4 ms·

I just started working somewhere that does a different equity scheme called “profit interest.” The gist is, they issue you equity whose worth is based on growth

I just started working somewhere that does a different equity scheme called “profit interest.” The gist is, they issue you equity whose worth is based on growth in valuation from when you joined. So if you’re granted 1% shares and the company grows from 100m to 200m on liquidity, you’re entitled to 1m. It avoids you having to front money for stock options, and it also avoids the tax burden b/c when issued, the shares are worth zero dollars

thomasahle 6y ago
> So if you’re granted 1% shares and the company grows from 100m to 200m on liquidity, you’re entitled to 1m. It avoids you having to front money for stock options, and it also avoids the tax burden b/c when issued, the shares are worth zero dollars Isn't that just like normal stock options?
- konschubert 6y ago
  It appears to simulate the normal stock options. Seems to be motivated by tax reasons. I think I've seen this called a "virtual option plan".
  - londons_explore 6y ago
    It might behave differently to dilution too...
- rutthenut 6y ago
  The 1% options would be one percent of shareholdings at the time the option was offered. With more shares created/sold later, the dilution means when the options mature, they will be less than 1% of the total company shareholding, or value.
ericbarrett 6y ago
It is pretty remarkable if it prevents dilution. Are you sure there's no weasel-wording in your contract that allows arbitrary changes in the future, has funky exercise restrictions, etc.? Their special tax structure makes me suspicious as well (if this is the US). Sadly I think VCs saw all the mini-millionaires being created at FAANGs in the last decade and have pressured many companies into watering down stock compensation, since it's "lost money."
- srtjstjsj 6y ago
  I don't think it prevents dilution. Hard to believe investors would agree to a scheme where new rounds pay a % fee directly to employees.
  - roflc0ptic 6y ago
    It doesn't. It's basically still monopoly money. According to the org, they've had 3 or 4 rounds of financing, and each time they've taken on new funding they've distributed new shares to offset the dilution. This isn't policy they've committed to, just something they've opted to do.
- roflc0ptic 6y ago
  Yes, I was suspicious, too. They offset my suspicions by 1. paying me a generous salary, and 2. giving me time to talk to an accountant about it. The accountant had never heard of it, but looked into it and it was legit. The reason that it's unfamiliar is because it's so danged advantageous to the employees. There is some room for them to dilute the shares out of existence. Notably I don't have to exercise them, I already "own" them. The vesting schedule is really more of a forfeiture schedule. If I leave after a year, I forfeit 3/4s of them. Otherwise, they're mine into perpetuity, until liquidation.
  - deleted 6y ago
    [deleted]
simonebrunozzi 6y ago
I believe that the tax treatment of your hypothetical Million dollars is different than the treatment of an equivalent Million dollars earned through stock options. I am not an accountant, so please correct me if I'm wrong.
- roflc0ptic 6y ago
  I think it falls under capital gains.
dd36 6y ago
Doesn’t that just mean you work for an LLC?
- brianwawok 6y ago
  Yah, I think this is fairly common in the LLC world. You don’t want to get equity in LLc, equity = tax burden. You own 1% equity in a LLC and profit 100 million dollars? Congratulations, you now owe the tax on 1 million in income, even if you saw none of the income and have no way to sell your shares.
- roflc0ptic 6y ago
  Yes, it's an LLC.
  - mizzao 6y ago
    Are you at one of the 4Catalyzer companies?
    - roflc0ptic 6y ago
      Nah, distributed ledger stuff.
mizzao 6y ago
Can you share more about this? Trying to figure out how to be fair to future employees as a founder and considering all the options
- roflc0ptic 6y ago
  https://www.investopedia.com/terms/p/profits-interest.asp https://www.investopedia.com/terms/p/profits-interest.asp In some detail. There's one thing that some of these articles claim that isn't quite right. Because this arrangement technically makes employees in a partnership, per the IRS this means they have to pay their own side of social security and isn't entitled to e.g. health insurance. It turns out the department of labor has issued conflicting guidance: if I am, for all intents and purposes, employed by a company, then I am to be paid as a W2 employee and am entitled to benefits. My company has chosen to follow the department of labor's guidance.
chollida1 6y ago
Help me understand this as it sounds interesting. So when do you get this equity? Is it only at a liquidity event? Because normally you pay taxes when you get something of value, equity in this case but you can't always sell said equity due to your company being private. I'm assuming your company is private as a public company doesn't have these issues, they just give you stock, you sell stock, everyone is happy. Or put another way, how does this setup not give you a tax bill each year, assuming you get your equity each year, that you have to pay with your own cash?
- roflc0ptic 6y ago
  So I'm fairly ignorant about these things, but I'll give it a go. My company is an LLC. In a sense, I have this equity. This is how the value is defined: Value = Percent_Of_Shares *(Current_Price_Of_Company - Price_of_Company_At_Time_Of_Issuance) Note that, on the day these issued to me, the value here is equal to zero, because the current price of company is equal to the price of company at time they are issued. Thus, I have received something which has no value, and thus have no tax burden. Technically I'm now a partner in the LLC. This has tax implications: when the company is making money, I owe tax money on that. However, they're in growth mode, and losing money, which means I get to carry a tax writeoff. Further, it's written into the company's bylaws that if they make money, they're obligated to give employees a distribution equal to the tax burden that the employee will incur, i.e. when there is a tax burden outside of a liquidation event, they are obligated to give me enough money to cover it. Also, if they sell the company, my shares are vested immediately. I don't know what happens to them covering the taxes if I leave; maybe I become liable for it, and there's a downside there. The shares are non transferrable, which is lame but apparently quite standard.
  - roflc0ptic 6y ago
    I only make money on this in the case of a liquidity event, or if the company decides to start paying "dividends" or whatever the appropriate finance word is here.
    - deleted 6y ago
marcus_holmes 6y ago
Private company valuations are invented out of whole cloth by the board for lots of reasons, almost none of which are an accurate reflection of the actual growth of the company. Same for profit sharing - profit is an entirely invented number. It doesn't really solve the problem of options being too easy to fiddle and too hard to cash in. I get the tax advantages of this, though. But I expect if it became common the taxman would want their cut of the nominal growth in value each year, or something. Bastards.

thomasahle 6y ago

> So if you’re granted 1% shares and the company grows from 100m to 200m on liquidity, you’re entitled to 1m. It avoids you having to front money for stock options, and it also avoids the tax burden b/c when issued, the shares are worth zero dollars Isn't that just like normal stock options?

konschubert 6y ago
It appears to simulate the normal stock options. Seems to be motivated by tax reasons. I think I've seen this called a "virtual option plan".
- londons_explore 6y ago
  It might behave differently to dilution too...
rutthenut 6y ago
The 1% options would be one percent of shareholdings at the time the option was offered. With more shares created/sold later, the dilution means when the options mature, they will be less than 1% of the total company shareholding, or value.

ericbarrett 6y ago

It is pretty remarkable if it prevents dilution. Are you sure there's no weasel-wording in your contract that allows arbitrary changes in the future, has funky exercise restrictions, etc.? Their special tax structure makes me suspicious as well (if this is the US). Sadly I think VCs saw all the mini-millionaires being created at FAANGs in the last decade and have pressured many companies into watering down stock compensation, since it's "lost money."

srtjstjsj 6y ago
I don't think it prevents dilution. Hard to believe investors would agree to a scheme where new rounds pay a % fee directly to employees.
- roflc0ptic 6y ago
  It doesn't. It's basically still monopoly money. According to the org, they've had 3 or 4 rounds of financing, and each time they've taken on new funding they've distributed new shares to offset the dilution. This isn't policy they've committed to, just something they've opted to do.
roflc0ptic 6y ago
Yes, I was suspicious, too. They offset my suspicions by 1. paying me a generous salary, and 2. giving me time to talk to an accountant about it. The accountant had never heard of it, but looked into it and it was legit. The reason that it's unfamiliar is because it's so danged advantageous to the employees. There is some room for them to dilute the shares out of existence. Notably I don't have to exercise them, I already "own" them. The vesting schedule is really more of a forfeiture schedule. If I leave after a year, I forfeit 3/4s of them. Otherwise, they're mine into perpetuity, until liquidation.
- deleted 6y ago
  [deleted]

simonebrunozzi 6y ago

I believe that the tax treatment of your hypothetical Million dollars is different than the treatment of an equivalent Million dollars earned through stock options. I am not an accountant, so please correct me if I'm wrong.

roflc0ptic 6y ago
I think it falls under capital gains.

dd36 6y ago

Doesn’t that just mean you work for an LLC?

brianwawok 6y ago
Yah, I think this is fairly common in the LLC world. You don’t want to get equity in LLc, equity = tax burden. You own 1% equity in a LLC and profit 100 million dollars? Congratulations, you now owe the tax on 1 million in income, even if you saw none of the income and have no way to sell your shares.
roflc0ptic 6y ago
Yes, it's an LLC.
- mizzao 6y ago
  Are you at one of the 4Catalyzer companies?
  - roflc0ptic 6y ago
    Nah, distributed ledger stuff.

mizzao 6y ago

Can you share more about this? Trying to figure out how to be fair to future employees as a founder and considering all the options

roflc0ptic 6y ago
https://www.investopedia.com/terms/p/profits-interest.asp https://www.investopedia.com/terms/p/profits-interest.asp In some detail. There's one thing that some of these articles claim that isn't quite right. Because this arrangement technically makes employees in a partnership, per the IRS this means they have to pay their own side of social security and isn't entitled to e.g. health insurance. It turns out the department of labor has issued conflicting guidance: if I am, for all intents and purposes, employed by a company, then I am to be paid as a W2 employee and am entitled to benefits. My company has chosen to follow the department of labor's guidance.

chollida1 6y ago

Help me understand this as it sounds interesting. So when do you get this equity? Is it only at a liquidity event? Because normally you pay taxes when you get something of value, equity in this case but you can't always sell said equity due to your company being private. I'm assuming your company is private as a public company doesn't have these issues, they just give you stock, you sell stock, everyone is happy. Or put another way, how does this setup not give you a tax bill each year, assuming you get your equity each year, that you have to pay with your own cash?

roflc0ptic 6y ago
So I'm fairly ignorant about these things, but I'll give it a go. My company is an LLC. In a sense, I have this equity. This is how the value is defined: Value = Percent_Of_Shares *(Current_Price_Of_Company - Price_of_Company_At_Time_Of_Issuance) Note that, on the day these issued to me, the value here is equal to zero, because the current price of company is equal to the price of company at time they are issued. Thus, I have received something which has no value, and thus have no tax burden. Technically I'm now a partner in the LLC. This has tax implications: when the company is making money, I owe tax money on that. However, they're in growth mode, and losing money, which means I get to carry a tax writeoff. Further, it's written into the company's bylaws that if they make money, they're obligated to give employees a distribution equal to the tax burden that the employee will incur, i.e. when there is a tax burden outside of a liquidation event, they are obligated to give me enough money to cover it. Also, if they sell the company, my shares are vested immediately. I don't know what happens to them covering the taxes if I leave; maybe I become liable for it, and there's a downside there. The shares are non transferrable, which is lame but apparently quite standard.
- roflc0ptic 6y ago
  I only make money on this in the case of a liquidity event, or if the company decides to start paying "dividends" or whatever the appropriate finance word is here.
  - deleted 6y ago

marcus_holmes 6y ago

Private company valuations are invented out of whole cloth by the board for lots of reasons, almost none of which are an accurate reflection of the actual growth of the company. Same for profit sharing - profit is an entirely invented number. It doesn't really solve the problem of options being too easy to fiddle and too hard to cash in. I get the tax advantages of this, though. But I expect if it became common the taxman would want their cut of the nominal growth in value each year, or something. Bastards.