How to build systems
rom dealing with payroll to setting up an options plan, startups need to put in place systems that permit employees to function as efficiently as possible. Having good systems in place can allow entrepreneurs to get back to doing what they do best: creating.
This article was written by the original owner of startupguide.com, Ryan Allis, and published on his website in 2012. Read more about why Ryan was happy to hand over his website domain to us here.
What is a system? A system is a set of processes that can run without you. As your business grows, you’ll need to build systems and processes that can be automated as much as possible.
You’ll need to build distribution systems, inventory systems, marketing systems, customer support systems, research and development systems, accounting and hiring systems, and many others. Putting these into place — sometimes within the first few months, and definitely within the first year — will allow you to take a step back and focus on higher order tasks like ideation and inspiration.
At first the number of systems you need to set up can seem daunting.
You’ll need to build systems for performance reviews. You’ll need systems for simple things like getting food during the day to feed your employees if needed.
You’ll need systems to train new people, to notify customers when your product is not working, to review the operations of your business, to gain and collect feedback on your product, to do expense planning and financial planning and pay for purchases, to pay salaries through payroll.
You’ll also need systems in place to determine how happy your customers are, to implement a net promoter score for your customers, to handle vacation requests for your employees, to test your marketing using the scientific methodology that we talked about in the previous chapter, to manage requests for proposals (RFPs), and so on.
With this in mind, start slow. In the entrepreneurial phase, try to be light on formal systems and focus on developing the minimal necessary amount of efficient systems that run smoothly. As you grow, you can then put into place more complex processes.
During your first year in business, your success is really about what you personally do and the product you build. After the first year in business, your success is determined more by the people you hire, than by you yourself.
After the first year, or even the first few months, stop trying to do everything. Hire smart people and help them put systems in place so that things happen even when you’re not there. In the early stages of your business, you can start by setting up a few key systems.
As your business grows, you’ll need to build systems and processes that can be automated as much as possible.
Setting up an accounting system
Make sure you hire a bookkeeper to keep track of and categorize your revenues and expenses (and if you can’t afford one, learn how to do it yourself). Have them send you a monthly income statement, balance sheet, and cash flow statement. Learn how to read a financial statement if you don’t know how. It’s up to you if you want to see your statements in a cash basis or accrual basis.
Most common accounting packages like QuickBooks and Peachtree or (or online accounting tools like Xero, Kashoo, or Legerble) can produce both cash-basis and accrual-basis reports. You will need an accounting system set up to be able to raise investment later.
In the entrepreneurial phase, try to be light on formal systems and focus on developing the minimal necessary amount of efficient systems that run smoothly.
Unless you’re purposely masochistic, there’s just no reason to attempt to do your payroll yourself. Hire a firm like Paychex, ADP, or Intuit Online Payroll to do it for you. They’ll take care of all the tax withholdings, calculations, and government compliance. ADP and Paychex can also set up a 401(k) program for your company.
Setting up a 401(k) and health care plan
As you get past a handful of team members and your sales volume can support additional investments in your team, consider setting up a 401(k) retirement program and begin to provide health coverage to your employees. You can often use your payroll provider to set up a 401(k) program.
To encourage employees to save, you may wish to match a percentage of employee contributions when you can afford to. For example, my company iContact matched twenty-five percent of all employee contributions to their 401(k) plans for the first four percent of salary contributed.
To set up a health care plan, go online and find a couple of health care providers in your state. As you consider which plan and provider to select for your company, take into consideration the major components of each plan outside of cost, including the deductible, co-pay, cost of generic and brand name prescriptions, and network coverage.
In the United States, there are three general types of health care plans. A PPO plan is generally considered more employee-friendly than an HMO or HSA plan but has the highest costs. Here’s a summary of the three types of health care plans:
A PPO (Preferred Provider Organization) provides your employees with access to a large network of health providers, and usually provides the most network coverage to the employee.
An HMO (Health Maintenance Organization) reduces costs by insuring visits at only in-network health care providers.
Finally, an HSA (Health Savings Account) enables employees to create a savings account that they can draw from tax free to cover high deductible health care plans. The company can contribute to the savings account in addition to the employee.
Creating an incentive compensation system
For early-stage companies, creating incentive compensation systems (both monetary and non-monetary) is key.
There are many reasons why people are motivated to work: for money, to be part of a team on a common mission, to feel challenged, to make a positive difference, and to have their talents appreciated. Getting your non-monetary compensation system right is just as important as getting your monetary compensation system right.
Compensation has a few different components to it, including base salary, incentive compensation (also known as bonus compensation), the ability to participate in the upside of a company via stock options or restricted stock units, and your benefits package.
For the first few employees, you will likely have to use every ounce of your persuasive abilities to convince great people to work for you for free or next to nothing. In the beginning, you pay what you can in cash or deferred salary and the rest in an ownership stake in your business.
Once you get to a multi-layered company in which everyone no longer reports to you, which tends to happen around the 5-8 employees mark, it becomes important to define in writing how your employees will be compensated.
The base salary component is generally established at the time of hiring and adjusted annually, or at the time of promotions. Incentive compensation is known by various names, including incentive comp, performance-based pay, variable pay, and bonus.
For incentive pay, you can either create an employee profit-sharing pool or have a bonus for each employee as a percentage of their pay that is paid out quarterly, twice per year, or annually. This allows the management to tie compensation directly to quantitative company, team, and individual performance.
How much of someone’s total compensation should be in the form of performance-based pay depends on their role in the organization.
Sales executives usually have the most amount of their compensation in the form of variable pay, as they are the individuals who are most driven by monetary incentives and want their compensation to be representative of their performance.
For SVPs and VPs outside of sales, 30 percent is a normal amount for variable pay, going down the scale to ten percent at the staff-level, who often want the large majority of their pay to be guaranteed.
The measures that the incentive comp are based on can be set quarterly, semi-annually, or annually. I prefer to set the company and departmental KPIs to which the incentive compensation system is tied twice per year. Every quarter is too often, and once per year doesn’t provide enough flexibility to adjust incentives as the business changes.
The employee should be able to over perform on their incentive compensation if they and the company do really well.
Setting up an options plan
Once you have your incentive compensation plan for each team member, it is time to set up your options plan. Your Board of Directors should approve a pool of shares in your company that you can use for your key team members.
The right size option pool for your company will depend on how much you want to use stock options as part of your compensation mix as well as how much you can pay in cash. If you can pay a market salary, then there’s no need to use stock options widely. If you cannot, they can be of significant use.
Rule of thumb for stock option percentages
It is standard for stock options to invest over four years, meaning that if someone leaves after a year they will only receive twenty-five percent of the total amount.
When you provide stock options to employees you usually provide incentive stock options (ISOs) which have certain tax benefits to non-qualified stock options that can be used for contractors and service providers.
One downside to ISOs is that an employee must usually exercise their incentive stock options within ninety days after they are terminated from employment at your firm.
Even if the options you grant early are at a low price, a cashless tax bill problem can occur when employees later exercise their options. This is because, (at least under current U.S. tax law), a person must pay taxes in the year they exercise stock options on the difference between the current fair market value and the original option strike price.
This is a really bad tax rule, as it causes people to have to pay taxes on stock that usually cannot yet be sold (due to the company being private), often forcing the employee to not be able to exercise the options at all.
Possible solutions include granting Restricted Stock Units (RSUs) instead of options (and pay the taxes on the compensation that year) or to set up a profit-sharing plan, instead of an options plan. But this can be too complicated for early-stage startups, and should be determined alongside company lawyers.
Main photo: Unplash/ Christin Hume
*This article was originally published on October 17th, 2018 and updated on December 11th, 2018.