6 ms·

An alternative to employee options/equity grants

93 points by InfinityX0 15y ago

pchristensen 15y ago
I think this is a really smart, fair program that every startup should read, especially since most companies (even those that want to) don't get sold/IPO at a huge price that makes tiny options worthwhile.
smackfu 15y ago
It's like anti-profit sharing. The employees own part of the company, but only for acquisitions and not for profits.
- seiji 15y ago
  They already have profit sharing though (it's where the million dollar cars come from).
  - roel_v 15y ago
    Uh? Regular employees of a company with million-dollar cars? Quite incredible claim. Even Google pays what, half a million or so to top engineers from what I read left and right? You don't drive million dollar cars on a salary (any salary).
    - borism 15y ago
      what car costs million dollars anyway? Lamborghini Gallardo is "only" quarter of a mil... And Veyron is way above (couple of) million.
      - true_religion 15y ago
        Base price of a Veyron is 1.7 million dollars. Lamborghini Murcielago, 2010, premiered at $400,000 to $600,000. However, when people are talking about a million dollar car they're most likely remembering the McLaren F1 which sold for $970,000 back in 1998.
    - qq66 15y ago
      I wouldn't call him a "regular employee" but incredible claim or not, DHH definitely did purchase a million dollar car recently.
      - roel_v 15y ago
        So I googled 'dhh car' and it turns out he is the owner of some company, hardly a 'regular employee'.
- tptacek 15y ago
  This is like an anti-comment. No part of it makes sense. The employees do not own part of the company. They're promised a bonus in the (unlikely) instance of a major liquidity event. Granting them that bonus in no way injures any other element of their comp. This is so much the case that Fried says most of his employees have probably forgotten they even have this bonus. That's not what you say when you're using a comp scheme as leverage with your employees. You have no idea what 37signals people make, how profit sharing and incentive comp work, or why people choose to work there. But you feel just fine snarking about them because they don't fit into the "first engineering hire gets 5%" shoot-the-moon mold we normally talk about on HN.
  - smackfu 15y ago
    Dude. You totally misunderstood my comment. An actual ownership stake means you share in both profits and acquisitions. A typical employee profit sharing means the employees shares in profits but not in an acquisition unless they also get stock options. In the scheme described, the employees share in acquisitions but not profit. So it is the anti-profit sharing. Anti- not meaning bad. Anti- meaning opposite. Maybe not the deepest thing in the world, but geez, you took it a bit too seriously.
    - tptacek 15y ago
      Options or restricted shares --- or even the common stock of publicly traded companies --- do not automatically entitle the owners to a share of the profits. Profit sharing and equity are orthogonal issues.
      - deleted 15y ago
        [deleted]
daimyoyo 15y ago
"And since we have no intention of selling 37signals or going public" It seems to me to be unfair to create incentives like this without intending on ever paying them out. I'm glad that they are creating this now instead of if and or when they are acquired, but I still think equity grants are a more fair way of handling incentives.
- jasonfried 15y ago
  This is one of the reasons we don't formally discuss or disclose this plan when hiring people. It's not pitched as an incentive to work at 37signals. It's a bonus, purely a bonus, if/when something very unlikely happens. We do not factor this in to the overall compensation package when making people offers or giving people raises.
  - smackfu 15y ago
    Do you think this detailed plan is even worthwhile then, rather than just a stated commitment to pay out at least 5% of the sales price to employees?
    - jasonfried 15y ago
      It's not terribly detailed. It's a few paragraphs long with a couple of pages of standard legal boilerplate. Employees don't have to sign anything or sign up for anything. It's better for everyone that it's in writing.
- nknight 15y ago
  Where does fair enter into this, exactly? The employees are paid for their work, and this isn't dangled over them to try and lower salaries. This is more like the founders making provisions to guarantee a gift to current employees in the event of a sudden windfall. Maybe even a form of severance pay in case an acquiring company starts laying people off. I think it's a pretty pointless program, but I don't see anything unfair about it.
patio11 15y ago
This plan conjures an image of accountant given a copy of the PHP manual and the instruction to write a login form. He may do it the right way... but I'd be a wee bit scared. Prior to implementing something like this at your own company, I'd ring your friendly neighborhood tax accountant and make sure you didn't just create a taxable event for all employees. Much like writing a login form, I think there are a lot of very subtle infelicities in implementations which have very serious consequences.
- smackfu 15y ago
  That was my first thought. That they might end up creating something that already has an existing name and existing requirements. From the employee's point of view, as long as it comes across as regular taxable income with proper withholdings taken out, it is probably safe.
- dhh 15y ago
  We had the plan vetted by lawyers and accountants. It's a taxable event should it trigger, but by then you have money to pay the taxes. It's not taxable at its implementation.
  - patio11 15y ago
    I know you guys have competent professional advice, but I was a little worried about a scenario where somebody a little less tax accountant-y copy/pastes the entire plan except for that bit about excluding former employees. Boom! It totally didn't look like a SQL injection but it was important anyhow! Equity compensation schemes are like programming language manuals and spellbooks of eldritch power: every word in here can kill you.
  - dcurtis 15y ago
    The bonus would, however, be taxed as income and not as capital gains. That's kind of a bummer.
    - gojomo 15y ago
      Indeed. In a large exit, this could more-than-halve what employees net, moving the proceeds from a 15-20% long-term capital-gains rate up to a 35-40% regular-income rate.
Murkin 15y ago
To clarify: * Employees working now will get nothing if they leave. * The amount you get is not tied to performance. * Chances of this happening are slim. * In many cases employees get new stock-option/bonuses at M&A anyway (to keep them on board). Sounds like the only good thing from this is: You have something to tell loyal employees asking you why you won't share with them some of the proceeds they created you by hard work.
- nknight 15y ago
  Salary comes from the proceeds created by the employees' work. If the employees don't feel they're receiving enough of the proceeds, they can search for other employment. It's not like the high-value employees at 37signals would have much trouble getting hired elsewhere.
  - fleitz 15y ago
    In software circles much of the salary comes from profits from the capital assets the employees create. This is why more mature software companies are able to pay much more than new software companies. If you compare to an industry like fast food where the goods created by labour are not capital in nature you'll see mature operations and new operations paying roughly the same. It doesn't matter whether you work at Bob's Burgers or Mc Donald's you're making min wage.
    - tptacek 15y ago
      First: what "capital assets" are you referring to? Second: never mind, what's your point? If most of the value in the company comes from employees and not the execution of the owners, the company pays more salary. If they don't, the employees leave. So, in what way is this responsive?
- ry0ohki 15y ago
  That's the main reason I like traditional options/equity, it makes me feel like I own part of the company (no matter how delusional or small of a share that may be), so sure I get paid for 40 hours of work, but if I work 60 hours and don't get overtime, it's not terrible because I'm helping the company I own part of. 37sigs has implemented essentially a non-performance based bonus (which is also what they call it), which kind of defeats the point of equity/options at all in my opinion. An interesting question would be, if 37sigs does take any more investment in the future, and this pool stays the same, it does seem to have the advantage of not being diluted?
adamtmca 15y ago
This just seems like the owners are being menschen in trying to ensure everyone gets a taste if they ever IPO. Given that this "isn't [used as] an incentive to work at 37signals" I don't see how it's an alternative to options which exist entirely to incentivize employees & management.
dkokelley 15y ago
Personally, I would be more interested in a profit-sharing system. I understand that actual equity is difficult to do in some situations, but the 1-5 units system could be adapted to offer profit sharing. When the company makes a profit, the portion designated as a distribution gets divided into the total units as employee bonuses. I'm not sure how these units are handled once an employee leaves, but as a guarantee against missing out on a windfall profit or exit I could see this system being useful.
TheSkeptic 15y ago
"We treat this entire idea purely as a bonus in the unlikely even of a future sale/IPO." At far too many companies, equity is seen by the employer and employee as a form of cash-equivalent compensation, even though it isn't unless that equity has an income stream attached to it (as would be the case in, say, a grant of restricted stock in a company that pays dividends). So it's somewhat refreshing to see a high-profile tech company eschewing this. The problem here is that 37signals' "plan" lacks all substance. The company doesn't intend to go public or seek acquisition, and its "bonus pool" is potentially limited to just 5% of any acquisition price. As such, this "plan" doesn't promote retention the way equity does, and for all intents and purposes, it doesn't promote much of anything as the savvy employee will never expect it to bear any fruit. Put differently, this "plan" feels sort of like an equity version of a poorly-made Louis V. knock-off. While, to its credit, 37signals' isn't pitching this as a justification for a less-than-market salary, there's a strong argument to be made that offering an equity substitute like this is worse than not offering equity at all. The better approach for a company like 37signals? Make sure salaries are highly-competitive, offer an attractive benefits package and, if you want employees to feel like they have a direct "stake" in the company's success, implement a profit sharing plan. The benefit of this approach is that you attract the type of employee who wants to work at a company like yours without creating any confusion on trying to pretend that you're offering something that you're not willing to offer.
drusenko 15y ago
You're giving away 5% of the pre-tax value, but that only translates to 2.5% net for those at the receiving end here. One key distinction with options is that they can be more tax advantageous if the employee exercises and holds their stock for more than one year, triggering long term capital gains (LT cap gains may or may not exist in the future, though).
borism 15y ago
Wow, gives employees all the impression of co-ownership but none of the real co-ownership. Much like the Skype-SilverLake plan. 37signals sure has some good lawyers!
sanj 15y ago
Why max at 5?
- jasonfried 15y ago
  So one or two employees that have been with the company for significantly longer than everyone else don't substantially dilute the pool.
  - Timothee 15y ago
    That would make for odd office dynamics where the more senior employees are driven to quit by the less senior ones…
ChuckMcM 15y ago
I think its a creative solution in response to the employee ask, but it doesn't seem to actually resolve the issue does it? One of the reasons that equity grants work is that people are incented to grow the company as the bigger/more valuable the company becomes they participate in that valuation growth. As equity, there is also the notion that if circumstances dictate that you move on you will still be rewarded for your hard work 'later'. The 'units for time served' system effectively simplifies to this if you allow the employees to 'keep' units after they leave the company. Its disingenuous to say 'we have no intention of selling or going public' since I can assure you that you also have 'no intention of doing this for the rest of our lives'. And no, I cannot read Jason's thoughts, but I can reason to this statement logically. Jason (and other co-owners) of the company have interests outside of 37signals. Working there may be the awesomest thing in the world now, but at some point when the realization comes that you're time on the planet is finite, it occurs to one that perhaps they should take some time to do some of these other things. The notion that if you had enough savings you could live off the returns from that capital, and do the things you love, and not worry about specific deadlines, becomes more and more appealing. At some point the owners reach the 'tipping' point where they would rather work 'free form' where the cash flow for basic lifestyle was disassociated from the work product they're doing (the word 'retired' really doesn't cut it, more like 'base expenses covered before work income is considered') If the combination of owners wanting to change their lifestyle, and some entity is willing to offer you enough money for 37signals to make that change possible cross, the environment is ripe for a sale. The only other statistically probable 'exit' for LLCs is for the founder to die unexpectedly. The outlier case is the founder runs the company until senility and degeneration results in them dying leaving behind what was once a thriving business/practice/partnership and is now simply an obligation to file a tax return once a year. By that reasoning I know that the principals of 37signals are going to either 'sell the company' or 'go public' at some point in the future, regardless of their protestations to the contrary. And when that happens, you've carved out 5% of the sales price / market value for the employees who have stuck with you to that point and are currently there. Which is admirable. But Jason's point number 3: 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. Does not sound like the system would provide anything for the folks who were instrumental in you getting there but for one reason or another had left the company. This system might leave them with a bad taste. A variation on this system would be to reserve a larger chunk (say 25%) of the transaction price or fair market value (FMV), and accumulate your units on a monthly basis (so 1 unit per non-owner employee / month) which fill the whole pool over the lifetime of the company ( prior to sale / IPO ). Allowing employees to retain their unit-shares even after people leave, so basically the employee-month units slowly grow over time (while the value of the company grows over time) and the payout is proportionate to the time of service, and is retained for employees who have left, and requires only that you compute the integral number of months any employee has worked. (no admin overhead). Finally, it gives a better signal of recognition to your employees that you value them with a more meaningful percentage than 5%. A sample worked problem where each employee-month-unit (EMU) accumuates 1 per non-owner employee per month. 3 founders, $500K seed round +1 year 5 employees (2 non-owners) (24 EMU accumulate if sold each EMU worth slightly more than 1% of the company) +2 year 15 employees (12 non-owners) (+144 EMU, 168 total, at sale each EMU worth .14% of the company, 2 yr vet worth 3.6%) +3 year 20 employees (17 non-owners) (+ 204 EMU, 372 total, each unit worth .07% of the sale price) People who stick around get a bigger payout, leaving isn't a penalty (you may not have a choice), and everyone gets rewarded the same. Unfortunately given that some employees are going to have a much bigger impact on the success and 'value' of the company than others, I doubt they would go for that scheme either. That doing compensation is hard isn't really a very surprising result I guess.
mbyrne 15y ago
This seems more like an attempt at rationalizing "equity" (in the social sense) rather than motivating performance, which is fine. I would love to hear what the document is that guarantees execution of their promise at a sale. And why not put 5% of shares into a trust for employees per the allocation stated so they don't face the significantly higher tax rate of ordinary income? Thanks for sharing your idea.
fourk 15y ago
They're trading the 'unfair' uneven distribution of equity based on position for one in which people are compensated equally regardless of position. This twist on the distribution seems like a great way to attract people to fill those positions that generally come with a less-than-average equity expectation. However, I'd be willing to guess that there is a negative correlation between ease of filling a position with a high-quality hire and the average expected equity amount for that position. It seems to be a disincentive for those with higher-than-average equity expectation in that it implies that their contribution to the company is valued at the same amount proportionally as the lowest-contributing employee of the company, salary notwithstanding. If you are looking to hire a new CEO and inform him/her that, in the case of an IPO or acquisition, the new secretary hired last week will get the same cut of the bonus pool as the prospective CEO, they might be less inclined to work for you vs a company that, all else being equal, might offer them a proportionally higher payout. Edit: Response to reply by jarin: 1) Right, I meant to encompass salary with 'all else being equal' in the last sentence. 2) The fact that something is currently unlikely doesn't mean that it won't ever become more likely. I think ChuckMcM's reply addresses this pretty well: http://news.ycombinator.com/item?id=2888740 http://news.ycombinator.com/item?id=2888740
- jarin 15y ago
  You have to consider two things though: 1) They pay good salaries. 2) They are not seeking an exit strategy, and this is merely a "just in case" scenario. I would guess that most technical and executive hires come to the company with full knowledge that an IPO or sale is against their core values.
dugmartin 15y ago
I always thought something like this would be the more fair: Employee X share = (Max(0, Business Days Worked Before Sale - Business Days After Leaving Employment) / (Business Days Open Before Sale * Total Number of Employees)) * Total Employee Equity Percentage * Total Equity Amount
Jach 15y ago
I don't know... What are some realistic numbers here? Suppose a mere $10m acquisition, 5% is a mere $500k. Suppose 10 employees, 5 are maxed out, the other 5 have 4,3,2,1,0 units respectively. The payout range then is $14k to $71k. Working there for 5+ years, taking home only $71k, which is definitely nice, while the boss gets at least a few million... I think employees should be made as happy as possible at acquisition time. I'm not sure this scheme would accomplish that, but I don't know what realistic numbers would be nor what competitive options/equity figures would look like.
- prawn 15y ago
  Boss gets those few million because they took the initial risk, provided the jobs, etc. Especially in this period of history, there is nothing stopping an employee from starting up their own venture and trying to hit the home run.
- metachris 15y ago
  Could be interesting to also apply this scheme to the company's yearly earnings! That way everybody would get something out of it, and it wouldn't focus the company so much on an acquisition/IPO.
- techiferous 15y ago
  You could run another thought experiment. $50M exit, 20% goes to employees (because 5% is just the minimum). Suppose 10 employees, 5 are maxed out, the other 5 have 4,3,2,1,0 units respectively. 20% of $50M is $10M. The payout range then is $286K to $1.4M (before taxes).
nhangen 15y ago
I don't know... I like that you're trying to address the problem, but I think this points to another problem, which is the core issue of whether you actually care about your employees' success as much as you do about the company. On a grand level, no, of course not, but at the micro level, you should. You want people to stay, even though they're considering moving on to form something of their own. You want them to feel like they are 37 lifers. Obviously, you want some to graduate and move on to bigger things too. These types are also valuable. All in all, it doesn't feel to me like you care about your employees, especially when one founder is busy in LA and/or racing around in expensive cars, and the other is writing posts like this. If I were an employee and presented with a plan like this, I wouldn't feel the need to invest in anything more than a paycheck, and while that's great for many companies, that doesn't seem right for one, like 37 Signals, that once was cutting edge. I want something I can sink my teeth into, and feel like I'm going somewhere. I have a feeling many other HN'ers feel the same. This won't attract people like that, or get them to stay, but maybe those aren't the type of people you want?
NHQ 15y ago
Doesn't that miss the point of giving your employees incentive to work "above and beyond", to the benefit of the company and all? It's a good thing they don't tell the employees, cuz what would an employee want with worthless "BIG IF" points?
Timothee 15y ago
I really like the simplicity and overall fairness of the plan. The only thing I wouldn't like (and it could very well be that way for technical reasons[1]) is the part where only current employees get a part of it. I understand the idea behind that but if someone were to do fantastic work for them for over 5 years and leave 6 months before Jason Fried and DHH change their mind about selling, that employee might feel stiffed. Instead, I could see a system where you earn units while you work there and lose them for the time you don't work with them, at the same or different rate. Say you earn 1 unit per year worked but lose 2+ per year non-worked. But, you know what? It's their company, they do it however they want to :) and considering they have no obligations to put that in place, it's hard to argue. [1] e.g. maybe it's a pain to pay somebody anything once they're not on the payroll…
alain94040 15y ago
It seems broken. While the guiding principles are interesting, there's a reason why stock-option plans have evolved to where they are today: all cases have been tried, and they are well understood. One example of problem in Jason's plan: if you go IPO, you immediately owe 5% payments on the full valuation of your company, to your employees. Where is this money coming from? The money raised during the IPO? Fine, but how many shares did you float?
- tptacek 15y ago
  "Broken". They're a 30-odd person web app company in Chicago. They aren't going public. They're throwing off cash at a rate that allows them to buy supercars. They're not selling. Why would they? What the fuck good would "options" do any of their employees? Options don't mean anything unless you go public or sell the company. Believe it or not, most companies don't sell or go public. PwC and E&Y seem to incent employees just fine.
tptacek 15y ago
The classic alternative to options/equity is a partner track. That's how huge law firms and the big 4 accounting firms do it. There are multiple levels in the partnerships, and the upper levels are often pretty spectacular. Partner tracks address some of the concerns Fried brings up here. For instance, they reward current employees and don't create a class of former employees with a painful claim on forward revenues. They're simpler than options (you're gunning to "make partner"; you don't need an Excel spreadsheet to figure out what a win is). They also have downsides; for instance, the biggest partner tracks are also all up-or-out systems where competent employees who are assets to the team but not ambitious enough to make partner are incented to leave. So the question I have is, why didn't 37signals do that? It's a proven model. I ask because I'm sure there's a reason, and I'd love to hear it.
- jaredmck 15y ago
  Isn't this fairly onerous to administer? At my previous company, a private consulting firm, there are some shareholders who are kept around largely because there is not liquidity available and if you've been around for 25 years, even if much of this was during a period of demographically-driven economic growth, it's hard to get rid of you as a partner (since you have to be bought out) no matter how little value you provide. I'm interested to hear why 37signals didn't go with this model and if they'd ever consider going with an S or C-corp over the LLC.
  - tptacek 15y ago
    I don't know; I've never administered one. But: the scheme I described also accounts for most small consultancies.
grellas 15y ago
Mature LLCs do have tricky issues when it comes to option grants for employees. Among other things: 1. LLCs are partnership-like entities governed by an operating agreement and every owner (member) has to sign and agree to the terms of such agreement, meaning also that every owner (employee) gets to see in intimate detail who owns what within the company, who has what management authority, who has invested what, and the like. Bad for the company. 2. LLCs have no counterpart to ISO-like grants, meaning that everyone who exercises options can (normally) effectively do so only at the time of a liquidity event because he would otherwise have to pay an immediate tax on the "spread" (difference between exercise price and fair value of equity interest acquired) as of the date of exercise and would thereafter hold an illiquid investment for what could be many years. Bad for the employee. 3. Apart from the limitations of LLCs themselves, it becomes difficult to administer an option plan when the value of a company is already high because it costs too much for employees to buy into it. For example, if a company is already worth $10M, the exercise price of options needed to buy .001% of it would be $10K. How many employees want to part with real dollars for the hope of a speculative return way down the road, especially if the company itself says it has no plans to move toward a liquidity event any time soon? Hence, the alternative plan adopted here makes sense. It does not represent any form of true equity interest but is an employee bonus plan. This means you lose the benefits if you leave employment. It also means you get, at best, employee compensation that is subject to tax at ordinary income tax rates as well as to all employment taxes (though no tax is due until the bonus is paid). It also means that the interest is not transferable. It is basically a special reward granted to those who stick it out over the years until the company gets to a liquidity event. It is not perfect but, given the problems noted above, it is actually a pretty good solution to the problem of how to afford special incentives to key employees whom you want to add value to a growing but mature company operating in LLC form.
- tptacek 15y ago
  Since we're on the subject: aren't there restrictions for LLCs about principles/members taking W2 wages? I know there's a way around this, but I'm curious about what the best practice is for issuing equity to employees at LLCs.
  - 15y ago
binh_nguyen 15y ago
We have this at my company at well. However, I treat it as a piece of paper, no more no less because the owner of my company has no intention to sale at all.
JoeAltmaier 15y ago
I don't understand how this is any kind of incentive at all. They've declared they have absolutely no intention of ever making good on it (will never sell out or go public). They don't even tell new employees about it. Other than making themselves feel like good benevolent managers, this utterly fails as an incentive. What's the point?
- techiferous 15y ago
  It's not meant to be an incentive.
  - JoeAltmaier 15y ago
    The very title is "An alternative to employee options/equity grants", which are certainly meant to be incentives! The thing that makes these completely worthless is, should the company ever actually have an equity event they are void, as the new owner may do whatever they please which probably won't include honoring "these spreadsheet scribbles we put together with no legal weight whatsoever"
    - techiferous 15y ago
      In the comments on the original blog post, Jason Fried says: "Because we’re making the point that this payout should not be expected. You should not be banking on this. It’s not an incentive to work at 37signals. It’s purely a bonus."
      - JoeAltmaier 15y ago
        A bonus is an incentive. And this one is defined as 1) never going to be paid, and 2) not legally binding in any case. The whole idea is doubletalk; that's my point. Its a non-incentive incentive. Its a non-paying insurance policy.
        techiferous 15y ago
        An incentive is a device to motivate employees. This is not what they are trying to do. They did not start with the problem, "How can we motivate our employees?" Incentive to work better is not the only motivation that an employer may have to share money with an employee. Generosity is another motivation, for example. Only Jason knows his true motivations, but if he says it's not an incentive, there is nothing inconsistent or logically wrong with that.
deleted 15y ago
[deleted]
staunch 15y ago
They say: "I wouldn't be surprised if many employees have forgotten about it or don"t even know about it at all." Which means it's not by any means "An alternative to employee options/equity grants".
zach 15y ago
I can vouch for the agreeableness of this system. I received a bonus from a similar pool when the company I was working at was sold. It came across to me and everyone else who received it as a genuine and thoughtful act. That may have been ameliorated by the fact that there was no expectation ordinary employees would get anything -- we just found out about this bonus at the same time we got our "Welcome to [Acquiring Company]" letters. The founders also had a very generous profit-sharing-equivalent project bonus plan as well, but as has been mentioned, this is in an industry where bonuses are more prevalent than equity.

93 points by InfinityX0 15y ago

I think this is a really smart, fair program that every startup should read, especially since most companies (even those that want to) don't get sold/IPO at a huge price that makes tiny options worthwhile.

smackfu 15y ago

It's like anti-profit sharing. The employees own part of the company, but only for acquisitions and not for profits.

seiji 15y ago
They already have profit sharing though (it's where the million dollar cars come from).
- roel_v 15y ago
  Uh? Regular employees of a company with million-dollar cars? Quite incredible claim. Even Google pays what, half a million or so to top engineers from what I read left and right? You don't drive million dollar cars on a salary (any salary).
  - borism 15y ago
    what car costs million dollars anyway? Lamborghini Gallardo is "only" quarter of a mil... And Veyron is way above (couple of) million.
    - true_religion 15y ago
      Base price of a Veyron is 1.7 million dollars. Lamborghini Murcielago, 2010, premiered at $400,000 to $600,000. However, when people are talking about a million dollar car they're most likely remembering the McLaren F1 which sold for $970,000 back in 1998.
  - qq66 15y ago
    I wouldn't call him a "regular employee" but incredible claim or not, DHH definitely did purchase a million dollar car recently.
    - roel_v 15y ago
      So I googled 'dhh car' and it turns out he is the owner of some company, hardly a 'regular employee'.
tptacek 15y ago
This is like an anti-comment. No part of it makes sense. The employees do not own part of the company. They're promised a bonus in the (unlikely) instance of a major liquidity event. Granting them that bonus in no way injures any other element of their comp. This is so much the case that Fried says most of his employees have probably forgotten they even have this bonus. That's not what you say when you're using a comp scheme as leverage with your employees. You have no idea what 37signals people make, how profit sharing and incentive comp work, or why people choose to work there. But you feel just fine snarking about them because they don't fit into the "first engineering hire gets 5%" shoot-the-moon mold we normally talk about on HN.
- smackfu 15y ago
  Dude. You totally misunderstood my comment. An actual ownership stake means you share in both profits and acquisitions. A typical employee profit sharing means the employees shares in profits but not in an acquisition unless they also get stock options. In the scheme described, the employees share in acquisitions but not profit. So it is the anti-profit sharing. Anti- not meaning bad. Anti- meaning opposite. Maybe not the deepest thing in the world, but geez, you took it a bit too seriously.
  - tptacek 15y ago
    Options or restricted shares --- or even the common stock of publicly traded companies --- do not automatically entitle the owners to a share of the profits. Profit sharing and equity are orthogonal issues.
    - deleted 15y ago
      [deleted]

daimyoyo 15y ago

"And since we have no intention of selling 37signals or going public" It seems to me to be unfair to create incentives like this without intending on ever paying them out. I'm glad that they are creating this now instead of if and or when they are acquired, but I still think equity grants are a more fair way of handling incentives.

jasonfried 15y ago
This is one of the reasons we don't formally discuss or disclose this plan when hiring people. It's not pitched as an incentive to work at 37signals. It's a bonus, purely a bonus, if/when something very unlikely happens. We do not factor this in to the overall compensation package when making people offers or giving people raises.
- smackfu 15y ago
  Do you think this detailed plan is even worthwhile then, rather than just a stated commitment to pay out at least 5% of the sales price to employees?
  - jasonfried 15y ago
    It's not terribly detailed. It's a few paragraphs long with a couple of pages of standard legal boilerplate. Employees don't have to sign anything or sign up for anything. It's better for everyone that it's in writing.
nknight 15y ago
Where does fair enter into this, exactly? The employees are paid for their work, and this isn't dangled over them to try and lower salaries. This is more like the founders making provisions to guarantee a gift to current employees in the event of a sudden windfall. Maybe even a form of severance pay in case an acquiring company starts laying people off. I think it's a pretty pointless program, but I don't see anything unfair about it.

patio11 15y ago

This plan conjures an image of accountant given a copy of the PHP manual and the instruction to write a login form. He may do it the right way... but I'd be a wee bit scared. Prior to implementing something like this at your own company, I'd ring your friendly neighborhood tax accountant and make sure you didn't just create a taxable event for all employees. Much like writing a login form, I think there are a lot of very subtle infelicities in implementations which have very serious consequences.

smackfu 15y ago
That was my first thought. That they might end up creating something that already has an existing name and existing requirements. From the employee's point of view, as long as it comes across as regular taxable income with proper withholdings taken out, it is probably safe.
dhh 15y ago
We had the plan vetted by lawyers and accountants. It's a taxable event should it trigger, but by then you have money to pay the taxes. It's not taxable at its implementation.
- patio11 15y ago
  I know you guys have competent professional advice, but I was a little worried about a scenario where somebody a little less tax accountant-y copy/pastes the entire plan except for that bit about excluding former employees. Boom! It totally didn't look like a SQL injection but it was important anyhow! Equity compensation schemes are like programming language manuals and spellbooks of eldritch power: every word in here can kill you.
- dcurtis 15y ago
  The bonus would, however, be taxed as income and not as capital gains. That's kind of a bummer.
  - gojomo 15y ago
    Indeed. In a large exit, this could more-than-halve what employees net, moving the proceeds from a 15-20% long-term capital-gains rate up to a 35-40% regular-income rate.

Murkin 15y ago

To clarify: * Employees working now will get nothing if they leave. * The amount you get is not tied to performance. * Chances of this happening are slim. * In many cases employees get new stock-option/bonuses at M&A anyway (to keep them on board). Sounds like the only good thing from this is: You have something to tell loyal employees asking you why you won't share with them some of the proceeds they created you by hard work.

nknight 15y ago
Salary comes from the proceeds created by the employees' work. If the employees don't feel they're receiving enough of the proceeds, they can search for other employment. It's not like the high-value employees at 37signals would have much trouble getting hired elsewhere.
- fleitz 15y ago
  In software circles much of the salary comes from profits from the capital assets the employees create. This is why more mature software companies are able to pay much more than new software companies. If you compare to an industry like fast food where the goods created by labour are not capital in nature you'll see mature operations and new operations paying roughly the same. It doesn't matter whether you work at Bob's Burgers or Mc Donald's you're making min wage.
  - tptacek 15y ago
    First: what "capital assets" are you referring to? Second: never mind, what's your point? If most of the value in the company comes from employees and not the execution of the owners, the company pays more salary. If they don't, the employees leave. So, in what way is this responsive?
ry0ohki 15y ago
That's the main reason I like traditional options/equity, it makes me feel like I own part of the company (no matter how delusional or small of a share that may be), so sure I get paid for 40 hours of work, but if I work 60 hours and don't get overtime, it's not terrible because I'm helping the company I own part of. 37sigs has implemented essentially a non-performance based bonus (which is also what they call it), which kind of defeats the point of equity/options at all in my opinion. An interesting question would be, if 37sigs does take any more investment in the future, and this pool stays the same, it does seem to have the advantage of not being diluted?

adamtmca 15y ago

This just seems like the owners are being menschen in trying to ensure everyone gets a taste if they ever IPO. Given that this "isn't [used as] an incentive to work at 37signals" I don't see how it's an alternative to options which exist entirely to incentivize employees & management.

dkokelley 15y ago

Personally, I would be more interested in a profit-sharing system. I understand that actual equity is difficult to do in some situations, but the 1-5 units system could be adapted to offer profit sharing. When the company makes a profit, the portion designated as a distribution gets divided into the total units as employee bonuses. I'm not sure how these units are handled once an employee leaves, but as a guarantee against missing out on a windfall profit or exit I could see this system being useful.

TheSkeptic 15y ago

"We treat this entire idea purely as a bonus in the unlikely even of a future sale/IPO." At far too many companies, equity is seen by the employer and employee as a form of cash-equivalent compensation, even though it isn't unless that equity has an income stream attached to it (as would be the case in, say, a grant of restricted stock in a company that pays dividends). So it's somewhat refreshing to see a high-profile tech company eschewing this. The problem here is that 37signals' "plan" lacks all substance. The company doesn't intend to go public or seek acquisition, and its "bonus pool" is potentially limited to just 5% of any acquisition price. As such, this "plan" doesn't promote retention the way equity does, and for all intents and purposes, it doesn't promote much of anything as the savvy employee will never expect it to bear any fruit. Put differently, this "plan" feels sort of like an equity version of a poorly-made Louis V. knock-off. While, to its credit, 37signals' isn't pitching this as a justification for a less-than-market salary, there's a strong argument to be made that offering an equity substitute like this is worse than not offering equity at all. The better approach for a company like 37signals? Make sure salaries are highly-competitive, offer an attractive benefits package and, if you want employees to feel like they have a direct "stake" in the company's success, implement a profit sharing plan. The benefit of this approach is that you attract the type of employee who wants to work at a company like yours without creating any confusion on trying to pretend that you're offering something that you're not willing to offer.

drusenko 15y ago

You're giving away 5% of the pre-tax value, but that only translates to 2.5% net for those at the receiving end here. One key distinction with options is that they can be more tax advantageous if the employee exercises and holds their stock for more than one year, triggering long term capital gains (LT cap gains may or may not exist in the future, though).

borism 15y ago

Wow, gives employees all the impression of co-ownership but none of the real co-ownership. Much like the Skype-SilverLake plan. 37signals sure has some good lawyers!

sanj 15y ago

Why max at 5?

jasonfried 15y ago
So one or two employees that have been with the company for significantly longer than everyone else don't substantially dilute the pool.
- Timothee 15y ago
  That would make for odd office dynamics where the more senior employees are driven to quit by the less senior ones…

ChuckMcM 15y ago

I think its a creative solution in response to the employee ask, but it doesn't seem to actually resolve the issue does it? One of the reasons that equity grants work is that people are incented to grow the company as the bigger/more valuable the company becomes they participate in that valuation growth. As equity, there is also the notion that if circumstances dictate that you move on you will still be rewarded for your hard work 'later'. The 'units for time served' system effectively simplifies to this if you allow the employees to 'keep' units after they leave the company. Its disingenuous to say 'we have no intention of selling or going public' since I can assure you that you also have 'no intention of doing this for the rest of our lives'. And no, I cannot read Jason's thoughts, but I can reason to this statement logically. Jason (and other co-owners) of the company have interests outside of 37signals. Working there may be the awesomest thing in the world now, but at some point when the realization comes that you're time on the planet is finite, it occurs to one that perhaps they should take some time to do some of these other things. The notion that if you had enough savings you could live off the returns from that capital, and do the things you love, and not worry about specific deadlines, becomes more and more appealing. At some point the owners reach the 'tipping' point where they would rather work 'free form' where the cash flow for basic lifestyle was disassociated from the work product they're doing (the word 'retired' really doesn't cut it, more like 'base expenses covered before work income is considered') If the combination of owners wanting to change their lifestyle, and some entity is willing to offer you enough money for 37signals to make that change possible cross, the environment is ripe for a sale. The only other statistically probable 'exit' for LLCs is for the founder to die unexpectedly. The outlier case is the founder runs the company until senility and degeneration results in them dying leaving behind what was once a thriving business/practice/partnership and is now simply an obligation to file a tax return once a year. By that reasoning I know that the principals of 37signals are going to either 'sell the company' or 'go public' at some point in the future, regardless of their protestations to the contrary. And when that happens, you've carved out 5% of the sales price / market value for the employees who have stuck with you to that point and are currently there. Which is admirable. But Jason's point number 3: 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. Does not sound like the system would provide anything for the folks who were instrumental in you getting there but for one reason or another had left the company. This system might leave them with a bad taste. A variation on this system would be to reserve a larger chunk (say 25%) of the transaction price or fair market value (FMV), and accumulate your units on a monthly basis (so 1 unit per non-owner employee / month) which fill the whole pool over the lifetime of the company ( prior to sale / IPO ). Allowing employees to retain their unit-shares even after people leave, so basically the employee-month units slowly grow over time (while the value of the company grows over time) and the payout is proportionate to the time of service, and is retained for employees who have left, and requires only that you compute the integral number of months any employee has worked. (no admin overhead). Finally, it gives a better signal of recognition to your employees that you value them with a more meaningful percentage than 5%. A sample worked problem where each employee-month-unit (EMU) accumuates 1 per non-owner employee per month. 3 founders, $500K seed round +1 year 5 employees (2 non-owners) (24 EMU accumulate if sold each EMU worth slightly more than 1% of the company) +2 year 15 employees (12 non-owners) (+144 EMU, 168 total, at sale each EMU worth .14% of the company, 2 yr vet worth 3.6%) +3 year 20 employees (17 non-owners) (+ 204 EMU, 372 total, each unit worth .07% of the sale price) People who stick around get a bigger payout, leaving isn't a penalty (you may not have a choice), and everyone gets rewarded the same. Unfortunately given that some employees are going to have a much bigger impact on the success and 'value' of the company than others, I doubt they would go for that scheme either. That doing compensation is hard isn't really a very surprising result I guess.

mbyrne 15y ago

This seems more like an attempt at rationalizing "equity" (in the social sense) rather than motivating performance, which is fine. I would love to hear what the document is that guarantees execution of their promise at a sale. And why not put 5% of shares into a trust for employees per the allocation stated so they don't face the significantly higher tax rate of ordinary income? Thanks for sharing your idea.

fourk 15y ago

They're trading the 'unfair' uneven distribution of equity based on position for one in which people are compensated equally regardless of position. This twist on the distribution seems like a great way to attract people to fill those positions that generally come with a less-than-average equity expectation. However, I'd be willing to guess that there is a negative correlation between ease of filling a position with a high-quality hire and the average expected equity amount for that position. It seems to be a disincentive for those with higher-than-average equity expectation in that it implies that their contribution to the company is valued at the same amount proportionally as the lowest-contributing employee of the company, salary notwithstanding. If you are looking to hire a new CEO and inform him/her that, in the case of an IPO or acquisition, the new secretary hired last week will get the same cut of the bonus pool as the prospective CEO, they might be less inclined to work for you vs a company that, all else being equal, might offer them a proportionally higher payout. Edit: Response to reply by jarin: 1) Right, I meant to encompass salary with 'all else being equal' in the last sentence. 2) The fact that something is currently unlikely doesn't mean that it won't ever become more likely. I think ChuckMcM's reply addresses this pretty well: http://news.ycombinator.com/item?id=2888740 http://news.ycombinator.com/item?id=2888740

jarin 15y ago
You have to consider two things though: 1) They pay good salaries. 2) They are not seeking an exit strategy, and this is merely a "just in case" scenario. I would guess that most technical and executive hires come to the company with full knowledge that an IPO or sale is against their core values.

dugmartin 15y ago

I always thought something like this would be the more fair: Employee X share = (Max(0, Business Days Worked Before Sale - Business Days After Leaving Employment) / (Business Days Open Before Sale * Total Number of Employees)) * Total Employee Equity Percentage * Total Equity Amount

Jach 15y ago

I don't know... What are some realistic numbers here? Suppose a mere $10m acquisition, 5% is a mere $500k. Suppose 10 employees, 5 are maxed out, the other 5 have 4,3,2,1,0 units respectively. The payout range then is $14k to $71k. Working there for 5+ years, taking home only $71k, which is definitely nice, while the boss gets at least a few million... I think employees should be made as happy as possible at acquisition time. I'm not sure this scheme would accomplish that, but I don't know what realistic numbers would be nor what competitive options/equity figures would look like.

prawn 15y ago
Boss gets those few million because they took the initial risk, provided the jobs, etc. Especially in this period of history, there is nothing stopping an employee from starting up their own venture and trying to hit the home run.
metachris 15y ago
Could be interesting to also apply this scheme to the company's yearly earnings! That way everybody would get something out of it, and it wouldn't focus the company so much on an acquisition/IPO.
techiferous 15y ago
You could run another thought experiment. $50M exit, 20% goes to employees (because 5% is just the minimum). Suppose 10 employees, 5 are maxed out, the other 5 have 4,3,2,1,0 units respectively. 20% of $50M is $10M. The payout range then is $286K to $1.4M (before taxes).

nhangen 15y ago

I don't know... I like that you're trying to address the problem, but I think this points to another problem, which is the core issue of whether you actually care about your employees' success as much as you do about the company. On a grand level, no, of course not, but at the micro level, you should. You want people to stay, even though they're considering moving on to form something of their own. You want them to feel like they are 37 lifers. Obviously, you want some to graduate and move on to bigger things too. These types are also valuable. All in all, it doesn't feel to me like you care about your employees, especially when one founder is busy in LA and/or racing around in expensive cars, and the other is writing posts like this. If I were an employee and presented with a plan like this, I wouldn't feel the need to invest in anything more than a paycheck, and while that's great for many companies, that doesn't seem right for one, like 37 Signals, that once was cutting edge. I want something I can sink my teeth into, and feel like I'm going somewhere. I have a feeling many other HN'ers feel the same. This won't attract people like that, or get them to stay, but maybe those aren't the type of people you want?

NHQ 15y ago

Doesn't that miss the point of giving your employees incentive to work "above and beyond", to the benefit of the company and all? It's a good thing they don't tell the employees, cuz what would an employee want with worthless "BIG IF" points?

Timothee 15y ago

I really like the simplicity and overall fairness of the plan. The only thing I wouldn't like (and it could very well be that way for technical reasons[1]) is the part where only current employees get a part of it. I understand the idea behind that but if someone were to do fantastic work for them for over 5 years and leave 6 months before Jason Fried and DHH change their mind about selling, that employee might feel stiffed. Instead, I could see a system where you earn units while you work there and lose them for the time you don't work with them, at the same or different rate. Say you earn 1 unit per year worked but lose 2+ per year non-worked. But, you know what? It's their company, they do it however they want to :) and considering they have no obligations to put that in place, it's hard to argue. [1] e.g. maybe it's a pain to pay somebody anything once they're not on the payroll…

alain94040 15y ago

It seems broken. While the guiding principles are interesting, there's a reason why stock-option plans have evolved to where they are today: all cases have been tried, and they are well understood. One example of problem in Jason's plan: if you go IPO, you immediately owe 5% payments on the full valuation of your company, to your employees. Where is this money coming from? The money raised during the IPO? Fine, but how many shares did you float?

tptacek 15y ago
"Broken". They're a 30-odd person web app company in Chicago. They aren't going public. They're throwing off cash at a rate that allows them to buy supercars. They're not selling. Why would they? What the fuck good would "options" do any of their employees? Options don't mean anything unless you go public or sell the company. Believe it or not, most companies don't sell or go public. PwC and E&Y seem to incent employees just fine.

tptacek 15y ago

The classic alternative to options/equity is a partner track. That's how huge law firms and the big 4 accounting firms do it. There are multiple levels in the partnerships, and the upper levels are often pretty spectacular. Partner tracks address some of the concerns Fried brings up here. For instance, they reward current employees and don't create a class of former employees with a painful claim on forward revenues. They're simpler than options (you're gunning to "make partner"; you don't need an Excel spreadsheet to figure out what a win is). They also have downsides; for instance, the biggest partner tracks are also all up-or-out systems where competent employees who are assets to the team but not ambitious enough to make partner are incented to leave. So the question I have is, why didn't 37signals do that? It's a proven model. I ask because I'm sure there's a reason, and I'd love to hear it.

jaredmck 15y ago
Isn't this fairly onerous to administer? At my previous company, a private consulting firm, there are some shareholders who are kept around largely because there is not liquidity available and if you've been around for 25 years, even if much of this was during a period of demographically-driven economic growth, it's hard to get rid of you as a partner (since you have to be bought out) no matter how little value you provide. I'm interested to hear why 37signals didn't go with this model and if they'd ever consider going with an S or C-corp over the LLC.
- tptacek 15y ago
  I don't know; I've never administered one. But: the scheme I described also accounts for most small consultancies.

grellas 15y ago

Mature LLCs do have tricky issues when it comes to option grants for employees. Among other things: 1. LLCs are partnership-like entities governed by an operating agreement and every owner (member) has to sign and agree to the terms of such agreement, meaning also that every owner (employee) gets to see in intimate detail who owns what within the company, who has what management authority, who has invested what, and the like. Bad for the company. 2. LLCs have no counterpart to ISO-like grants, meaning that everyone who exercises options can (normally) effectively do so only at the time of a liquidity event because he would otherwise have to pay an immediate tax on the "spread" (difference between exercise price and fair value of equity interest acquired) as of the date of exercise and would thereafter hold an illiquid investment for what could be many years. Bad for the employee. 3. Apart from the limitations of LLCs themselves, it becomes difficult to administer an option plan when the value of a company is already high because it costs too much for employees to buy into it. For example, if a company is already worth $10M, the exercise price of options needed to buy .001% of it would be $10K. How many employees want to part with real dollars for the hope of a speculative return way down the road, especially if the company itself says it has no plans to move toward a liquidity event any time soon? Hence, the alternative plan adopted here makes sense. It does not represent any form of true equity interest but is an employee bonus plan. This means you lose the benefits if you leave employment. It also means you get, at best, employee compensation that is subject to tax at ordinary income tax rates as well as to all employment taxes (though no tax is due until the bonus is paid). It also means that the interest is not transferable. It is basically a special reward granted to those who stick it out over the years until the company gets to a liquidity event. It is not perfect but, given the problems noted above, it is actually a pretty good solution to the problem of how to afford special incentives to key employees whom you want to add value to a growing but mature company operating in LLC form.

tptacek 15y ago
Since we're on the subject: aren't there restrictions for LLCs about principles/members taking W2 wages? I know there's a way around this, but I'm curious about what the best practice is for issuing equity to employees at LLCs.
- 15y ago

binh_nguyen 15y ago

We have this at my company at well. However, I treat it as a piece of paper, no more no less because the owner of my company has no intention to sale at all.

JoeAltmaier 15y ago

I don't understand how this is any kind of incentive at all. They've declared they have absolutely no intention of ever making good on it (will never sell out or go public). They don't even tell new employees about it. Other than making themselves feel like good benevolent managers, this utterly fails as an incentive. What's the point?

techiferous 15y ago
It's not meant to be an incentive.
- JoeAltmaier 15y ago
  The very title is "An alternative to employee options/equity grants", which are certainly meant to be incentives! The thing that makes these completely worthless is, should the company ever actually have an equity event they are void, as the new owner may do whatever they please which probably won't include honoring "these spreadsheet scribbles we put together with no legal weight whatsoever"
  - techiferous 15y ago
    In the comments on the original blog post, Jason Fried says: "Because we’re making the point that this payout should not be expected. You should not be banking on this. It’s not an incentive to work at 37signals. It’s purely a bonus."
    - JoeAltmaier 15y ago
      A bonus is an incentive. And this one is defined as 1) never going to be paid, and 2) not legally binding in any case. The whole idea is doubletalk; that's my point. Its a non-incentive incentive. Its a non-paying insurance policy.
      - techiferous 15y ago
        An incentive is a device to motivate employees. This is not what they are trying to do. They did not start with the problem, "How can we motivate our employees?" Incentive to work better is not the only motivation that an employer may have to share money with an employee. Generosity is another motivation, for example. Only Jason knows his true motivations, but if he says it's not an incentive, there is nothing inconsistent or logically wrong with that.

deleted 15y ago

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staunch 15y ago

They say: "I wouldn't be surprised if many employees have forgotten about it or don"t even know about it at all." Which means it's not by any means "An alternative to employee options/equity grants".

zach 15y ago

I can vouch for the agreeableness of this system. I received a bonus from a similar pool when the company I was working at was sold. It came across to me and everyone else who received it as a genuine and thoughtful act. That may have been ameliorated by the fact that there was no expectation ordinary employees would get anything -- we just found out about this bonus at the same time we got our "Welcome to [Acquiring Company]" letters. The founders also had a very generous profit-sharing-equivalent project bonus plan as well, but as has been mentioned, this is in an industry where bonuses are more prevalent than equity.