Retaining High-Performing Employees

Good people are always in demand, so new ventures face the same problem that all companies do: how to retain high-performing employees. Doing so is especially crucial for new ventures for two key reasons: (a) Replacing good people requires time and other precious resources that the new venture can ill afford, and (b) when they leave, they might take important information with them—perhaps to competitors! For these reasons, it is truly important for new ventures to retain their key employees. Many strategies can be useful in this regard, but two are most important: (a) developing excellent reward systems and (b) building a high level of commitment and loyalty among employees. These two strategies are related, but because they involve somewhat different actions, we will discuss them separately, taking care to note links between them.

Reward Systems: Linking Pay and Performance

When bright, talented people come to work for a new venture, they are, in essence, taking a risk; such people can always find good jobs in large organizations—ones that offer higher levels of job security. So why do they choose to join relatively risky new ventures? Several factors probably play a role: the commitment and enthusiasm of the founders, who tell a good story about their companies and their potential futures, and dissatisfaction with conditions in the large companies where they worked previously. Another factor that is crucial, and the one on which we will focus here, involves potential rewards: Good people come to work for new ventures because they perceive greater potential for rewards in this setting. If this is so, then assuring that these beliefs are realized—or at least remain viable—is a crucial task for entrepreneurs. How can this goal be attained? The answer is largely through the development of effective reward systems—systems in the new venture for recognizing and rewarding good performance.

In general terms, the kind of systems most suitable for new ventures is described in the field of human resource management as pay-for-performance systems (or incentive systems). Such systems assume that employees differ in how much they contribute to the company’s success and that they should be rewarded in accordance with the scope of their contributions. In other words, such systems strive for distributive justice. Several varieties of such plans exist. The most common type, merit pay plans, offer employees an increase in base pay, with the size of the increase being determined by their performance. The higher this is rated to be, the larger the raise. (Space limitations preclude our discussing the complexities involved in measuring and rating employees’ performance, but suffice it to say that it is crucial that these tasks be carried out in a systematic and accurate manner. This is far from easy. In fact, this matter is so complex, that we recommend that entrepreneurs hire appropriate consultants to help them establish such systems of performance appraisal.)

Another type of individual pay-for-performance plan involves bonuses. In such plans, employees receive a bonus based, again, on their performance. A variant of these plans involves awards—tangible prizes, such as paid vacations, electronic equipment, or other desirable items. In new ventures, entrepreneurs might also provide either actual stock in the company or stock options to employees. The latter give the employees the right to purchase shares of the company at a given price. Research findings indicate that new ventures that provide equity to employees grow faster and attain greater success than those that do not, so this appears to be a very useful technique well worth considering.¹

All of these pay-for-performance plans can be highly effective if designed and administered carefully. The advantages lie primarily in the fact that such plans translate the principles that we described in our discussion of motivation into tangible actions important to employees. The link between performance and reward is strengthened, commitment to the company’s goals is increased, and fairness (in terms of a balance between contributions and outcomes) is obtained. No wonder these plans often work!

Like every management procedure, however, pay-for-performance plans have a downside. Most important among these is the possibility that a “do only what you get paid for” mentality might develop. In other words, employees might focus on whatever indicators of performance are part of the system, while neglecting everything else. For example, in some school systems, teachers’ pay has been linked to the scores their students attain on standardized tests. The result? The teachers focus on helping their students do well on these tests (e.g., by learning various test-taking tactics) rather than on helping them understand the subject matter that they are studying. Similarly, the number of “no shows” (passengers who book tickets but do not show up) rose when airlines began compensating reservations agents on the number of reservations they booked.

Another problem with pay-for-performance plans is that they are hard to follow during tough economic times. When funds for raises and bonuses are severely limited—or even nonexistent—it might not be feasible to offer meaningful rewards to employees even for truly outstanding performance. Under these conditions, entrepreneurs need to be creative to hold onto their first-rate employees. People will not work hard forever without tangible rewards, so this, experts suggest, is when effective communication with employees becomes essential. They should be fully informed about the current situation and about the entrepreneurs’ plans to help things improve. In the meantime, entrepreneurs should do everything they can to demonstrate that they really do value excellent performance. For example, they can offer nonmonetary support to hard-pressed employees, such as adopting flexible hours and creating a pool of child care resources. The main point is that ambitious, hard-working people can put up with difficult situations—including a gap between their performance and their rewards—on a temporary basis. But to maintain their motivation, it is important to assure them that this state of affairs will not persist. If they conclude that it will not change, their motivation will drop and they will head for the exit as soon as it is feasible.

In contrast to individual pay-for-performance plans, other reward systems offer incentives to teams of employees rather than to individuals. In such plans, all team members receive rewards based on the team’s overall performance. This can lead to increased performance and a high level of cohesiveness among group members but is unsatisfying to many people who prefer to float or sink on their own merits. It also encourages free-riding effects in which some team members do most of the work while others ride on their coattails.

Perhaps more useful to new ventures are company-wide pay-for-performance plans, in which all employees share in the company’s profits. Profit-sharing plans distribute a portion of the company’s earnings to employees, while employee stock ownership plans reward employees with stock or options to purchase the company’s stock at a specific (favorable) price. These plans make employees partners in the new venture, and this can work wonders for their motivation—and their desire to remain with the company. We are reminded of this every time we visit a Home Depot. This large corporation has an unusually generous employee stock ownership plan, and it shows in the behavior of employees; almost all are eager and happy to help, and when asked if they like working there, they reply “yes!” with enthusiasm. Moreover, several have gone on to explain to us that they feel strong loyalty to Home Depot, mainly because they feel that they own a share in it themselves.

In sum, instituting an effective and fair reward system is one major technique through which new ventures can retain their best employees. Thus, this is an issue entrepreneurs should consider with care as their new ventures grow and they hire increasing numbers of employees.

Building Employee Commitment

Why do people decide to leave one job for another? The answer is definitely not as simple as “because they can earn more money.” On the contrary, the decision to leave appears to be a complex one, involving lots of thought and many factors.² How, then, can entrepreneurs tip this decision-making process in their favor, so that high-performing employees remain on board? A key factor involves organizational commitment—the extent to which an individual identifies and is involved with his or her organization and is, therefore, unwilling to leave it.³ High levels of organizational commitment are often present in new ventures, where, at least initially, employees are recruited and hired by the founders. As new ventures grow and this task is delegated to others, however, there is the real risk that such commitment will decrease, so this is an important consideration that entrepreneurs should not overlook.

Actually, three distinct kinds of organizational commitment exist. One, known as continuance commitment, refers mainly to the costs of leaving. If an individual would lose a lot by leaving (e.g., some portion of a pension plan, the opportunity to see close friends), this can weigh heavily in the balance and cause him to remain. For example, stock contributions made by companies to retirement funds are nontaxable until employees redeem the stock. This can increase continuance commitment because employees want to remain with the company until the stock rises to high levels. Similarly, stock distributed as part of employee stock ownership plans might not become fully vested for employees until some period of time has elapsed. Again, this can increase continuance commitment. A second kind of commitment is known as affective commitment—it refers mainly to positive feelings toward the organization. If an individual shares the values of her or his company and holds it in high regard, this employee is less likely to leave than someone with the opposite feelings. Finally, individuals might remain with a company as a result of normative commitment—they stay because of a feeling of obligation to others who would be adversely affected by their departure.

All three of these forms of commitment are important to new ventures, because each tends to help in the retention of employees. Employees of new ventures often identify with them because they believe in what the company is doing—that is why they came there in the first place! So to the extent that such feelings can be strengthened, new ventures can retain their best employees.

Is building a high level of organizational commitment worth the bother? Research findings indicate that it is. The higher employees’ commitment, the less likely they are to leave for another job.⁴ And that, after all, is what entrepreneurs want—retention of people whom they have worked hard to hire and who are essential to their companies’ continued growth.

Overcoming the “Control Barrier”: A Note on the Necessity of “Letting Go”

While many entrepreneurs want to surround themselves with the best people—to hire excellent employees—they often have a very hard time “letting to”—delegating authority to other people.⁵ The reasons for this are understandable: Entrepreneurs often have a passion for their companies and view them almost through the eyes of a doting parent. And just like loving parents, they find it difficult to surrender their authority and let other people control their new ventures’ fate by making important decisions or setting strategy. Yet—and here is the paradox—unless they can accomplish this task, they might put the future of their growing companies in jeopardy. To understand why, we need to take a brief look at how new ventures grow and move through successive stages of development.

Company growth is a continuous process, so dividing it into discrete phases is somewhat artificial. Still, many experts find it convenient to talk about six different phases through which many companies move:

1. Conception/Existence. This is the classic “start-up” phase, during which companies emerge and move toward the point at which they can deliver a product or service. During this phase, founders do essentially everything, so the issue of delegating does not arise.
2. Survival. At this stage of development, the new venture has become a real company; it has customers and is earning revenues. During this phase, too, the issue of delegation is relatively unimportant; while there might be a small number of employees, the founders remain central in every aspect of its operation.
3. Profitability and Stabilization. During this phase, the company attains economic health; it is earning a profit and has a growing number of employees. Functional managers are hired, but since the company is still small, the founders continue to play a key role and delegation is just beginning to become an important issue.
4. Profitability and Growth. At this stage, the company moves toward real growth, and to reach this goal, its growing cash reserves are placed at risk (i.e., they are used to finance further growth). The founders are still central to all aspects of the company’s business, but high-quality managers are needed to oversee its increasingly complex operations.
5. Takeoff. This is the pivotal phase of company’s growth from the point of view of delegation; the company is growing rapidly and becomes far too large for one founder or even a team of founders to oversee effectively. This necessitates the hiring of first-rate, professional managers—and these people will not come on board, or remain, if they are not given sufficient authority and autonomy to do their jobs. This phase encompasses what some authors term the control barrier. The founders must surrender at least a significant amount of control over the company to others—people whom they have hired, bankers, new shareholders who have provided needed capital. If they successfully pass through this barrier, the company can continue to grow; if they do not, its fortunes might begin to decline—a pattern that is far from rare.⁶
6. Maturity. If founders successfully navigate their way through the control barrier, the company becomes truly mature; it has, in a sense, arrived and is a significant player in its industry or market.

Here is a key point about these phases: In the early ones (phases 1 and 2), entrepreneurs’ skills, abilities, and knowledge—their capacity to accomplish various tasks—are crucial to the success of the company. From the third phase on, however, their importance in determining the success of the company begins to decline. At the same time, though, the importance of another factor—the founders’ ability to delegate—increases until the two curves cross; this is the point at which the control barrier occurs. Beyond that point, success at delegating is crucial and, in fact, is closely tied with the company’s ability to recruit, motivate, and retain high-quality employees and staff.

What all of this suggests, in essence, is that entrepreneurs must change their style of leadership as their companies grow. At first, they act as team leaders, people who lead a small group of highly motivated people toward shared goals—primarily through the vision that they describe and endorse. Later on, they must become leaders of teams—key decision makers who, nevertheless, delegate a large degree of authority and autonomy to other people who lead various teams within the company, such as separate departments or, perhaps, integrated cross-functional teams. Whatever form the growing organization takes, founders must truly let go—delegating authority and recruiting, motivating, and retaining first-rate people. Once they are on board, it is only reasonable for entrepreneurs to entrust them with key tasks; if this does not occur, why should these talented, energetic people stay around? The answer is simple: They will not. So letting go in an orderly manner, and at the appropriate point in time, is one of the best things founding entrepreneurs can do for their companies. And this is another reason why paying careful attention to recruiting, motivating, and retaining first-rate employees is crucial to the success of new ventures; when entrepreneurs do a good job at these tasks and are surrounded by truly excellent people, the pain of letting go might be significantly reduced. After all, they realize that they are placing the fortunes of their companies in very good hands!