In the early days of Netflix, Reed Hastings, Co-Founder and CEO, wanted Patty McCord to help write out the company’s core values. At first, they considered something standard — words like “excellence” and “respect.” Instead, McCord suggested they “write down the things we expect in people.” This simple idea led to an infamous document and philosophy now known as, “Netflix Culture: Freedom & Responsibility.” Sheryl Sandberg even called it “the most important document ever to come out of the Valley.” It’s a living set of “behaviors and skills” that the Netflix management team updated continuously and fastidiously. And it drives toward a single point: a company is like a pro sports team, where good managers are good coaches, and the goal is to field stars in every position.

This is how McCord runs things, with a built-in expectation of high performance, radical honesty, and the motto ‘we’re not family.’ As she explains in her First Round Capital CEO Summit talk, maintaining a “high performance” team is all about instilling people with a sense of both freedom and responsibility. But when you do, you might also need to have some tough conversations.

Saying Goodbye

There’s no tougher conversation than one that begins with “You’re fired.” Especially if the person on the other side of the table is one of that core, band-of-brothers team you started out with. In 2001, the dot-com bust pulled the rug out from under Netflix, dashing IPO dreams and forcing McCord to axe one third of the only 120 people on staff. It was brutal.

"I said goodbye to everyone who wasn’t a classically trained engineer and anyone who wanted to do anything other than DVD by mail at that point," says McCord.

I said goodbye to the whiners and the babies and the people who didn’t believe. If they didn’t believe then we had no chance at all.

But this isn’t the only type of situation that calls for rethinking your team. In fact, that should be a constant process that occurs throughout a startup’s growth.

When it comes to who should stay and who should go, McCord says founders should start by projecting six months into the future. What do you want to have happen with your business in six months? What do you want to be doing in six months that you aren’t doing now? When you think about the skills and talents you’ll need to reach these goals, it’s likely that “you’ll see the delta,” McCord says. In other words, you’ll see the people who don’t have what it takes to get you to where you want to be.

The good news is, letting these people go doesn’t have to be a tragic drama. In fact, McCord says, the people in this “delta zone” usually know it before you do, and haven’t been happy at the company for a while.

McCord advises a constant, six-month, optimistic projection. What could you be doing then that you’re not doing now? “If things are going to be amazing in six months, what does that look like? Who’s talking to who in what meetings? Is everyone excited? Is this person standing up and winning and is that person writing an algorithm that no one else could have put together?” You have to look at the kind of skills and experience it would take for someone to accomplish what you set out to do, and compare that to who you’ve got. “You’ll see the delta,” McCord says. You’ll see that delta person who hasn’t caught up in the last six months and is unlikely to accelerate in the next six.

“The thing to know is this person probably isn’t very happy, and unhappy employees act like it,” says McCord. “You can ask them what’s on your mind? What’s bugging you? And they’ll say, ‘I don’t think people realize how talented I am.’ And the answer is, well yeah, we haven’t realized it because you’re late to everything, and everything you said was going to happen didn’t.” This is where some managers can get sentimental, handing out extra chances, but the basic premise remains that people do work and their companies pay them for it. Leniency shouldn’t be the go-to.

Humans hate two things: being lied to and being spun.

Both are manifested in the popularization of ‘performance improvement plans,’ an HR tool for blocking lawsuits and documenting bad behavior, not actually raising work standards. In McCord’s opinion, too many managers offer performance improvement plans to employees who they know will fail — either because they think it’s the law or they simply don’t want to be mean.

“I tell an employee I’m going to put you on a performance improvement plan, but the truth is they don’t actually know how to do what I need someone in their job to do,” says McCord. “I did my six months out thing and realized she wasn’t qualified, and I put her on a plan even though it’s not an issue of performance, it’s an issue of skillset.” The manager in this situation continues to meet with the employee every Thursday to tell her how bad she is. She cries and feels terrible about herself, and the manager wastes time and energy feeling bad about it too. When the employee is finally fired with no useful feedback, she leaves with a burning resentment, feeling deceived that she ever had a shot.

Here’s how it could have gone down, in McCord’s words: “Instead, I could have told the employee, ‘here’s what I’m going to need six months from now, and here’s the talent and skills I’ll need.’ Then you tell her, ‘It’s not you. I don’t want you to fail. I don’t want to publicly humiliate you.’” With that out in the open, a good manager can offer something generous: 60 to 90 days pay to find a new job, a glowing reference, and hearty thanks for making everything up to that point possible. “She may not like it,” McCord says. “But it’s a hell of a lot better than the other way. People can take it if it’s the truth.”

The Compensation Dance

Startups have three forms of compensation at their disposal: title, equity, pay — a lot to juggle when you’re growing fast. To manage this, McCord suggests leaders bank one of them. “I suggest you bank early on title, because you’ll be wrong. If you have a company of 15 and you make six of them VPs with a director reporting to each, trust me, those will not be your six VPs at 300 people.”

Success will always mean more people, but not everyone will scale with company, and a lot of people will end up with ill-fitting titles. When this happens, offering them more food and beer and simply working harder won’t do the trick. This is why McCord’s made Netflix as flat as possible — every engineer was a senior software engineer.

Not that this didn’t ruffle some feathers. McCord recalls a conversation with a Microsoft engineer turned Netflix candidate. He had worked his way up through his department’s ranks and had the puffed-up title to match. Contemplating the move, one of his top questions was how could he go from being a grandmaster level engineer to a simple senior software engineer? When he moved on, what would the next company think of the step down?

McCord handles these talks with a just-the-facts attitude. “I say, ‘Well if you come to Netflix, we’re going to pay you $350,000 a year to work on something no one else on the planet has ever done. And should you accomplish that, when you go on to your next company and they ask you why you went from this title to that one, you say because they paid me $350,000 a year and I got to accomplish all of this. They’ll get it.”

With title out of the way, that leaves salary and equity. McCord advises, “Spend that equity. You’re hiring risk takers, and that’s often the way to tell if someone is willing to do that.” In the same way, a lack of performance bonuses qualifies who should be there and who shouldn’t. Not only are they difficult to manage in a rapidly changing startup environment — you never know what you’ll be able to budget — it’s never a good idea to shell out early promises.

“I don’t do bonuses because they’re too hard to tag and to be realistic. If you try to do it, there’ll be that one geek on the team who makes a complicated process up to figure out why and how we give bonuses,” says McCord. “But didn’t I say we have a high performance culture? Do we need to incent people to perform? If you’re the kind of person who wouldn’t make a bonus, then we don’t want you. The performance bonus is you’re employed or not.”

General pay talks are also contentious in one way or another, but McCord has a formula to guide her decision making:

If an employee leaves, how much will it cost to replace them?

If an employee says they are leaving, would you beg them to stay?

What would people somewhere else pay them?

In the end, the answers to these three questions can be used in everything from salary negotiations to raise requests. Asking how hard you would fight to keep someone may even determine whether they’re worth paying at all.

‘We’re Broke’

All this tough love isn’t just one-sided though — something McCord knows only too well. Rewinding to the early millennium, when Netflix had just let 30% of its staff go, there was no way the leadership could have predicted a turnaround within the year. Digital media was still in its infancy, DVD players remained expensive, and 9/11 and the subsequent anthrax scare had made opening the mail especially unappealing. The company’s foundation was cracking, and McCord came close to missing payroll. “We were on borrowed money and time was running out,” she says.

What followed was a series of tough conversations — with the employees who were let go, with investors who ended up kicking in a last round of funding and, most importantly, with the employees who remained with no certain futures and a winnowing set of perks.

“The thing is, when we were broke, everyone knew it. And when we got small after the layoff, we had a meeting every week in the parking lot. We called it the metrics meeting, and we’d hand out a piece of paper with nine charts showing exactly how much money we had in the bank, how many customers we had, you know like a basic P&L,” shares McCord. “We taught everyone the fundamentals. They could see payroll versus revenue.”

It was all about setting the right context, rather than controlling people’s actions. Making objectives, metrics and roles clear will always yield better results than top-down micro-management and decision by committee. When a project or employee fails, your first question should be, “Where did the context fail?” High performance people will do better work if they understand the context and are turned loose to work within it. In the early 2000s, Netflix’s context was simply, “we’re broke,” and everyone acted accordingly.

Of course, this strategy can have its downsides. People panic easily over numbers, but McCord holds that the right people will stick with you, especially if you’re straight with them about the situation. How to find these people? “Ask them in the interview, what’s the riskiest thing they’ve ever done? What’s the scariest thing they’ve ever done? Ask them personally and you’ll get a better answer.”

Freedom & Responsibility

Trusting employees to make the best decisions for themselves and the company is a huge part of building a great team. This means you have to give them the rope to be creative and work on their own terms. But you also need to make sure everyone has a built-in commitment to your company’s success above all.

A prime example of this dichotomy is Netflix’s vacation policy. That’s to say, it’s lack of one. The fact that the company lets employees decide when and how much vacation to take has gotten a lot of news coverage and is now commonplace in Silicon Valley, but when McCord proposed the idea, it was groundbreaking. “You rely on everybody to understand the rhythms of how they work, not just with their manager but with all of their co-workers, and make sure everything gets covered.” When asked if employees exploit the policy’s absence, McCord shakes her head. “If you want to take six months off, then you actually want to quit."

Sometimes you just have to use your reptile brain. If something sounds stupid, it is stupid.

The same goes for Netflix’s non-existent travel policy. There’s no documentation outlining sanctioned hotels, or corporate rates, or appropriate per diems. Traveling employees are trusted to use common sense. “You can ask for adult behavior from almost everybody, really,” McCord says. “You just have to call them on it.” Employees should know that their traveling expenses end up on the company’s tab and that it’s money is their money. Those who want the best for the whole will be more prudent.

When it comes to these decisions, McCord says it all boils down to belief — how much do people believe in the business. That’s how invested they will be in its success.

“Here’s what you want in your first 100 employees: the best talent you can afford, who work hard and believe,” she says. “The belief part can actually outdo the other two. It’s more than passion. Passion is such an interpretive statement. People need to believe.”