An alternative to employee options/equity grants | Hacker News Reader

An alternative to employee options/equity grants

37signals.com

93 pointsInfinityX086 comments

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.

Some context your analysis is missing:

37signals is older than any YC company. In its current incarnation, I believe it's older than Facebook. It is clearly not on the same trajectory as the typical company we talk about on HN. It is not a flavor-of-the-month, or even of-the-year, for Fried and DHH.

and

Supply and demand probably does give them an edge on employee comp, but from friends I know who've worked there, they're making market wages. People aren't taking jobs there on the promise of hockey-stick upside. It's a pretty amazing work environment. You should see the offices. Place is nuts.

You don't have to take them up on their comp plan, but it's naive to write comments as if there was something wrong with it. Most YC companies would be very poorly served indeed by the comp plan 37signals laid out here; those companies are all on VC shoot-the-moon trajectories, and a stake in a liquidity event is a big chunk of the reason you'd work at any of them. In 37signals case, you have to start by defining what a liquidity event even looks like.

It was not my intent to criticize their overall compensation plan. Jason put this blog post up as their response to the employee request for equity participation. My analysis was to look at how his solution responded to that request. I works well in some ways, not as well in others.

As I mentioned the desire on his part and that of the other owners to respond to that request was admirable. And certainly for non S-Corp type businesses it can be very difficult to respond to this sort of request in any way.

My comment on compensation was targeted to exactly this:

"People aren't taking jobs there on the promise of hockey-stick upside. It's a pretty amazing work environment. You should see the offices. Place is nuts."

Compensation is such a rich confluence of things, from wages to benefits to corporate culture to 'lifestyle perks' to profit sharing. My mother-in-law ran a CPA practice for 30 years and did various things over those years as forms of compensation. So its a rich, complicated, highly nuanced, and rarely replicatable space where companies have to operate. I get that.

The word "disingenuous" means something unflattering. Also, compensation may indeed be a rich tapestry, but options only matter if you're going to sell, go public, or buy them back. For companies without a defined trajectory towards liquidity, they're actually deceptive.

Ahh, got it. Perhaps naive would have been a better word, although I recognize that in some circles that can be a larger insult. And for the record, I think that their plan for this 5% is much less deceptive than options in an S-Corp can be.

The disparity for me is that Jason makes this claim, "And since we have no intention of selling 37signals or going public – the two scenarios where options/equity really make sense – the complexity became too hard to justify."

My claim is that that statement is disingenuous because it posits the following argument; The company will never be sold, thus options or equity would never be liquidated, so providing equity or options doesn't make sense. The implicit claim on which this argument rests is that they will never sell the company, and that claim is neither supported by a structural contingency on the company, nor supported by a statistical comparison with the ways in which LLCs are dissolved (granted medical practices and law practices seem to dominate in this area, and can skew the results). In my opinion, it deceptively leaves that impression rather than being 'up front' about what are the real constraints.

I would completely believe him if he said instead "The Articles of Organization for the LLC specify exactly how any proceeds from the sale or dissolution of this company are to be distributed, and we are loathe to change them. Thus we don't really have an option here." (no pun intended)

And again, I think its really impressive that they came up with a way to share 5% of the proceeds when the company is sold. I merely suggested some ways they could make it 'look more' like what other people get in terms of equity and options by both allowing people to keep accumulated time after leaving the company and by having those 'units' represent a similarly sized chunk of the company.

I agree. Different strokes for different folks. When you go to work at a YC company, you are betting on the upside. The salary is a good 'pay-my-bills' perk. But the real sweetspot is the 15% tax you pay on a liquidity event.

Whereas with 37Signals, you are getting a 'regular' job - where you can do everything to excel and become better at what you do and earn a nice living.

If you want to save your own money and invest in companies, then that's up to you. But it's not the same type of math.

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.

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.

The members in an LLC can take W-2 compensation just as owners of any other entity can be employed by that entity and take salary, etc. There are no special restrictions on this, at least that I am aware of.

If early-stage LLCs want to adopt equity incentives, they can mimic what a corporation does with a little custom drafting to the operating agreement. Instead of defining ownership in terms of percentage ownership as set forth in a schedule (the typical LLC pattern), LLC owners who want to issue equity to employees can define the ownership in terms of "units" of ownership. They define a number of authorized units in an operating agreement (e.g., 10M units) and then reserve a grouping of them for an equity incentive pool. These can then be used to support unit option grants (like stock options, albeit always NQO and never ISO) or restricted unit grants (akin to restricted stock grants in a corporation). If this is all done in the early stage, the units can be priced at nominal pricing so as to avoid adverse tax consequences to the employees. There is still the problem of option holders being taxed on the spread on the date of exercise (as with NQO options in a corporation) but, otherwise, such grants may be made very much as they would be in a corporation (made subject to vesting, etc.).

The key to an effective plan is to do this early in the LLC's existence and, if done in that way, this is pretty comparable to what happens with a corporation (except for the absence of ISO-like options). As long as this is all done right, there are no special restrictions on issuing equity incentives to employees in an LLC.

LLCs are state-specific and it might be that there are special restrictions in Illinois or other states that don't exist in California where I practice. But the above sums up the essence of how it is done here.

I do not pretend for a moment to be the attorney here, but it is my understanding that members of LLC, unless that LLC has made an 8832 election, are mandatorily considered self-employed and must make quarterly SEP payments, and that they cannot be employed as W-2 because, as a creature of state statute, the LLC is not held at the federal level (for tax purposes) to be a distinct entity apart from its members.

This is false in at least the commonly understood case, you can elect to be treated like an S-Corp under an LLC and receive a salary and keep your SEP-IRA among other things.

The obligation to be 1099 is the default case for single-proprietor LLCs but can be overcome as I described above. It is not necessarily the case for multiple-member LLCs.

FYI:

I am not a lawyer, but I have done all this before.

you can elect to be treated like an S-Corp

Right, that's what an 8832 election I referred to in the original comment is.

You are correct; members of an LLC are considered self-employed, and since the entity is disregarded at the federal level for tax purposes, it's not really possible to pay them[selves] W-2 wages. You don't issue equity to employees in an LLC; you can issue shares of some sort of bonus pool like Jason describes, or you can make them members, but in that case, they have to pay SEP taxes and cannot be considered W-2 employees.

Generally speaking, LLCs are not appropriate entities for a highly fluid, ever-changing shareholder picture. If you want to be able to easily add or drop employees--and for that matter, institutional investors--as partners, don't choose a pass-through entity. Choose something that is structured as an appropriate vehicle for that kind of thing, i.e. a C-corp with a share pool.

There are ways to get around this, of course. The simplest idea I can think of if you are an LLC is to create a separate C-corp as a holding company, and have it own some (presumably non-trivial) percentage of the LLC. You can then issue shares in the Inc. holding company to your senior employees. The Inc. would of course be entitled to the highest liquidation preference, be dilution-proof to whatever extent desired, etc.

Edit: You can also do what grellas said above and make some sort of accommodation for an equity pool in an operating agreement. But if you want to actually write any employees in as partners, you'll have to amend your articles of organisation every time you do it. So, it's still by far not the most flexible entity type for that.

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.

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.

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.

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.

The bonus would, however, be taxed as income and not as capital gains. That's kind of a bummer.

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.

But this is a true bonus, since employees are compensated fully in their paychecks, unlike options that typically replace some amount of salary.

How is 60-65% less than half of 80-85% ?

If it is taxed as W2 income, you also need to pay social security and medicare, another 7.65%. State taxes may also differ, if the state has a separate capital gains rate. Also, the max federal capital gains rate is 15% as far as I know.

Yes, I mispoke, and should have said 'more-than-double what they pay in taxes', rather than talking about the net.

In a max-tax scenario (high-tax state like California, expiration of the Bush tax cuts in 2013), the bulk of a large exit would be taxed at about 53% if ordinary income, but only about 33% if long-term capital gains treatment can be obtained. So they'd be netting about 30% less due to the 'bonus' approach rather than equity.

(I'm counting medicare tax, which no longer phases out any income, but not social security, which isn't collected on income over ~$107K.)

Same as non-qualifed employee stock options in that regard.

Very interesting employee "benefit." I wonder if it would be considered as an employee benefit subject to reporting requirements / oversight by the U.S. Department of Labor or other federal agency?

They just reinvented the RSUs without the S part.

Since RSUs are generally treated as shares, employees have a slight idea of what kind of piece they're getting. With this setup, "At least 5% of the ultimate sale price" could be anywhere from 5% to 100%.

Could you explain why a public company would issue RSUs instead of restricted stock?

They wouldn't be public, right? Hence all the liquidation event talk.

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.

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.

I don't know; I've never administered one. But: the scheme I described also accounts for most small consultancies.

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.

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.

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.

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?

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?

The employees want the sale price of the company to be higher so their portion of the 5% pool will be higher. As far as incentives go, it's not much different from equity/options.

There are the tax implications. This scheme will be ordinary income and subject to FICA and income tax rather than being taxed as capital gains. By being clever they're screwing their employees out of a lot of money. Employees also can't make an 83(b) election on a bonus.

Equity encourages employees to build long-term value even if they plan on leaving the company, and act favorably to the company after leaving. A buyout lottery for current employees hurts morale and encourages people to hang on to the job for the sake of hanging on (and royally screws them tax wise).

Mainly this is an argument against ever using an LLC for a long-lived business. LLCs should be reserved for personal shell companies and companies that will be wound down at a fixed time. If this had been an S corp or C corp, they could have simply adapted an off the shelf stock option agreement.

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

They already have profit sharing though (it's where the million dollar cars come from).

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).

what car costs million dollars anyway? Lamborghini Gallardo is "only" quarter of a mil... And Veyron is way above (couple of) million.

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.

I wouldn't call him a "regular employee" but incredible claim or not, DHH definitely did purchase a million dollar car recently.

So I googled 'dhh car' and it turns out he is the owner of some company, hardly a 'regular employee'.

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.

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.

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.

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).

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.

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.

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.

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).

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

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.

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.

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.

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…

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.

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".

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.

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?

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?

It's not meant to be an incentive.

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"

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."

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.

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.

Ok, then if he's so generous, why not quit screwing around and just share equity? Then, if a loyal employee leaves after 5 years they own something of what they built. If they get bought out the loyal employees would have some legal leverage to profit by the buyout.

Instead they have a promise of a bonus they're never going to get (by his own declaration), and have to start wondering what he's playing around at. Its the opposite of generosity - "its all mine, but maybe some indefinite share might go to you if somebody else later feels like it, but I'm going to try hard so that never happens"

This non-bonus bonus plan seems to be lazy, ineffective and insincere.

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.

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?

"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.

"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.

"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.

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.

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?

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.

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.

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

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.

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?

Why max at 5?

So one or two employees that have been with the company for significantly longer than everyone else don't substantially dilute the pool.

That would make for odd office dynamics where the more senior employees are driven to quit by the less senior ones…

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!

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