Ownership is the most important tool for aligning long-term incentives across individuals building a business. At one extreme, Constellation Software has gone so far as to eliminate stock-based compensation entirely and require employees to buy shares with their own cash, creating one of the most aligned ownership cultures in software. If we all have ownership in a company, we are all incentivized to see it succeed and for our equity, or stock, to grow in value over time. This core alignment of individual actors underpins so much of the invisible hand that inherently guides economic prosperity.

For early-stage companies, founders typically own the vast majority, if not all, of the company's stock. Equity can be sold to investors to raise capital to fund operations and kickstart the business. Additionally, employee stock option pools (ESOPs) are set up to grant equity to early employees. 

ESOPs at the Early Stage 

For early employees, joining a startup is typically a very risky move. Startups tend to pay much less than the market, while often demanding much more time and effort. ESOPs are necessary to tip the scales on the reward side; by joining early, employees stand to make millions if they are successful. While valuable early on, ESOPs are not the best long-term tool for keeping employees aligned.

Beyond the early stages of a company, once product-market fit has been established, there is strong revenue generation, and (for venture-funded businesses) significant capital has been raised, cash is no longer a key restraint. 

As the growth slows and the valuation stabilizes, the risk of options going “underwater” emerges. When stock options are granted, they come with a specific exercise price (typically the most recent 409A valuation). For early-stage companies with little revenue traction, that 409A valuation is very low, often an order of magnitude lower than any venture funding round would be. This means that the strike price is relatively cheap for employees to exercise. But this creates issues as businesses mature:

RSUs to the Rescue?

To deal with these drawbacks as companies mature, ESOPs are often phased out for Restricted Stock Units (RSUs). Unlike stock options, RSUs are actual stock and they are granted for free. As they are actual stock, they protect employees from downside risk (if the stock price drops, RSUs still have value; while options can become worthless). This is because RSUs are issued at no cost (the stock can drop from $50 to $10, but it is still worth something) versus an ESOP award being valued at the most recent 409A valuation (the company stock price can drop below this). 

RSUs are also straightforward and easy for everyone to understand. Employees simply receive X amount of RSUs at Y value when they vest; whereas with options, employees need to understand strike prices, exercise windows, and the tax implications of when they chose to exercise.

But granting stock for free is not ideal either, because there is nothing to really lose for employees. There is no risk, or no “skin in the game” as Warren Buffett would say. To solve this, Mark Leonard of Constellation has employees put up their own money to buy into the business.

The Skin in the Game Approach

Unlike many other companies, Constellation provides zero stock-based compensation. Rather, they pay cash bonuses, and a significant part of those bonuses must be used to purchase Constellation stock on the open market, which is then locked up in escrow for four years. For executives, the portion (post-tax) that must be used to purchase stock is 75% (Business Breakdowns). While this is less tax-efficient, this approach forces employees to have skin in the game, encouraging an owner’s mindset of the business over time.

While Constellation’s stock performance has taken a hit over the past year (due to AI-displacement concerns and Mark Leonard stepping down as CEO for health reasons), it has had incredible long-term returns since going public in 2006. The company has posted 32.5% average annualized returns from 2007 through 2025, and only two negative years over the same period (89% rate of positive calendar-year returns).

While Constellation Software’s unique business model of acquiring overlooked small to medium sized software businesses with robust fundamentals is a driving force behind its success, Mark Leonard’s mandatory stock purchase model has made employees true owners in the business with the right incentives for long-term growth.

A great way to think about the psychology for employees and how they will act with granted options or RSUs compared to a mandatory buy-in model is through the lens of famed behavioural economist, Daniel Kahneman, and his theories on loss aversion, the endowment effect, and the “sunk cost” commitment. 

Loss Aversion

In decision-making under risk, people tend to value the prospect of losses more than the prospect of gains. The prospect theory Wikipedia page example scenarios illustrates this perfectly:

“Consider two choice scenarios:

When faced with a risky choice leading to gains, agents are risk-averse, preferring a certain outcome with a lower expected utility. In the example, agents will choose the certain $450 even though the expected utility of the risky gain is higher.

When faced with a risky choice leading to losses, agents are risk seeking, preferring the outcome that has a lower expected utility but the potential to avoid losses (i.e., the value function is convex). Agents will choose the 50% chance of losing $1100 even though the expected utility is lower, due to the chance that they lose nothing at all.” 

Applied to the granting of free stock, prospect theory suggests that since employees paid $0, their “reference point” is zero. If the stock price falls, they have not lost anything, they have only failed to win something. So employees will treat their equity in a company as a lottery ticket rather than as true owners, which could lead to supporting riskier moonshots over safer strategies as they do not feel the pain of failure.

Conversely, if employees put up their own money to purchase stock ($10k for example), their “reference point” shifts to -$10k, which they will fight harder to avoid losing than a potential $10k gain. This creates an ownership mindset.

Endowment Effect

The endowment effect says that we overvalue things that we already own. While employees might have stock options, they are an abstract derivative where no stock is actually owned. With purchased stock, employees would tend to form a stronger emotional attachment and loyalty for stock they have purchased and own compared to options or unvested RSUs.

The “Sunk Cost” Fallacy

Rational actors should ignore “sunk costs”, but most people rarely do (Thinking, Fast and Slow). An employee who has put $10k of their own money into the stock of a company is far less likely to quit when things are not looking great compared to someone who has $10k in free RSUs or, worse, underwater options.

Private Growth Stage Implementation

Constellation Software is a public company that can easily implement this strategy because a readily available liquid public market for its stock exists. A private company would need to 1) value the stock on some basis (often the latest financing round’s valuation) and 2) provide liquidity for employees to sell in the future. Both of which have been implemented in various ways at numerous larger-scale private companies that have RSU programs, such as SpaceX, Databricks, and Stripe.

The key missing ingredient is higher cash compensation and mandatory stock purchases with lockups rather than RSU grants.

Takeaways: Early stage startups are cash poor but equity rich. Stock options are necessary early on in a startup’s lifecycle to motivate employees and reward them for the risk they are taking. As companies mature, find product-market fit, begin generating cash flows, and potentially raise significant capital, resource scarcity changes: the company’s equity becomes incredibly more valuable and cash becomes a more readily available resource. 

While RSUs help solve some of the inherent issues of options (high exercise prices, the potential for underwater options), cash rich growth stage companies should consider a “skin in the game” approach to motivate employees: higher cash-based compensation paired with mandatory stock buying and lockups. While not standard (and will require some employee education), this creates a stronger ownership mentality and long term alignment. As companies stay private longer, we expect more cash-rich private companies with strong fundamentals to strengthen their employee-base and foster this long-term alignment with similar structures.

Have a great weekend,

Josh