4 ms·

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

by birken 10y ago

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).

williamscales 10y ago
Well-put. I'll only add that even with options, 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.
- birken 10y ago
  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. 1: https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows
  - terravion 10y ago
    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.
deleted 10y ago
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1123581321 10y ago
Based on the entire article, I don't agree. 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.
- deleted 10y ago
  [deleted]
alenlpeacock 10y ago
I'll add another: 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?
- wefarrell 10y ago
  > 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.
  - alenlpeacock 10y ago
    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.
troydavis 10y ago
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.

by birken 10y ago

williamscales 10y ago

Well-put. I'll only add that even with options, 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.

birken 10y ago
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. 1: https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows
- terravion 10y ago
  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.

deleted 10y ago

[deleted]

1123581321 10y ago

Based on the entire article, I don't agree. 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.

deleted 10y ago
[deleted]

alenlpeacock 10y ago

I'll add another: 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?

wefarrell 10y ago
> 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.
- alenlpeacock 10y ago
  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.

troydavis 10y ago

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.