Firm investments in employee-led startups are a win-win

New research from Martin Wiernsperger, assistant professor of accounting at the Samuel Curtis Johnson Graduate School of Management in the Cornell SC Johnson College of Business, shows that firms making equity investments in employee startups has a positive impact on their motivation and productivity. Employees maintain strong effort across both startup-related tasks and core business tasks, benefiting both firms and employees.

“Top employees are smart, hardworking people, and they usually get business ideas in their day-to-day work life,” Wiernsperger said. “Since they are high performers in the workforce, it’s really important for firms to keep them and not lose them to other firms or the startup sector.”

Firms with a culture of innovation, particularly in tech, healthcare and biotech, often establish startup sponsorship programs to accommodate entrepreneurial-minded employees. However, since financial resources are limited within a firm’s startup sponsorship programs, they tend to be highly selective. If investment is denied to an employee, the framing of the company’s decision is critical for their future motivation.

“The vast majority of people who apply get denied,” Wiernsperger said. “So, it’s very important to understand not just the positive reaction of the few cases where employees get into the programs, but to also understand how the majority behaves when denied.”

Wiernsperger measured motivation outcomes by having study participants pose as both firm investors and employees in a simulated game. The employees could choose to either work on core business tasks — rote, simple work that contributes to firm profits — or startup work, a knowledge-intensive task with a chance of failure.

If the firm’s investment is framed like a gift — such as a discretionary grant or bonus — and denied to the employee, their reaction is very negative, impacting their motivation and productivity. If they don’t outright leave the company, they’re much more likely to “quiet quit” or fulfill the bare minimum requirements of their role while scaling back effort.

This negative reaction can be attributed to reciprocity theory, the social norm that perceived kindness should be returned with kindness and vice versa. When a company shows perceived unkindness by denying a gift that employees feel they deserve, it violates an unspoken social contract they are no longer motivated to uphold.

On the other hand, if the firm offers an equity investment in their startup, employees are much more understanding when the firm denies the investment. This type of rejection is viewed as a business decision rather than a personal decision.

“They know that the firm cannot invest in every single startup, and they know that there is a lot of risk involved for the firm, so they have to deny many of those entrepreneurial projects,” Wiernsperger said. “If this is more like a business transaction, then having investment denied is not personal, it’s just part of the process.”

When an equity investment is denied, the employee still retains high motivation across startup and firm tasks. Since their relationship with the firm remains strong and their startup’s success is proportionally related to effort, productivity holds steady in both areas despite the employee having more responsibilities.

The same is true when their startups receive either gifts or equity investments, but for employees with high expectations of startup success, equity investments actually motivate more effort than gifts because it’s a sign of the firm’s confidence in their abilities.

“When the firm decides to fund an employee’s startup idea, it’s a very strong signal that they really believe in what the employee can do,” Wiernsperger said. “They’re saying ‘I think you can do it. We know it’s very unlikely, but we still put money into your venture.’ I find that it’s motivating not only in the startup, but that this also spills over and motivates them on their core tasks.”