Motivation Puzzle

One of our clients faced a conundrum. They sponsored an employee to build a new business leveraging the firm's artificial intelligence platform that is outside of their own market. This represents a potentially disruptive play that could see them create a business equal to the size of the parent company within a decade or two. Were this new business to be seeking funding from a venture capital firm, it would have access to abundant capital to fund its expansion, and the Corporate Explorer would have a path to significant wealth creation. However, if the business wants to keep this new venture in-house, it must fund expansion from within the existing operating budget, with our Corporate Explorer receiving a modest bonus. Keeping the new business in-house creates a safety net for the employee, who will still have a corporate salary if the new venture fails, but the employee's growth upside is limited by what can be funded from the parent corporation's operating budget. It is a tale of two worlds. The gap between what you can earn as a Corporate Explorer working for a large company and the potential rewards from a successful venture-backed startup are startling. Whatever Krisztian Kurtisz earns from Cherrisk is unlikely to rival that of the insurtech startup Lemonade whose founder netted $87 million from selling stock in the company after it went public.

This presents an apparent motivational conundrum that has led some firms to try to rethink how to balance risk and reward for Corporate Explorers: we want startup-like outcomes but cannot offer startup-like rewards. This disparity of reward and risk is cited as a reason why large firms struggle to commercialize innovation – employees lack the incentives to motivate them to act with the ambition and urgency of a startup. A Corporate Explorers is a startup founder, but one that does not have the ability to motivate a team with the promise of an exit payout, either after an IPO or after acquisition by another firm. This is one of the most powerful motivators that enables the sort of breakthrough results.

There are two major problems with this analysis. The first is that most startup stock options are nowhere near as valuable as commonly believed. One study found that the reported valuations of so-called startup unicorns (i.e., firms valued as being worth more than $1 billion) used in staff compensation schemes average 48% above fair value.¹ There is a reality gap between what people think you can earn from a startup and what most people experience. The second problem is that there are no data that confirm that a lack of financial rewards impedes Corporate Explorers. Almost all the successful Corporate Explorers featured in this book received relatively modest financial rewards for success. A special compensation plan may make little difference to whether a new venture is successful and can lead to some perverse, unintended, side effects.

In this chapter, we will describe four strategies firms have adopted to close the risk/reward gap between Corporate Explorers and entrepreneurs. Some try to replicate the motivational dynamics associated with the venture-capital backed entrepreneur. The core premise of these approaches is that Corporate Explorers are primarily motivated by wealth creation. We think the evidence suggests this is untrue. As a result, though some of these strategies have merit; mostly they are cautionary tales of what not to do.

First is a venture model that aims for the best of both worlds – a corporate venture that generates a startup-style financial return for the founders. Second is the use of shadow stock that aims to achieve a similar goal, but within the corporation. A third approach is to adapt existing compensation plans by creating long-term incentives or bonus plans that seek to reward Corporate Explorers for the effort involved in creating a startup. This could include using stock option grants in the main company. A fourth approach is to try to replicate the risk side of the equation, both by adjusting compensation to try to replicate more of the sacrifice of the entrepreneur, and by limiting the ability of employees to return to the mothership.

Venture Model

The venture model involves spinning-out a venture into a separate company, then spinning it back into the corporation as an acquisition – what you might call a spin-along. Employees leave an established business to set up a new firm with funding from their employer. In return, the existing business gets first refusal on an acquisition of the startup. Cisco was a leading exponent of this approach. One estimate is that they have spent $2.4 billion on acquiring firms started by just four employees.²

This is the same team that led Crescendo Communications, from which Cisco acquired its lucrative “switch” technology to augment the company's router franchise. Based on this track record, Cisco repeated the formula many times over in the succeeding 20 years, including its purchase of the “software-defined switch” company Insieme. Cisco invested $100 million in 2012 and then acquired the firm for $863 million two years later. When the founders of Insieme came back into Cisco, it was immediately apparent to their colleagues that they were working alongside billionaires (most likely Cisco overpaid for the spin-along acquisitions as well). Making it worse, the Insieme approach of combining networking software with Cisco's switches replicated the company's historic hardware-centric model. VMware, the main competitor, was killing Cisco in the market with a pure software platform that worked on anybody's hardware. Shortly after the founders exited, Cisco switched strategies. The jealousies and power plays led to an ugly separation in 2016. The new CEO, Chuck Robbins, announced a reorganization of the networking group, of which the acquired business was a part. The Insieme founding team resigned the next day. A venture model may sound promising, but, at least in Cisco's case, it creates huge tension and may encourage “inside-out” thinking. Cisco has wisely abandoned the approach.

The venture model is high-risk. One study examined 200 corporate acquisitions. It found acquired companies with preexisting ties to a corporation do outperform other acquisitions by a small margin. However, the corporations still had to write-off 52% of the acquired assets.³ It costs a lot, has no better odds than acquiring a startup, and breaches employees’ expectations of fairness. Our advice is: don't do it!

Shadow Stock

Shadow stocks aim to mirror the startup incentive by linking the value of a bonus payment to the valuation of the new venture. That means that if you can build a new business that receives an external valuation of more than $1 billion, you are entitled to an agreed percentage of that value. This is the approach that Intel's Emerging Growth Initiative adopted to link the external value of the new entity to the rewards enjoyed by Corporate Explorers. This makes some sense given Intel's location at the heart of Silicon Valley. Attracting and retaining outstanding technical talent is hard when one of the key levers for compensation is missing. The shadow stock approach may work if the new venture is attractive enough to the core business. If the venture has a legitimate $1 billion valuation, then a Corporate Explorer with a 1% interest in the venture could expect to net $10 million. The condition is that there is a general manager in the existing business with the desire to acquire the new venture and pay the $10 million bonus or a corporate strategy decision to invest in standing up a new business unit to pursue the opportunity.

This is where the approach can get tricky. There is no capital transaction since the venture is already on the balance sheet of the mothership. The receiving business unit needs to be ready to commit to pay a bonus out of its annual operating expense budget. That should be no big deal; after all, that is a very small price to pay to acquire a unicorn. It is literally 1% of acquiring an equivalent startup external to the company. However, acquiring an external company is a capital expense. Companies can use their balance sheet assets – a combination of cash, debt, or equity – to fund an acquisition. As the company already owns the new venture, there is no acquisition, and no equity event to release capital to pay the founders. Any payments to Corporate Explorers and their teams come out of annual operating expenses. Operating expenses are tightly controlled in many companies striving to satisfy the financial markets’ expectations for earnings per share. Business unit managers need to believe that there is a potential to convert opportunity into a sustainable revenue stream, and to do so on a timeline that will help the manager meet their own short-term performance incentives. Those revenues are still likely to be uncertain, for example 80% of unicorns that go to IPO have no profits. That may be something you can tolerate for a capital expense but making the payments from operating expense will simply hurt the profitability of the business unit.

Shadow stock is an unproven approach, and it is not clear how it benefits a corporation looking to build disruptive new ventures. We are ready to be convinced, but again we do not recommend this approach.

Long-Term Incentives

Many firms have long-term incentive plans that provide bonus payments linked to the overall performance of the business. Adapting these plans is an effective way of creating attractive rewards for Corporate Explorers, without trying to create startup-style wealth. In these plans, Corporate Explorers get a bonus that pays out when they hit revenue goals set for five to seven years in the future. That way, payments are linked directly to financial outcomes, making it easier to justify. The rewards are less generous, though still substantial – often two or three times the bonus that a manager might have received in a core business role. The challenge is timing. Introduce the revenue goals too early in the life of a new venture and it may encourage a Corporate Explorer to find revenue at the expense of pursuing long-term growth. Introduce the goals too late and the incentive has no motivational value, thereby defeating the objective. Linking long-term incentives to revenue goals is good for scaling a new venture – when adding customers is critical – but poor for incubating it – when the focus is on learning.

Another similar approach is to grant Corporate Explorers stock options in the main company that vest when the venture hits agreed valuation targets. The expensing of stock options is a complex topic. This option avoids the disincentive of expecting a business unit manager to have to find the cash from an operating budget to take on a new growth venture. Some firms tie rewards to milestones. When the new business achieves revenue and profitability targets, that triggers vesting of corporate stock options and cash bonuses. The payoff period may be longer, but the connection to an outcome that matters to the corporation will be stronger. However, even here there is a potential challenge if the milestones set turn out to be easier to achieve than originally anticipated. One corporation chose to cancel a special incentive plan for the leadership team of a successful corporate venture because it became clear that that they had woefully underestimated the difficulty of the milestones. The implication is to be sure to link special compensation plans to real outcomes, like revenue generation, even if that means a long period without a significant payout for Corporate Explorers.

Personal Risk

The opportunity for great wealth creation for entrepreneurs comes with significant personal risk. Entrepreneurs work for months, even years, without remuneration, incur large debts, often relying on the kindness of friends and family to continue. This financial risk is significantly greater than for a Corporate Explorer who has a salary, benefits, and a budget to pay for the many things that early-stage entrepreneurs learn to do without. It is possible to replicate some risk by introducing a one-way door to the venture with no return possible to the main company. Google's fabled X-teams had this arrangement; teams got 6–12 months of funding to pursue an idea, but if they failed, they were out of the business. Intel's Emerging Growth Initiative uses a kinder version of this approach. Team members get six months to prove a concept but must then decide between a return to their former roles or committing themselves to the internal startup. UNIQA employees wanting to join the Cherrisk team in Hungary had a similar choice – join the startup with no right of return to your original job. The advantage of this approach is that it manages the boundaries to the new environment, ensuring that those who cross over into the new world do so having fully committed themselves to a different way of working. This helps to keep out employees who want to “play” at being an entrepreneur without any consequences. There are also some firms who put financial risks in place. Some take a 15–20% cut in basic pay to offset the availability of the attractive long-term incentives or shadow stock. Others request founder team members put their own money at risk by making a payment to buy-in to the equity of the new venture.

Career risk is a big concern for Corporate Explorers. No one wants to be associated with a failure in a risk-averse organization, and even being associated with a long-shot idea can be enough to put a question mark over a manager's judgment. Recruiting Corporate Explorers to lead ventures coming from a top-down growth initiative can also have challenges. At IBM, one of the executives tapped to lead an emerging business opportunity agreed to take the assignment on the condition that the CEO would tell him, “What it is I did wrong.” He could not believe that being given a business with zero revenues represented a career opportunity.

There is no quick fix to this problem. Corporate Explorers can try to enroll the chief people or the human resources officer as an ally to the venture. They may be able to shape a perception of the role and help ensure that “good failures” (i.e., those that generate learning) are celebrated in the company. One company organizes open sessions to discuss failures – the meeting has an appropriate expletive in its title, which captures attention. At Analog Devices, CEO Vince Roche invites Corporate Explorers to write a debrief memo describing what was learned from the failure, and he then distributes this inside the company to encourage people to be receptive to learning. It would also make sense to give some sort of “failure bonus” that rewards Corporate Explorers for pulling the plug on failed initiatives. This supports firms in aggressively pruning the venture portfolio, so that only the best projects advance to scaling. We know of no firm that has such an incentive, but we think it is worth exploring.

Much of the career risks are more perceived than real. At IBM, the reluctant Corporate Explorer had his venture canceled after a year. That did not prevent him from going on to lead a large business unit, and he was the runner-up in the selection of the next CEO. Jim Peck went on to be CEO of LexisNexis Risk Solutions and has since led two other corporations. Much like an entrepreneur, there is a path to senior business leadership, if that is what motivates the individual.

Corporate Explorers Motivation

The belief that it is important to replicate the risk and reward of an entrepreneur for the Corporate Explorer is open to question. There is no empirical research to guide us on which approach will best achieve the desired outcome of growing a new venture inside an existing corporation. Many of the most impressive examples of Corporate Explorers building multibillion-dollar businesses – Carol Kovac at IBM Life Sciences, Jim Peck at LexisNexis Risk Solutions – did so within existing firm compensation plans. These leaders could have made the decision earlier in their careers to step out of the corporate life and pursue a venture-backed startup. Indeed, Peck did follow this route before returning to LexisNexis. They were not, for whatever reason – psychological or financial – entrepreneurs. It may be that the focus on individual wealth creation is misplaced. Corporate Explorers need to be enabled to succeed, but it is not clear that they are more or less likely to do that because of the prospect of creating life-changing wealth. Many employees of established companies may be drawn to exciting new ventures simply by the opportunity to do something entrepreneurial, not by the prospect of vast wealth.

Corporate Explorers can benefit from compensation plans that motivate working on long-term goals. In a scarce talent market, such as that faced by technology firms in Silicon Valley, there may be an argument for being more generous in the scale of such rewards. But we may not need to replicate startups too closely when we do this. Startup rewards are not always as attractive as the headline results might suggest, and it is not clear that the gain for the corporation is worth the investment. Corporate Explorers are not entrepreneurs, they are wired differently, and it is more valuable to focus on helping them achieve the shared outcome of building a new business than it is figure out how to make them billionaires. It is better not to design any specific incentives for Corporate Explorers than try to mimic entrepreneurial incentives that are as likely to go wrong as they are to deliver the required result.

Chapter Summary

Successful entrepreneurs often are motivated and rewarded by very large financial payouts. But what motivates their corporate counterparts and how should they be rewarded? Our experience is that although successful explorers would like to be recognized and rewarded, their motivation is different from the Silicon Valley entrepreneurs. They want to be treated fairly but do not expect a huge payout.

There are four ways to address the risk/reward equation for Corporate Explorers; most are counterproductive.

First, it may be possible to use the traditional startup venture model by spinning out the new venture as a separate legal entity with its own stock. If successful, it can be bought back; this created major problems for Cisco.

A second approach is to use some form of shadow stock that measures a ventures success based on a hypothetical market value. The company must buy back the venture, so providing the Corporate Explorer with an attractive return. We wait to see if this application of startup logic works, we are skeptical.

A third option is to use a long-term incentive program that provides a reward to the explorer after reaching certain milestones—as implemented at IBM.

Entrepreneurs often take on personal risk when they create a startup venture. Corporate Explorers work in relative comfort. Corporations can replicate some of this sense of personal risk by making entry to the venture a one-way door – with no return to the previous job in the corporation should the venture fail. Alternatively, the corporation may even ask them to take a salary reduction or invest their own capital in the new venture.

Rewards are important, but our experience is that what motivates a Corporate Explorer is not the same as that of a true entrepreneur—and the rewards are therefore different. It is best not to experiment with schemes that try to force the venture capital world into the corporate.