Salary pays for effort. Equity pays for uncertainty

Consider someone holding a share award in a private company.

They received it twelve months ago, during an optimistic conversation about growth and value creation. They signed the documents. They may even have paid something for it.

But ask them today what it is actually worth - not the number communicated, but what has to happen before they can make money from it - and many will struggle to answer. They know they have "equity". They are less clear on what they own, what sits ahead of them in the capital structure, what conditions apply and whether the exit timeline is realistic.

This is not unusual. It reflects a persistent confusion at the heart of how equity is used in remuneration.

Equity is often presented as reward. In economic terms, it is something different. It is the transfer of entrepreneurial risk. Until that distinction is understood - by the companies designing plans and the individuals receiving them - equity will continue to be oversold, misunderstood and, in many cases, a source of disappointment rather than alignment.

I have previously written about incentives as risk instruments, the idea that equity and long-term incentives are often less about distributing reward and more about allocating uncertainty. This piece looks at the same issue from the participant's perspective. If equity transfers entreprenurial risk, what exactly is the individual being asked to accept and is the upside credible compensation for that risk? 

The original bargain

There is a simple architecture to reward that is worth restating.

Salary pays for effort. It provides the floor. It compensates time, skill and availability regardless of whether the business ultimately succeeds. Most employees need this and are right to need it. They have financial commitments that cannot wait for a future exit.

Bonus often pays for performance. It rewards delivery against agreed targets over a defined period.

Equity, at its best, pays for uncertainty.

That is not a complete theory. Equity is also used for retention, tax efficiency, recruitment and market positioning. In listed companies, share awards sometimes operate more like deferred salary than genuine risk capital. But as a starting point, the distinction matters.

At the beginning of a business, the founder carries most of the risk. They may have invested capital, sacrificed salary, given personal guarantees or lived with years of uncertainty. Employees are largely protected from that exposure. That is the original bargain, not a criticism of employees, simply the economic reality of what salary is for.

Equity changes the terms of that bargain. It does not simply add reward. It invites someone to share in the uncertainty.

Ownership is not a mindset

The phrase "think like an owner" is used so often in incentive conversations that it has become almost meaningless. I, for one, refuse to use those words anymore.

It's a bit like the advice offered to ambitious junior lawyers “You need to think like a partner, to become a partner”. Hogwash.

Ownership is not a mindset. It is an economic position. Owners do not simply participate in upside. They absorb uncertainty. They live with valuation risk, liquidity risk and the knowledge that debt and preference shares may consume much of what the business eventually produces. They may hold something that looks valuable for years without ever being able to sell it.

Two equity awards with the same headline value can have completely different economic substance. A market-value option in a mature business with a clear exit pathway is a different instrument from a growth share in a leveraged structure with a high hurdle, subordinated economics and no obvious timeline. Calling both "equity" obscures more than it reveals.

The real question an equity plan answers, whether or not the documents say so, is: how much of the founder's or investor's entrepreneurial risk is being transferred to this individual and what share of the future upside should follow that transfer?

Private equity is clearer about the bargain

Private equity structures are sometimes criticised for being complex or opaque. But they have one quality that many founder-led equity plans lack: honesty about the bargain.

A management equity plan in a PE-backed business is explicit. Management is being asked to invest alongside a sponsor, operate within a leveraged capital structure, help deliver a value-creation plan over a defined hold period, accept meaningful leaver risk and wait for an outcome that may take five years or more to materialise. Sweet equity - typically a relatively small slice of the fully diluted equity, but with leveraged exposure to future growth - is the economic answer to that ask. The instrument is calibrated to the exposure.

That discipline is often absent from incentive design in private founder-led businesses, where equity is granted as a retention gesture or cultural statement rather than a considered response to the risk being transferred. The result is plans that carry the language of ownership without the economics to support it.

The PE model is worth studying not because its structures are universally appropriate, but because it forces a question that many equity plans never ask properly: what are we actually asking this person to accept, and is the upside credible compensation for that?

The founder who needs a team

Take a common scenario. A founder owns most of a profitable business. The next phase of growth requires a stronger senior team - perhaps a CFO to professionalise finance, a commercial director to open new markets, an operations lead to improve margin. A sale or private equity investment is three to five years away.

Salary will buy those individuals' time. Bonus may reward annual delivery. But if the founder wants them genuinely aligned over a multi-year period - making decisions as value-creation partners rather than well-paid employees - something different may be needed.

The honest question is not whether those executives "deserve" equity in some abstract sense. They did not found the business. They did not take the original risk. The better question is whether they are now being asked to carry a different form of entrepreneurial risk. Are they joining before the outcome is clear? Accepting delayed reward? Putting career capital behind a strategy that may not work? Committing to stay through an exit process and help convert founder value into institutional value?

If so, equity has a legitimate role. Not because alignment sounds good in a presentation. Because the risk being transferred may justify sharing a portion of the future upside.

Where founders struggle is in accepting the implication: that credible upside means meaningful upside. An equity plan that transfers the appearance of ownership without the economics to support it will not produce owner behaviour. It will produce cynicism.

What employees actually want to know

There is also a tendency to assume that employees always want equity. Many do not, or more accurately, many like the idea of equity without fully engaging with the risk it carries.

The practical question for an employee is rarely "am I an owner?". It is more specific: what has to happen before this instrument produces value I can actually spend, and what can happen in the meantime to reduce or eliminate it?

Three risks are consistently underestimated.

The first is capital structure risk. Employees in leveraged businesses frequently do not appreciate how much debt, preference capital or investor instruments sit ahead of their equity and must be satisfied before management equity produces meaningful value.

The second is leaver risk - the provisions that reduce or eliminate the award on departure, which can be triggered at exactly the moment an individual most needs certainty.

The third is tax timing risk, where, depending on the structure, a charge can arise before value has become liquid, creating a cash liability against an asset that cannot yet be sold.

None of this makes equity unattractive. It just means equity needs to be understood. Calling something ownership does not make it understood. Participants need to know what they are receiving, what risks they are accepting and what has to happen before value is actually delivered. 

That usually requires more than a percentage figure. It requires a worked-through view of the hurdle, the capital structure, likely exit values and the circumstances in which the award produces nothing.

Equity without explanation is not empowering. It is expensive confusion.

This is a perennial hobbyhorse of mine and echoes many of the same points made in a co-authored piece for the publication Corporate Financier, which you can read here.

The design question

The question in incentive design is not whether equity is good or bad. It is whether the instrument matches the risk being allocated.

If an individual is being asked to accept limited uncertainty, a modest share award or cash-settled arrangement may be entirely appropriate. If management is being asked to invest, wait, subordinate itself to a capital structure and help deliver a transformational exit, the upside needs to be more meaningful. A plan that transfers the form of ownership without the economics to support it is not an ownership plan. 

The best plans are more honest than that. They are clear about what is being asked of the participant, what the instrument is genuinely worth under realistic assumptions and what risk sits between grant and realisation.

Equity works where the bargain is understood on both sides. The company knows what it is asking someone to accept. The individual knows what they are agreeing to carry. The upside is credible compensation for the risk.

That is not a complicated standard. It is, however, a demanding one and many equity plans fall short of it.

At Burges Salmon, we advise founders, boards, investors and management teams on incentive structures across private companies, listed groups and private equity-backed businesses. The most effective arrangements are rarely the ones with the largest headline numbers. They are the ones where effort, performance, risk and reward are properly understood - and deliberately allocated - from the outset.