Top management team compensation in high-growth technology ventures

Human Resource Management Review 16 (2006) 1 – 11 www.elsevier.com/locate/hrmr

Top management team compensation in high-growth technology ventures David Balkin ⁎, Michele Swift 1 University of Colorado at Boulder Leeds School of Business, UCB 419 Boulder, CO 80309, USA

Abstract We examine the key compensation issues pertaining to the top management team that occur during the early stages of growth in new ventures, specifically those anticipating rapid growth such as in technology-intensive markets. Similar to other new ventures, high-growth technology ventures are small in size but they have a goal of rapid growth giving rise to a need for resources and managerial talent to sustain the growth. New ventures are likely to compete in the market with larger organizations for top management team members. As a result, new ventures in rapid growth technology markets experience some unique compensation challenges. Critical for these firms is the issue of distributing equity among members of the founding team and structuring compensation to attract and retain non-founder executives. Drawing from the human resource management and entrepreneurship literatures, this paper develops a set of propositions predicting top management team compensation strategies for rapidly growing new ventures. Directions for future research are also discussed. © 2005 Elsevier Inc. All rights reserved. Keywords: Top management team; Compensation; High-growth technology venture; Venture capitalist

1. Introduction The entrepreneurship and human resource management literature have reported the importance of selecting appropriate human resource practices in new ventures (Aldrich & Langton, 1997; Heneman, Tansky, & Camp, 2000). However, the emphasis of research in entrepreneurship and new ventures has focused on finance and new product development which are drivers of growth. Less attention has been directed on human resource issues including those that pertain to the executive team (Balkin & Logan, 1988; Cardon & Stevens, 2004). While some research has examined reward systems in entrepreneurships pertaining to technologists such as scientific employees, we are not aware of any research that studies pay decisions for founders and non-founders on the top management team (e.g., Balkin, 1988; Graham, Murray, & Amuso, 2002). One of the most critical human resource issues for new ventures is compensating the top management team (TMT) given the high impact these key employees have on growing the firm. However, we notice that the preponderance of compensation research has focused on executive compensation in larger, publicly traded firms ⁎ Corresponding author. Tel.: +1 303 492 5780. E-mail addresses: [email protected] (D. Balkin), [email protected] (M. Swift). 1 Tel.: +1 303 492 5985. 1053-4822/$ - see front matter © 2005 Elsevier Inc. All rights reserved. doi:10.1016/j.hrmr.2005.12.002

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(Daily, Johnson, Ellstrand, & Dalton, 1998; Finkelstein & Boyd, 1998; Gerhart & Milkovich, 1990; Gerhart & Trevor, 1996; Sanders, 2001; Tosi, Werner, Katz, & Gomez-Mejia, 2000; Westphal & Zajac, 1994). Larger firms have more resources to establish comprehensive compensation systems. The amount and form of the top management team compensation of public companies is also disclosed making them attractive subjects for scholars of executive compensation. In contrast, compensation systems in small firms are informal, undocumented, and less transparent. New ventures have fewer resources, are at a higher risk of failure, and have fewer choices in terms of compensation options so that the pay practices adopted by large firms are less applicable (Cardon & Stevens, 2004). Additionally, the literature on executive compensation has focused on the use of equity to align the interests of executives with the shareholders whereas in new ventures the executives are likely to be the owners as well. Instead, a key concern in a new venture is the distribution of equity between the founders rather than aligning the interests of the executives with the owners. As this example shows, different aspects of compensation are likely to be emphasized in a new venture, compared to what takes prominence in a large organization. Having a compensation system that enables a new venture to attract and retain top management team (TMT) members while operating within the financial constraints of the firm is particularly important to a venture's performance and survival (Kazanjian, 1988). Compensation systems are key to eliciting and reinforcing behaviors that support firm strategy (Balkin & Gomez-Mejia, 1990) which means they can have a substantial positive or negative effect on a venture's performance. How to structure compensation for the TMT is a critical human resource management decision for a new venture. What makes this decision challenging to a new venture, is how to offer attractive pay to non-founders with critical management skills who need to be recruited to the TMT, when there may be only limited amounts of company stock to allocate to these key employees. Fortunately, as a new venture continues to grow it may also have access to financial capital that was not available at its inception. Venture capitalists (VCs) are a common source of financial resources for many new ventures, especially those considered higher risk such as high-technology ventures (Rosenstein, Bruno, Bygrave, & Taylor, 1993). The funding provided by venture capitalists enable these ventures to grow and reach their performance goals. In return for the funding provided, venture capitalists are given equity in the venture and a voice in its governance, including compensation decisions (Rosenstein et al., 1993). Existing research on the role of venture capitalists though has focused on broader governance issues such as the timing of an initial public offering or establishing strategic alliances with larger firms (e.g., Bouresli, Davidson, & Abdulsalam, 2002; Sahlman, 1990); less is known about how venture capitalists influence the distribution of equity and compensation among the top management team. In sum, new high-technology ventures face several compensation issues for the TMT that differ from those faced by larger firms. In our review of the literature, we identify three domains of compensation decisions that provide the focus of this paper: (1) how to distribute equity among the founding team; (2) how to compensate non-founding executives in order to attract them to the venture and then retain them; and (3) how venture capitalists influence executive compensation in these ventures. In the next section we examine the context of high-growth ventures, focusing on those in high-technology industries, and discuss the role of ventures capitalists in the domain of human resource decisions. This is followed by a discussion of executive pay in new ventures, differentiating between founder and non-founder concerns with pay. Next, we develop a set of propositions regarding the compensation for founders and non-founder executives in high-growth technology ventures, including the effects of venture capitalists. We conclude by discussing possible directions for further research on TMT compensation in new ventures. 2. High-growth technology ventures The new ventures in high technology of interest in this paper are entrepreneurships that differ from small businesses (Carland, Hoy, Boulton, & Carland, 1984; Stewart & Watson, 1999). The principal goals of high-technology ventures are profitability and growth and the business is likely to compete on the basis of innovation. Entrepreneurships expect to grow into large organizations at some future period. In contrast, small businesses represent any business that is independently owned and operated, is not dominant in its field, and does not anticipate high growth. The type of ventures of greatest interest in this paper are those anticipating substantial future growth and are likely to be in growing industries such as biotech, software, or digital electronics which represent high-technology industries. High-technology ventures are specific entrepreneurial ventures distinguished by their focus on new products or services based on

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technology. For high-technology ventures, the commercialization of their technical ideas is fundamental to the realization of the business strategy (Anderson & Kleingartner, 1987). According to Milkovich (1987), high-technology firms possess some distinctive characteristics: invention and innovation are emphasized in the business strategy, a significant portion of the available financial resources are allocated to research and development, a high percentage of the workforce is scientists and engineers (i.e., knowledge workers), and they compete in global markets with short product life cycles. High-technology employees are highly skilled, are likely to have advanced university degrees, and are motivated by intrinsic factors related to the work itself (Anderson & Kleingartner, 1987). High-technology work is associated by job characteristics such as job autonomy, self-paced work, goals that are internally defined, and demanding delivery schedules related to performing the work. It is also likely that high-technology new ventures are founded by a team, rather than one person, and that the executives of these firms have backgrounds in engineering or scientific disciplines, which affects their outlook when they become managers. Because of the need for rapid growth, a characteristic of high tech ventures, a key issue is recruiting the managerial talent with the capabilities to achieve the growth goals. New ventures are limited in how fast they are able to grow according to their ability to develop new products, find and exploit new markets, hire and train new employees with the needed skills, and build the administrative infrastructure required to accommodate an increase in size (Barringer & Jones, 2004). The managerial capacity problem was first articulated by Penrose (1959) and reflects a firm's ability to add the managerial talent necessary to accommodate the venture's growth (Barringer and Jones, 2004). To the extent that a new venture can attract and retain TMT members who can address its managerial capacity issue, the growth goals are likely to be realized. Research indicates that most ventures experiencing rapid growth are likely to mitigate the managerial capacity problem by using various pay incentives to elicit appropriate management responses (Barringer, Jones, & Lewis, 1998). High-technology new ventures attract attention from venture capitalists who seek to invest in entrepreneurships that show potential for attaining rapid growth and becoming a market leader. Consistent with this point, new ventures in high technology have been found to represent a significant proportion of venture capitalists' investment portfolios (Rosenstein et al., 1993). With the infusion of venture capitalist funding linked to goals of rapid growth, comes the need for managers with the skills and experience to build the infrastructure that characterize rapidly growing firms (Barringer, 1998). Venture capitalists are cognizant that their interests are closely related to having a successful top management team. Since venture capitalists take an active “hands-on” investor approach to firms in their investment portfolio, it is no surprise that venture capitalists are well represented on the boards of the ventures they select for receiving their capital. The boards of firms backed by venture capitalists have been found to be highly involved in firm decision making, including the selection of TMT members and other human resource management decisions (Fried & Hisrich, 1995). In addition, venture capitalists have been observed to take an active interest in pay decisions that pertain to the TMT to ensure that they are appropriately motivated. Determining compensation and pay incentives for the TMT is critical to sustaining the performance of a venture. A timeline summarizing the key compensation decisions that we have identified is provided in Fig. 1. After each critical event that is presented in the timeline, there follows a critical compensation decision that needs to be made. The critical events we identify include (1) inception of the new venture, (2) the addition of non-founders to the top management team, and (3) the introduction of venture capitalists to help fund the growth of the firm. In the sections to follow, we discuss each of these events and the compensation implications to the TMT. Equity distribution among founders

Pay mix and equity distribution for non-founder executives

Equity distribution to VCs and TMT

Time

Venture Inception

Addition of non-founder executives to TMT

Introduction of venture capitalists (VCs)

Fig. 1. Timeline of key TMT compensation decisions in high-growth technology ventures.

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3. Executive pay in new ventures A major emphasis of research on executive compensation has focused on examining the pay and performance relationship for the CEO and members of the top management team (Tosi et al., 2000). However, motivation theory suggests that both extrinsic forms of compensation and intrinsic forms are important to employees (Mitchell, 1999). In addition to money, individuals work for intrinsic rewards, such as interesting and challenging work and opportunities for personal development and advancement (Bartol and Locke, 2000). Mitchell (1999) has also argued that money has symbolic aspects in that it is associated with achievement, recognition, status, autonomy, and discretion which are also important to employees. According to job characteristics theory (Hackman & Oldman, 1976), individuals are motivated by intrinsic rewards such as (1) the opportunity to develop new skills and experience job challenge, (2) the opportunity to influence others and control one's own destiny, and (3) the opportunity to experience greater job satisfaction. Research on the antecedents that predict an individual's decision to become an entrepreneur reports that monetary wealth is only one of several factors that leads to the act of starting a new venture. Dyer (1994) argued that entrepreneurs tend to have a high need for autonomy, achievement, and the freedom to take risks. In a study comparing entrepreneurs with managers, Fagenson (1993) also found that entrepreneurs value their freedom, independence, having a sense of accomplishment, and opportunities to be imaginative. Similar arguments could be made about the motives of executives that leave large corporations for the opportunity to join new ventures. They change jobs in order to experience greater job challenge and to have more discretion and autonomy in their work. Therefore, we expect that corporate executives who are recruited to work in new ventures will carefully scrutinize both the monetary and nonmonetary rewards. While we recognize the importance of the role of non-monetary rewards in shaping the behavior of executives that are recruited at new ventures, the focus of this paper will be on decisions affecting the monetary compensation. The first compensation decision we examine concerns the relative distribution of equity between the team of founders of a new venture. We will see that the ownership of equity provides both the potential for monetary wealth as well as status for each founder. 4. Distribution of equity to the founders in a new venture When new high-technology ventures are conceived, they are most likely to only consist of a team of founders with diverse but complementary skills. This allows them to collaborate with each other in flexible roles so they can achieve goals that move the business closer to meeting important performance milestones. Their focus is on defining the venture's market and developing the product to meet a need in the market (Kazanjian, 1988). Resources are scarce at this stage since sales to the customer has yet to take place and the new venture is consuming cash without being able to replace it with incoming sales revenues. As a result, the resources used to sustain a new venture are likely to consist of the founders' personal savings and their unpaid labor. These resources are limited and likely to be exhausted within a 6- to 12-month period of time unless the venture is able to achieve planned growth milestones and provide a positive flow of cash to cover its expenses. Due to the scarcity of cash, monetary compensation for the founders at the inception of the venture is limited. Equity is therefore a critical component of the founders' compensation and the relative distribution of equity to the founders (i.e., founders' stock) is a critical issue to be resolved. Equity represents potential future wealth for each founder contingent on the success of the new venture. Equally important, equity represents control of the venture when a coalition of founders own more than 50 percent of the stock. When a coalition of founders (or a single founder) controls a majority of stock, they can determine the direction the business takes when there is disagreement over the strategic goals of the organization. Therefore, the distribution of equity concerns more than just wealth. It also symbolizes the value of the contribution each founder brings to the startup team and the relative influence each founder may have on the direction of the enterprise. Consequently, the decision to distribute equity to founders is likely to be emotionally charged. A distribution of equity perceived as unfair by one or more founders is likely to undermine the degree of teamwork produced by the founding team of entrepreneurs (Ensley, Allison, & Amason, 2002; Shaw, Gupta, & Delery, 2002). Because of the potential for conflict between founders over the perception of a fair distribution of equity, the principals often turn to trusted advisors or consultants to provide a recommendation for a decision rule to fairly distribute equity between the new venture founders (Shepherd & Zacharakis, 2001).

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The organizational justice literature suggests there are two distribution rules for distributing equity to founders: (1) the rule of equality and (2) the rule of equity (Greenberg, 1987). The application of the equality rule results in an equal distribution of founders' shares to each member of the founding team, while the equity rule distributes shares in proportion to the value of each founder's inputs. The underlying assumption of the equality rule is that each founder's contribution to addressing the venture's critical resource acquisition issues is approximately of similar value. In many new ventures, the founding team is assembled on the assumption that all resource issues facing the venture at this stage are critical and the knowledge and skills possessed by each of the founders is equally important in addressing these critical issues. As a result the equality rule is the one likely to be selected as a basis for the distribution of equity to founders. In new ventures, the founders are also likely to need to fill multiple roles that are quite flexible. The complementary and diverse nature of the founders' knowledge and experience provides them with the ability to carry out multiple roles, for example technology development and marketing, creating overlap in the roles enacted by the founders. This makes it difficult to separate and determine the value of the marginal contribution of each founder. Another reason why we expect the founding team to agree to an equal distribution of founders' stock for each team member is that new ventures with a founding team are not dissimilar to partnerships where the equality distribution rule has long been incorporated as an established practice. Partnerships are a legal form of organization often used by professionals in accounting, law, consulting and medicine. Each founding partner in a partnership receives an equal share of the organization's profits, and consequently assumes an equal burden to assume the partnership's financial liabilities (Mann & Roberts, 1994). The equality distribution rule provides an impetus for the partners to collaborate with each other over the governance of their firm so that a norm of collegiality is nurtured within the partnership which reduces the potential for conflict among the partners. Conflict between partners has long been recognized as a major threat to the success of a partnership. Thus, the founding team of a new enterprise can be viewed as analogous to a partnership, consisting of individuals who are jointly dedicated to building a successful organization. Finally, since new ventures are characterized by high levels of uncertainty and heavy work demands placed on each founder (Greiner, 1998), the need to preserve social harmony and avoid shirking on the founding team is particularly critical. Allocating equal shares of stock to each founder on the team preserves social harmony and is less likely to cause conflict and disruption to team motivation (Deutsch, 1949; Ensley et al., 2002). By reinforcing teamwork and reducing the potential for conflict by establishing rules with provisions for owning equal amounts of equity and having an equal voice over the operation of the enterprise, the founders are more likely to make comparable personal sacrifices of time and energy which are necessary to propel the new venture toward achieving its growth goals. This may explain why in many new ventures founders are likely to receive equal amounts of equity even when there are minor differences in their relative contributions. This leads us to our first research proposition. Proposition 1. When members of a founding team are perceived to contribute equally to addressing the key resource issues and uncertainties facing a new venture, the founders will receive equal amounts of equity. Furthermore, we recognize that special circumstances may exist where an equality distribution rule will not be appropriate as a basis for the allocation of equity among the members of the founding team of a new venture. In these circumstances, an equity distribution rule is the most likely to be perceived by founders as a fair way to distribute stock. The equity rule distributes amounts of founders' shares in proportion to the value of the inputs that each founder provides to a new venture. The presence of an asymmetrical distribution of founder inputs is likely to display noticeable differences in the resources that the founders bring to a new venture, such as the founders' knowledge, skills, or access to monetary resources. When there are significant differences in founders' inputs, there are likely to be significant differences in the effects these inputs have on reducing the uncertainties facing the venture and addressing the venture's key issues. This suggests that when there are significant differences in the founders' abilities to contribute to resolving the venture's critical issues and recognizing the differences in their relative contribution is important, it becomes appropriate to apply the equity rule in the distribution of the venture's equity. This leads us to our next proposition. Proposition 2. When there are significant and noticeable differences in the ability of the founders to address a new venture's critical resource issues, the amount of equity in the firm allocated to each founder will be in proportion to the relative value of each founder's contribution.

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5. Compensation for non-founder executives in a new venture As the venture grows, the focus of its strategy shifts to the acquisition of financial resources and activities that can bring its product into the market (Churchill & Lewis, 1983; Kazanjian, 1988). One of the key business risks in technology markets occurs when the product needs to move beyond the early adopter customer of a product and find the market for the mainstream adopter who is looking for a product that is easy to use and free of problems (Moore, 1991). Adding executives to the top management team with the knowledge, skills, and ability to access financial resources necessary for the venture to manufacture, market, and sell its product to the mass market as well as to take it to the next stage of growth is critical. While the founders are able to assume some of the important roles involved with managing the value chain activities of a rapidly growing business, other value chain activities will need to be managed by hiring non-founder executives who have the knowledge and experience to grow the business (Greiner, 1998; Kazanjian, 1988). These non-founder executives will be found at larger corporations and will be familiar with managing complex systems. Compensation will play a role in the recruitment of new talent on the top management team. A challenge facing the founders of a new venture is how to develop the appropriate pay mix that will support the recruiting efforts targeted at executives who are currently employed by large corporations and receive competitive compensation from their employers (Balkin & Bannister, 1993; Gomez-Mejia & Balkin, 1992). Fortunately, as a new venture grows, more financial resources are available to pay for competitive salaries. Despite the latent availability of financial resources to cover compensation expenses, however, there is a competing need to re-invest these resources into the business to fuel future growth in order to realize the long-term potential of the business model (Churchill & Lewis, 1983). As a result, the level of cash compensation to provide is a key issue to address. The pay mix consisting of salary and a menu of pay incentives should provide enough pay so that the non-founder executives should expect to be able to maintain their current standard of living. The pay mix should also allow them to have the opportunity to share in the upside financial success when the new venture reaches its anticipated growth goals. The pay comparators used as a basis for determining salaries for the non-founder executives will be diverse, and not be limited to small firms of similar size to the new venture. Pay levels in small firms (defined as less than one hundred employees according to the U.S. Bureau of Labor Statistics) have been reported to be below the median rate of pay in the market (Milkovich & Newman, 2002). However, because high-tech ventures expect to grow rapidly, they are likely to be competing with large organizations for the managerial talent necessary to support the ventures' growth (Balkin, 1988). Therefore, the standard pay practice of using similar size firms as comparators for establishing salary ranges is not likely to attract the quality of managerial talent that is needed. High-growth technology ventures operate in less certain business environments than larger corporations so that employment security is less certain for executives who are recruited to work at a new venture. For example, a marketing executive moving from a large pharmaceutical firm to a biotechnology venture is exposed to more insecurity in employment if the firm's biotech product fails its human subject testing to meet federal regulations or if there is an acquisition triggering a change in management control. Non-founder executives who are recruited to a new venture expect to be compensated for being exposed to threats of job loss by being provided with the opportunity for additional compensation. According to behavioral agency theory, executives are more loss averse than risk averse (Wiseman & Gomez-Mejia, 1998), suggesting that they should be willing to take risks with their overall potential compensation, yet they seek to avoid losses in the level of salary. The results of a study by Miller, Wiseman, and Gomez-Mejia (2002) provide support for this point. The results of this study suggest the appropriate pay mix of salary and incentives depend on executives' ability to manage the risks associated with the incentive pay. However, due to the need to recruit non-founder executives from larger corporations, the design of the pay mix in the new venture is likely to have a prominent incentive pay (i.e., pay contingent on meeting pre-arranged strategic goals) component that would permit the total compensation to have the potential to equal or exceed the amount that offered by larger organizations. The pay incentives offered to non-founder executives are linked to achieving the growth and performance goals of the new venture (Bloom & Milkovich, 1998; Gerhart & Milkovich, 1990; Stroh, Brett, Baumann, & Reilly, 1996). The pay incentives are likely to include an individual performance cash bonus, a pay incentive tied to short-term organization performance such as profit sharing and long-term incentives such as stock options or phantom shares. Phantom shares are long-term financial incentives that are similar to stock bonuses but result in a cash distribution that does not dilute the equity holdings of the founders (Taulli, 2001).

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The pay mix design that contains a prominent cluster of pay incentives for non-founders provides an environment of shared risk with the founders so all members of the TMT (founders and non-founders) are financially motivated to prospect for opportunities for growth (Bloom & Milkovich, 1998; Miller et al., 2002; Stroh et al., 1996). If the incentives are properly aligned, both founders and non-founder executives on the TMT will share financial success when the firm is prosperous, and also experience a loss of economic benefits when the venture misses its expected performance or growth goals. To recap, due to the employment risk that is concomitant with joining a new venture, the pay incentives component for non-founder executives is expected to be prominent relative to the salary (Micelli & Heneman, 2000; Stroh et al., 1996). The resulting pay configuration in a new venture entails a greater degree of pay variability than the pay design provided by larger corporations but also offers higher upside pay potential (to reward executives for bearing more employment risk). Therefore, the amount of total potential compensation offered to non-founder executives added to the TMT may equal or exceed the amount of compensation offered at the larger corporations where non-founder executives are being recruited. Based on the proceeding discussion, we offer the following proposition. Proposition 3. The level of salary provided to non-founder executives in a new venture is expected to be comparable to that offered by larger firms that employed the executives, and the pay incentives component of the pay mix in a new venture will provide the potential for total compensation to exceed the amount offered by larger firms. In addition to cash compensation, it is important that non-founder executives on the TMT have a significant stake in the enterprise in the form of equity holdings so that they develop an ownership perspective consistent with that of the founders. A primary concern that needs resolution is the decision to distribute shares of equity to non-founders because some of the founders may be unwilling to share equity with non-founder executives (Timmons, 1994). If a significant amount of equity is distributed to incoming executives, it may result in a dilution of the equity holdings of the founders and this situation could give rise to resentment and conflict within the TMT between founders and non-founders. Founders may rationalize that since they assumed the greatest burden of risk by starting the venture, it should be justified that the founders keep the lion's share of equity in the enterprise, and they may have serious reservations about sharing any of it with executives who are recruited at a later period. Due to our previous discussion explaining why the distribution of equity is both controversial and emotional to founders, we expect that in most cases founders will be willing to share a limited amount of equity with incoming key non-founder employees. Since the founders assumed greater levels of risk at the earliest stages of the development of a new venture, we expect that they will retain the largest amount of equity in order to be appropriately rewarded. Therefore, it is expected that the non-founder executives will have more modest equity holdings than that of the founders. This leads us to our next proposition. Proposition 4. The proportion of equity allocated to each non-founder executive on the TMT of a new venture is expected to be less than each founders' proportion of equity. 6. Venture capitalists and TMT compensation in new ventures Many high-technology ventures receive some form of venture capital funding which can affect a venture's compensation decision making due to the role of the venture capitalists as active investors (Rosenstein et al., 1993). A venture capitalist's decision to invest in a new venture is a function of the expected returns if the venture is successful and the potential to recover residual value from the investment if it fails (Gompers, 1995). Once a venture capitalist has decided to invest, one of the key issues to be resolved is how much equity the founders will agree to sell to the venture capitalist to compensate them for assuming the risk associated with investing in the venture. The deal that determines the relative distribution of equity between the venture capitalist and the founders depends on the value of the contributions that the founders and the venture capitalist bring to the enterprise (Admati & Pfleidere, 1994). For example, an experienced founding team, with a history of one or two successful start-up experiences prior to starting a new venture, will be able to negotiate a better deal with venture capitalists and therefore retain more equity. Since venture capitalists provide financial resources for early growth stage firms in emerging technology sectors, a high risk/high reward domain that traditional financial institutions avoid, one way they manage risk is by becoming active investors and provide management advice to the firms that receive their funding. Successful venture capitalists have access to powerful networks of talented managers who specialize in enabling emerging companies to achieve their

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growth objectives. Venture capitalists use their networks and know how to assist a client's TMT in making critical management decisions. The ability of venture capitalists to provide advisory services has been found to be an important criteria utilized by a new venture's founders in selecting a venture capitalist (Rosenstein et al, 1993). These valueadded advisory services include assistance recruiting future executive team members and identifying suppliers (Bouresli et al., 2002; Gomez-Mejia, Balkin, & Welbourne, 1990; Sahlman, 1990). To the extent that venture capitalists can provide both financial capital and the aforementioned advisory services, they are likely to require a greater proportion of the venture's equity in return for their investment and services. Venture capitalists are also stewards for the funds given to them to manage from private investors. These investors are willing to bear greater risk on new ventures but in return, they expect high returns. Therefore, venture capitalists seek out opportunities to invest in firms that show potential to meet the expectations of their financial backers. A new venture with great potential to generate high returns will be attractive to venture capitalists. For example, venture capitalists who provided capital to Google and Cisco Systems in exchange for equity in those firms when they were at the early stages of growth achieved enormous returns on their investments. The more attractive the venture the greater the incentive for the venture capitalist to invest, providing the venture's founders with the opportunity to retain a greater proportion of the venture's equity. The net attractiveness of a venture is a function of the risk and potential return associated with the venture. A significant proportion of a venture's risk to investors is based on the variability in quality of the TMT and its ability and resolve to develop the opportunity into a successful business (Kaplan & Strömberg, 2004). TMT quality includes its aggregate amount of human and social capital. The human capital of a new venture TMT, including its education, skills and experience, affect its access to financial capital by signaling information on the quality of the team and the quality of the venture (Florin, Lubatkin, & Schulze, 2003; Spence, 1973). Ventures with higher quality TMTs represent less of a risk for venture capitalists increasing the venture's net attractiveness. The social capital of a TMT, another dimension of TMT quality, also affects access to funding opportunities by enabling the team to identify a greater number of potential investors (Florin et al., 2003). Each member of the TMT has a network containing weak and embedded ties. A network of weak ties (i.e., to be acquainted with a person) provides access to a greater number of funding opportunities and having embedded ties (i.e., to have a close personal relationship) increases the probability of receiving more favorable funding terms (Uzzi, 1999). A new venture that has a TMT with high levels of human and social capital should be viewed as attractive by venture capitalists. When the venture capitalists find a new venture to be attractive, the TMT can be expected to negotiate a deal that allows them to retain a greater amount of equity. This leads to the following proposition. Proposition 5. A new venture with high levels of TMT human and social capital will be attractive to venture capitalists, enabling the TMT to retain a higher portion of equity. Even when a new venture represents a highly attractive investment opportunity, however, it still contains a significant element of uncertainty. Information asymmetry exists between the venture capitalist and the TMT in regard to its capability to achieve strategic objectives (Busenitz, Arthurs, Hoskisson, & Johnson, 2003; Kaplan & Strömberg, 2004). An approach that venture capitalists use to manage some of this uncertainty is by allocating financial capital in stages based on achieving strategic benchmark goals that trigger additional increments of capital. Another approach that venture capitalists use to manage some of the uncertainty is through the use of compensation. Through the application of pay incentives to the TMT venture capitalists attempt to align the interests of the TMT with their interests. A limitation on the use of pay incentives for motivating executives is that the executive compensation literature reports that pay incentives have weak effects on firm performance (Dalton, Daily, Certo, & Roengpitya, 2003) and that they may control executive behavior in unintended ways (Gomez-Mejia & Balkin, 1992). A different and softer approach that venture capitalists use to manage the uncertainty of outcomes in a venture is by recruiting executives to serve on the TMT who have established social relationships with the venture capitalists. By selecting individuals to add to the TMT who are trusted colleagues who have worked with the venture capitalists previously, the venture capitalists can reduce uncertainty and decrease information asymmetry in regard to the venture. Venture capitalists and the TMT that both operate within the same embedded network have increased access to information on each other that they would otherwise not be able to obtain (Uzzi & Lancaster, 2003). These embedded network relationships are similar to friendships suggesting that when ventures obtain financial capital from venture capitalists that have established relationships with the venture's executives, the executives are more likely to feel obligated to exert more effort in achieving the performance milestones desired by the venture capitalist (Blau, 1964;

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Gouldner, 1960; Uzzi, 1996). The favorable combination of greater transparency between the venture and the venture capitalists and a decreased potential for opportunistic behavior on behalf of the TMT can be expected to eliminate the need for venture capitalists to depend on compensation as a form of control to motivate TMT behavior. While we expect pay incentives to continue to play a role in the compensation of the TMT, we suggest that the venture capitalists will not attempt to impose their views on how the pay incentives are used when they have strong network ties with the TMT. This leads us to our final proposition. Proposition 6. The presence of a strong social relationship between a venture's TMT and the venture capitalists will eliminate the need for the venture capitalists to put an emphasis on pay incentives to motivate the TMT. 7. Conclusion In contrast to large established firms, new ventures operate without many formal human resource policies including compensation. In the absence of formal policies, compensation in a new venture is likely to be negotiated on an individual basis based on the needs and resource constraints of the enterprise along with the skills, experience, and other assets that each TMT member brings with him or her. Drawing from the literatures on human resource management and entrepreneurship, we developed a set of propositions that predict the distribution of equity and the pay mix for the TMT in a new venture anticipating high growth. Key compensation decisions affecting TMT compensation in high-growth technology ventures include the basis of equity distribution between the founders, the pay mix for nonfounder executives, and the effect of venture capitalists on the distribution of equity and pay mix for the TMT. While the explanations presented here assume a new venture with goals of rapid growth in high-technology industries, they are not meant to apply to all new ventures. Many new ventures seek alternatives to venture capital financing such as corporate partners or wealthy private investors (Gompers, 1995). Corporations and private investors may influence compensation decisions over TMT pay in different ways than the explanations provided in this paper. One direction for future research that is suggested by this paper would be to develop in greater detail a set of decision heuristics concerning how the founding team of entrepreneurs decides to divide ownership of the enterprise between themselves. It would be useful to know the mediating or moderating variables that may influence the distribution of equity to the founding team. For example, if a founding team consisted of a family of three brothers, would this team of relatives use a different type of decision criteria than a group of unrelated founders? 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