Looks like you lose them. "It should reward current employees. This was about who was at the company at the time of a sale/IPO, not people who worked here years ago."
I think it makes a lot more sense to give lower-level employees yearly performance bonuses than illiquid equity. Lower-level employees generally don't have sufficient information or perspective about the company's performance or long-term outlook to make an informed decision about exercising illiquid options. As a result, most low-level employees value illiquid equity at 0 these days. On the other hand, their individual, short-term performance can be evaluated according to objective standards much more easily than a similar evaluation can be made for management.
Asking an employee being promoted to management to give up the possibility of future performance bonuses in return for equity is also an effective way of making sure management is aligned with the long-term success of the company.
If you have no intension of every going public or selling the company do you still fall inside the current definition of a startup?
It seems unfair, if the founders are able to sell their equity privately.
Overall, in a startup my view is that equity offsets the risk that the company might just disappear. You're taking on that risk, you should get to keep that equity compensation (even if you leave).
From the employers point of view, equity should help motivate staff so they don't just consider their own job security, but overall company success.
If you're never going to IPO, perhaps do that via dividends? Or other profit sharing mechanism.
Why is this unfair? Since when do employees feel entitled to own a part of the company -- but only if it goes well, right? Wouldn't it be more fair if they had to pay up if the company went under?
Misplaced sense of entitlement, this. You work for a company, they pay you. What the owners/founders do with it is up to them. And if you think this is unfair, then you should probably start your own -- with all the risks, hardships and possible benefits that come with it.
For non-profitable companies, option/equity/eventual-bonus like this one are good ways to dingle the carrot to motivate people. For profitable companies that have no plan to get liquidated, an annual dividend or bonus is fairer.
This is a cute system and I'm not going to be against a company having a secret bonus that might give employees free money. But c'mon, don't write a blog post about how this is great. This system is much worse than equity. This is basically like a lottery that might give extra money to employees lucky enough to be presently employed in case the magic numbers hit.
The whole point of equity is to incentivize people to create value for the company and give them upside in case the company does grow a lot (how people personally value equity is another story, but the incentive is the same). This plan doesn't do that at all...
1) The company says it has no plans to exit so there really isn't an incentive for an employee to think their contributions might return them upside.
2) The 5% figure for all employees is tiny. A growing startup might give away 5-10% in equity, per year, to employees via stock grants. This is 5% total. Every year that goes by employees should own more of the company because they are doing more of the work, a fixed number makes no sense.
3) Past employees who might have made significant contributions and created tons of value get nothing. Do you think if any founders leave they are giving up their real equity?
> it’s a great alternative to the organizational complexity of option grants, acceleration, strike prices, conversion into shares, private markets vs. public markets, dilution by outside parties, partial vesting, etc.
So no, it isn't a great alternative to equity, it does completely different things. It is a random bonus that nobody can expect which is loosely correlated with whatever value they may have contributed. This is certainly better than no bonus, but maybe is worse than a good bonus (though they might also have other bonuses, I have no idea).
3) Past employees who might have made significant contributions and created tons of value get nothing
is an issue because ISO options expire at most 90 days after termination. Some companies have begun to provide terms that allow employees to exercise their options for much longer (7 years in Pinterest's case I believe), but this is far from a universally accepted practice.
Yes there are a bunch of companies with extended exercise windows now [1]! I'm a huge proponent of extended exercise windows and would personally never work at a company that didn't offer that.
However, even ISOs with 90 day expiry periods are way better than this. If you are presently employed at the company at the time of IPO/acquisition then you don't have any issue with the 90 day window, and if you do run into the 90 day window at least you have the choice to exercise them or not. And if early exercise is available then you could exercise options early on when the company is worth very little and then not have to worry about the 90 day expiry period later.
Also, every plan allows for exercise of vested options. While this might not be tax advantageous you can use the options and get the stock at a sweetheart price. If you believe in the company this still seems like a good deal.
1. They don't plan to exit, which is why they pay well and have good benefits. It says right in the article that this shouldn't be factored into fair compensation; it's extra. Equity is factored into compensation if it's worth anything, or it's valued at $0 and not factored in. So an employee at 37signals is making more right now because of this 'exit benefit' than they would if they had equity.
2. The article says it's a 5% minimum and gives an example of a spinoff sale where 100% was distributed. If the company is successful, having a fixed share in this pool increases in value every year, just like equity. If it's not too successful, than the value stays steady; a startup giving away 5-10% every year not successful should be diluting its employees.
3. Early employees often don't realize much of their equity for a variety of reasons. Often, these reasons aren't really understandable by the employee when they took the job. The system in the article is very easy to understand.
Being upfront about good, full salaries and benefits and throwing this on top just to make sure, in the unlikely event of an exit, there's a simple system to make sure employees aren't left out and have a much easier transition does indeed sound like a great alternative.
4) a bonus paid at time of exit will be subject to regular income tax, while options can (but don't always) benefit from long term capital gains tax.
Rough example: if an employee were to benefit to the tune of $1M due to sale of company, under this system, they would be taxed in the highest bracket, at 39.6%, plus FICA withholdings, so they'd end up getting less than $600K from the sale. If they had options instead, and had held them for at least a year, they'd pay 20% in capital gains, so they'd walk home with $800K.
Your plan is costing your employee $200K+ in this scenario, with no commensurate benefit to the company.
If you don't want to give options, why not do profit sharing instead? Let current employees who have been with the company longer than 1 year enjoy some cut of the profits each year the company has them?
> If they had options instead, and had held them for at least a year, they'd pay 20% in capital gains, so they'd walk home with $800K.
That isn't the case. They would be taxed as regular income if you waited to exercise them until the exit.
In order to be taxed as long term capital gains they'd need to exercise them and hold them for a year. When they exercise them they would be taxed as regular compensation based on the fair market value. That isn't without its risks - if the value of the options declines it's possible to lose money.
I should have said "if they held exercised options." You are absolutely right if not exercised, and right that there are always risks of declining value if held. It is possible, btw, to exercise options prior to exit.
In practice, there is often a mandatory holding period for sale of options after IPO and even after sale of company when stock is converted to stock in the acquiring company, so that risk doesn't disappear by virtue of choosing to not hold.
Personally, I'd take the risk of decline in value over the non-risk of a guaranteed 20% reduction in value, but undoubtedly you can find examples of companies which do lose more than 20% over the 12 months after exit.
My point is simply that the arrangement to pay out bonus in the event of an exit begins in the hole 20% over the arrangement to give out stock. And the worst part of this is it doesn't even accrue 20% more to the company or to other stock holders -- it just evaporates due to bad tax planning. I guess those who experience this can take some solace in their loss buying more roads, missiles, schools, corporate tax breaks, or whatever preferred tax policy they'd like to imagine contributing to.
I'm not anti-tax. Taxes are good, and people should feel good about paying them, mostly. But low long term capital gains exist for a reason. The government is incentivizing the exact type of investment that stock options can represent.
YMMV. In some countries you have to pay taxes when you receive options -- as opposed to when you exercise them. This can make it impossible for some people to receive options, as they may not be able to afford the taxes.
If my company offered to reward me with a brand new car I might not be able to accept it because of the requirement to pay the taxes - but I wouldn't think that the tax man was being unreasonable.
I don't really understand why you'd expect the tax code to allow you to receive options tax free? If they have a fair market value then receiving them as part of comp should be taxed as such.
We did something like this, and the goal was absolutely not "to incentivize people to create value for the company."
For a venture-backed startup, that can make sense, but for us it didn't. The company already had value when people joined and not only was "an exit" not guaranteed, it was quite unlikely. We built the company to run it indefinitely. I believe I used a phrase like "In the very unlikely event that the company changes hands.." to introduce this bonus.
Because of those differences, this isn't compensation or incentive and, as you noticed, it doesn't try to be. Think of this as electively sharing a neat event with those who have invested part of their career in the company.
I've always been curious about trying a system that rewarded people for the value they created now, instead of owning shares/options and waiting for a liquidity event. Bonuses are the traditional option I guess, but is there anything else? How else might you distribute a portion of funds earned by the company in a meaningful manner to employees?
All forms of cash comp are things startups will want to minimize for burn rate reasons. Also, startups are risky and giving out lots of cash comp takes employee risk out of the game, which is arguably undesirable.
That's great but only for profitable companies which doesn't describe most startups. The other reason they usually use equity is because they're relatively cash poor
The company I work for has in past years paid a bonus based on metrics that try to approximately characterize the value being created at the company. This could be considered an alternative to profit-share for companies that have no profit.
Preferred stockholders usually have terms on their preferred shares that entitle them to a cut of any dividend paid. I think that in those cases, most of the dividend would end up going to the investors which is probably not what's intended.
I like the idea as a way to distribute gains to employees. Wondering why the units are limited to integer years rather than allowing constant accrual up to the 5 units.
Additionally, it seems unfair that employee units go immediately to 0 upon leaving, rather than some sort of decay. They're saying that employees contributed to the success and deserve a bonus, why would that contribution be worth nothing the minute they leave? Something like an exponential decay on the units seems much more equitable.
Subject to the problems above I much prefer this system to one of giving out options. It is nice and transparent and would give me a bit more confidence in actually getting a payout than the more usual options route.
Having said that I did work for a company that did something like this and didn't follow though (with creating the trust etc). When they eventually sold they made employees a cash offer to sign away they rights. Money was equivalent to a couple of months pay which is more than I've made on any other company share incentive..
This is an unbelievably bad plan to the point of sending a strong negative signal to former employees or any potential hires.
Sure a typical option plan is loaded with cliff, restrictions on sale, vesting/expiration but at least end of the day you end up owning a "share" of the company however unpreferential it might be. Something which has at least some form of legal precedent.
This on the other hand riducules the intelligence of an average employee and is equivalent to playing a near-sociopathic trick where everyone is "equal" so you better not ask for higher share or salary.
To comapre this in same light as options/RSU or even bonuses is an insult.
Another alternative that is not often discussed in technology circles is to form cooperative businesses where workers wholly own the business and make democratic decisions about its governance. Why should the workers, who produce the value, not be paid according to their contributions? Why do we need management to tell us what to do and siphon off the surplus profits in the process?
If the workers are doing everything, why don't they found the company themselves and get rich thereby?
If it were that easy, surely everybody would be doing it and we would have only self-employment.
Reasons are numerous but risk aversion (and lack of willingness to deal with consequences in case of a negative outcome) is probably one of the biggest among them.
Even if they don't decide to go public, equity can pay dividends. Maybe it was just me but it felt like the founders are just trying maximize their upside by dangling a small bone for employees. But let'a not forget who this is benefiting. I'd love to hear from some Basecampers on this.
Maybe I'm not familiar with how equity works but this seems to have all sorts of weird properties like how after 5 years the amount of money you would get starts to decrease (assuming that the total number of units rises, which in this system it is almost assured to), the amount of money you get decreases as more people join, and if you leave you get nothing at all. The cap on what percentage employees get seems weird to me and it really messes with the math in a way that seems to screw the employees.
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[ 7.4 ms ] story [ 129 ms ] threadI couldn't see any explanation on how this idea compares to one of the biggest issue with options, namely leaving the company before it gets sold.
So say I work at basecamp for 5 years, and then leave to work somewhere else. What happens to my 5 units?
Asking an employee being promoted to management to give up the possibility of future performance bonuses in return for equity is also an effective way of making sure management is aligned with the long-term success of the company.
It seems unfair, if the founders are able to sell their equity privately.
Overall, in a startup my view is that equity offsets the risk that the company might just disappear. You're taking on that risk, you should get to keep that equity compensation (even if you leave).
From the employers point of view, equity should help motivate staff so they don't just consider their own job security, but overall company success.
If you're never going to IPO, perhaps do that via dividends? Or other profit sharing mechanism.
Misplaced sense of entitlement, this. You work for a company, they pay you. What the owners/founders do with it is up to them. And if you think this is unfair, then you should probably start your own -- with all the risks, hardships and possible benefits that come with it.
Company 2: Startup with 1.5 years runway.
If the pay is the same, equity compensates for lack of job security in company 2.
The whole point of equity is to incentivize people to create value for the company and give them upside in case the company does grow a lot (how people personally value equity is another story, but the incentive is the same). This plan doesn't do that at all...
1) The company says it has no plans to exit so there really isn't an incentive for an employee to think their contributions might return them upside.
2) The 5% figure for all employees is tiny. A growing startup might give away 5-10% in equity, per year, to employees via stock grants. This is 5% total. Every year that goes by employees should own more of the company because they are doing more of the work, a fixed number makes no sense.
3) Past employees who might have made significant contributions and created tons of value get nothing. Do you think if any founders leave they are giving up their real equity?
> it’s a great alternative to the organizational complexity of option grants, acceleration, strike prices, conversion into shares, private markets vs. public markets, dilution by outside parties, partial vesting, etc.
So no, it isn't a great alternative to equity, it does completely different things. It is a random bonus that nobody can expect which is loosely correlated with whatever value they may have contributed. This is certainly better than no bonus, but maybe is worse than a good bonus (though they might also have other bonuses, I have no idea).
However, even ISOs with 90 day expiry periods are way better than this. If you are presently employed at the company at the time of IPO/acquisition then you don't have any issue with the 90 day window, and if you do run into the 90 day window at least you have the choice to exercise them or not. And if early exercise is available then you could exercise options early on when the company is worth very little and then not have to worry about the 90 day expiry period later.
1: https://github.com/holman/extended-exercise-windows
1. They don't plan to exit, which is why they pay well and have good benefits. It says right in the article that this shouldn't be factored into fair compensation; it's extra. Equity is factored into compensation if it's worth anything, or it's valued at $0 and not factored in. So an employee at 37signals is making more right now because of this 'exit benefit' than they would if they had equity.
2. The article says it's a 5% minimum and gives an example of a spinoff sale where 100% was distributed. If the company is successful, having a fixed share in this pool increases in value every year, just like equity. If it's not too successful, than the value stays steady; a startup giving away 5-10% every year not successful should be diluting its employees.
3. Early employees often don't realize much of their equity for a variety of reasons. Often, these reasons aren't really understandable by the employee when they took the job. The system in the article is very easy to understand.
Being upfront about good, full salaries and benefits and throwing this on top just to make sure, in the unlikely event of an exit, there's a simple system to make sure employees aren't left out and have a much easier transition does indeed sound like a great alternative.
4) a bonus paid at time of exit will be subject to regular income tax, while options can (but don't always) benefit from long term capital gains tax.
Rough example: if an employee were to benefit to the tune of $1M due to sale of company, under this system, they would be taxed in the highest bracket, at 39.6%, plus FICA withholdings, so they'd end up getting less than $600K from the sale. If they had options instead, and had held them for at least a year, they'd pay 20% in capital gains, so they'd walk home with $800K.
Your plan is costing your employee $200K+ in this scenario, with no commensurate benefit to the company.
If you don't want to give options, why not do profit sharing instead? Let current employees who have been with the company longer than 1 year enjoy some cut of the profits each year the company has them?
That isn't the case. They would be taxed as regular income if you waited to exercise them until the exit.
In order to be taxed as long term capital gains they'd need to exercise them and hold them for a year. When they exercise them they would be taxed as regular compensation based on the fair market value. That isn't without its risks - if the value of the options declines it's possible to lose money.
In practice, there is often a mandatory holding period for sale of options after IPO and even after sale of company when stock is converted to stock in the acquiring company, so that risk doesn't disappear by virtue of choosing to not hold.
Personally, I'd take the risk of decline in value over the non-risk of a guaranteed 20% reduction in value, but undoubtedly you can find examples of companies which do lose more than 20% over the 12 months after exit.
My point is simply that the arrangement to pay out bonus in the event of an exit begins in the hole 20% over the arrangement to give out stock. And the worst part of this is it doesn't even accrue 20% more to the company or to other stock holders -- it just evaporates due to bad tax planning. I guess those who experience this can take some solace in their loss buying more roads, missiles, schools, corporate tax breaks, or whatever preferred tax policy they'd like to imagine contributing to.
I'm not anti-tax. Taxes are good, and people should feel good about paying them, mostly. But low long term capital gains exist for a reason. The government is incentivizing the exact type of investment that stock options can represent.
I don't really understand why you'd expect the tax code to allow you to receive options tax free? If they have a fair market value then receiving them as part of comp should be taxed as such.
For a venture-backed startup, that can make sense, but for us it didn't. The company already had value when people joined and not only was "an exit" not guaranteed, it was quite unlikely. We built the company to run it indefinitely. I believe I used a phrase like "In the very unlikely event that the company changes hands.." to introduce this bonus.
Because of those differences, this isn't compensation or incentive and, as you noticed, it doesn't try to be. Think of this as electively sharing a neat event with those who have invested part of their career in the company.
Additionally, it seems unfair that employee units go immediately to 0 upon leaving, rather than some sort of decay. They're saying that employees contributed to the success and deserve a bonus, why would that contribution be worth nothing the minute they leave? Something like an exponential decay on the units seems much more equitable.
Having said that I did work for a company that did something like this and didn't follow though (with creating the trust etc). When they eventually sold they made employees a cash offer to sign away they rights. Money was equivalent to a couple of months pay which is more than I've made on any other company share incentive..
Sure a typical option plan is loaded with cliff, restrictions on sale, vesting/expiration but at least end of the day you end up owning a "share" of the company however unpreferential it might be. Something which has at least some form of legal precedent.
This on the other hand riducules the intelligence of an average employee and is equivalent to playing a near-sociopathic trick where everyone is "equal" so you better not ask for higher share or salary.
To comapre this in same light as options/RSU or even bonuses is an insult.
If it were that easy, surely everybody would be doing it and we would have only self-employment.
Reasons are numerous but risk aversion (and lack of willingness to deal with consequences in case of a negative outcome) is probably one of the biggest among them.