use hybrid approaches maintaining strong equity programs while introducing immediate performance incentive mechanisms. Small investments in near term recognition enhance equity program effectiveness by keeping high performers engaged long enough to hit meaningful milestones.
It’s up to the founders of this next generation of successful VC backed companies to ensure they hire for the right risk profile, and for employees to ensure they are joining startups and scaleups for the right reasons: belief in the team, passion for the vision, and an opportunity for outsized career growth and experience.
