Introducing Progressive Equity – Increase employee ownership as company grows
blog.detour.com
blog.detour.com
Say SuperAwesomeStartup had a system like this, and the threshold was an ungodly high amount of 50 million dollars. The company IPOs and is worth 100 billion dollars.
Founder X owns 10%, Founder Y owns 8%, Founder Z owns 6%, Early Employee A owns 1%, Early Employee B owns 0.5%, Early Employee C owns 0.25%
And there are 5,000 employees of the company
Before After
Founder X 10B 5.02B
Founder Y 8B 4.02B
Founder Z 6B 3.02B
Early Employee A 1B 525M
Early Employee B 500M 275M
Early Employee C 250M 150M
Amount Distributed to each employee: 12.72B / 5,000 = 2.5 million each on avg
"Although the model may seem fair on the onset, it can be criticized the same way we criticize a flat tax. Those at the threshold are "punished" the most."
It seems to me that because it's a "progressive" tax this criticism doesn't apply.
Edit: math checks out now, I think
Does that clarify it @cespare?
This is the dusty trap door. Just so you know, getting rich is "weird"[1] for a lot of people. You can see examples of it in lottery winners, movie stars, and tech employees.
Of course some folks tie their net worth to their self image. This is, in my experience, both common and a moral hazard. But that said, the more interesting thing is that people in a company have opinions about other people in the company, and during a 'liquidity' event (aka IPO or sale) there can be a lot of drama and angst around the internal metrics people are carrying around in their head and the monetary reward that gets paid out.
You need only imagine someone in your company, who you have a very low opinion of their contribution, become $FU rich while you see only a modest change in your personal net worth. I have seen that dynamic break people.
[1] And oddly getting 'un rich' as many did during the dot com explosion is less weird.
You probably shouldn't work in the tech industry if that upsets you :-)
Once the IPO happens and you pay your employees $4.5 million, their $100-$200k salary doesn't seem worth much anymore. What actually would have happened to Facebook, if they did this? Is it possible that the company collapses, while too many employees quit so they can do their own thing, or retire? Would they have had to double or triple everyone's salaries to keep them on board?
I could see it being a disaster. It could also significantly de-value a company's IPO (or sale) because the investors would see this as a massive risk. At least until it's been tested with a company that IPOs.
The excruciating burden of going to work is almost non existent if you can say fuck off at any moment. A lot of folks there do lots of interesting and fun stuff.
While you could see some run away I would suppose that the numbers will be small if you have good corporate culture and policies.
Good point about adding risk to the IPO.
edit: BTW working at companies like Facebook and Google is pretty good from a lifestyle perspective so I'm guessing most wouldn't leave.
Some more recently hired SVP brought him with her on a trip to various offices as her go-to guy to make sure she wasn't bullshitted when discussing a specific project with the local teams. He had often brought along on trips like this in the past because of years of experience he had with the company infrastructure.
To be nice, each time she would offer to get her PA to book the flights and hotels, so he could benefit from her ability to get them booked into better rooms than the standard policy would allow for his role. Each time he'd politely declined.
Finally she pressed the issue and asked why he didn't want the better rooms.
Turned out he'd done well enough out of the IPO that he soon afterwards had decided to buy apartments near the local offices in the 5-6 cities across Europe where the main subsidiaries were, so he'd not have to stress with packing etc. when travelling there.
> have little impact on founders
really?
This is super innovative and cool - provided it holds up legally and with the IRS. (I gather it's meant to be a tax-efficient approach.) I sympathize with Andrew's motivation because as a founder, if my company made it big, I would want all the employees to do well. I always figured in that case I would just pay them out of pocket and take a huge tax hit to make it happen.
On the other hand, as a founder who has not yet "made it", an extra 50% hit on top of the 50% the taxman will take, is way more than I can stomach. The potential for outlandish wealth is part of what motivates me, even though I would be fine with much less. But the percentage and threshold can be adjusted to find numbers that should be suitable for anyone.
One thing that I'm not clear on and I didn't read through all the legalese is on what basis the "taxed" amount is redistributed to the remaining employees. If it's based on share vesting like a normal system, it sounds like it wouldn't change the distribution much. If it's an even split it sounds potentially unreasonable, for instance, to give 2.5 million an employee who joined 2 weeks ago.
Either way cool stuff and I'd expect something like this to become standard in Silicon Valley.
I think it's awesome to distribute money between employees like this but wouldn't it have a devastating effect on the company?
Some questions off the top of my head
- Since employees leaving don't receive from the kicker pool. Doesn't this incentivize people who are unhappy and want to leave to stay? There are some benefits to this, but seem like a ton of costs too (and part of what Pinterest's change was addressing)
- How is the kicker pool redistributed? Equally or along the lines of people's current distributions of equity?
- Curious if you have opinion on where the threshold should be set? And if it eventually makes sense to do tiers of thresholds? Or if you think the simplicity makes it make sense not to.
But think this sounds like a great thing, and would love to hear updates on it as it develops.
So does any other kind of "golden handcuff" stock option or time-vested stock grant.
Also, consider this. Someone who joined one month before IPO would get more from the kicker than someone who worked for years and then left 1 month before IPO.
You could even recognize higher risk of earlier employees by issuing special shares which have some mechanism by which if they leave, those shares may still deflate, but at a slower rate than later ones. e.g. for every time-period distribution of shares, these shares receive some fraction of the new distribution.
Along the lines of current (fully vested) distribution. So if there are three employees - Lisa, Erin, and Aaron, and Lisa has 5%, Erin has 2% and Aaron has 3%, then Lisa would get 50% of the kicker pool.
> Curious if you have opinion on where the threshold should be set?
I do have an opinion, if the 18 year old version of myself heard it, he'd want to punch the 34 year old version of me in the face, so I'm going to let you guys figure out your own number and not put myself in a position of defending a position that I'm semi ashamed of anyway.
> And if it eventually makes sense to do tiers of thresholds? Or if you think the simplicity makes it make sense not to.
We decided to keep things simple treat financial independence as a binary state, but you could definitely do tiers if you wanted to.
What were the reasons the Groupon board opposed your original proposal to redistribute equity? This time around, what type of pushback did you get from your lawyers and investors?
Second, consider the "median" startup raising a series A or B--not necessarily a rocket ship with a lot of negotiating power, and not necessarily a famous founder. Do you think progressive equity would raise concerns from your typical series A/B VC?
I don't have any experience with VCs, but from the FAQ at the bottom:
> ...it's designed so investors remain unaffected, but you're welcome to try and get them to opt-in.
So I don't see why VCs should be concerned given that they will be unaffected by this system. I could be missing something, though.
It's fine that everyone agree to this up front as they join the company, but it's difficult to go back in time and re-write the employee stock plan.
As well it should be.
But Andrew: instead of inventing this new model, why not achieve the redistribution by changing the percentages of the well-understood system. So instead of, say:
50% founder, 35% investors, 15% option pool (i.e., all employees combined)
20% founder, 35% investors, 45% option poolIt's a structure supporting the idea that the first $X million are pretty important for the founders (or anyone, really) but the next $XXXm aren't as big of a deal and can be spread around somewhat, hopefully increasing the total number of people who hit $Xm within the company if it becomes huge.
I like the idea.
Also, could the redistribution of equity at the time of sale have more cost in tax obligations than earlier redistribution?
While I really appreciate the legal docs, the truth is in a longer description that remains easily comprehensible. I think the main barrier to most of these alternative equity structures is a lack of understanding from all parties.
[1] https://blog.wealthfront.com/the-right-way-to-grant-equity-t...
In practice though, I think it's hard for a lot of companies, because unless you're planning on having a larger % of the company in the employee equity pool in the long-term, you're basically robbing from the size of the up-front grants to feed the follow-on grants. So when you give your employee his or her offer letter, you'll say, "I know this is less than what you're getting at other companies, but if you perform better than 50% of the employees here, you'll end up getting more than what you'd get from other companies." A lot of employees are just going to go for the sure thing, making recruiting harder.
At Detour we do give big follow-on grants, but we can do that because our employee option pool is like 45% or something, which we can only do because I'm funding the company, so it's not really a replicable model (while progressive equity is, I think).
Unlike the usual jungle of capped/uncapped notes, dilution, vesting schedules, option pools, pre/post valuation, etc...
It's a great idea because it means that average employees will actually be motivated by the equity; let's be honest, 0.05%, vesting over 4 years, of a 100-person company isn't enough to motivate anyone except for a starry-eyed young kid on his first startup.
If Silicon Valley ever wants to grow up and remain innovative, that's the sort of thing we'll need. A 0.05% slice is just a bonus and, compared to Wall Street, a pretty weak one.
I like the idea of something being pre-determined, set from the get-go, however as you mentioned different individuals have and bring different value and have different impact in the company. Does it make sense for high impact people to get a 1 megadonk increase, along with a low impact employee?
There's another model I was hoping to be able to explore, though I don't have a lawyer nor could afford putting the resources towards writing any draft for it - which takes more of a convertible notes with a cap -- you give employees higher equity initially, so if the company doesn't do as well then those employees gain more, and that equity comes with a cap - so say it's 2.5% of the company with a $5 million cap and that employee has agreed they'd be happy with that outcome. The company exits for $1 billion which would require a lot more effort from a lot of people - save if it's some automatic viral scaling company with only a small team, e.g. WhatsApp with ~35 employees before selling to Facebook ... under this model then employees 30-35 in WhatsApp scenario could gain $100s of millions of dollars for very little time and energy invested?
Audio compressors have features such as "soft knee," which gradually eases into compression over the threshold. Easing into the threshold might be a beneficial complication to the idea of Progressive Equity.
If I were a 4th level worker at your company implementing some important but invisible part of the core product, and suddenly the kicker pool rewards me with a couple of million, I might seriously consider quitting. Who wants to be a middle class salaryman in (pretty shitty) San Francisco when they could be a comfortable upper class person in almost everywhere else in the world?
Imagine running Facebook, and 50% of your 3200 employees suddenly earns $2M (for perhaps 2 years of work). How will your company suffer if even 10% of those immediately quit their jobs?
That looks like a possible catastrophe to me. A simple solution would be to make the kicker pool a bonus pool that just pays out the due amount linearly over 5 years. No one will be thinking of leaving if they're going to be paid a bonus that's 3 times their salary for the next 5 years.
This is precisely why equity vests over time instead of being awarded as a one-time event, and generally why the best employees are given regular equity refreshers.
You could quit when you hit that $1m mark, but on the other hand, if you stay for another N years, you might make even more. That's the thinking they're trying out here.
If you're really worthwhile to the company, your progressive equity refreshers might even be superlinear -- so you stand to make significantly more than what you've already made as an incentive to stay.
The assholes leave, the people that you want to work with stay.
When the compensation model at MS shifted away from equity (because of an essentially flat share price) in the '00s, then it became correspondingly more valuable to game the promotion system, and so the assholes become political and the rest is history...
It's tough sell to leave a high-paying stable job for a risky lower paying job... but what if you could adjust your salary and "earn-in" more equity... It could lower the burn and align interests better. Thoughts?
Also, can I get paid in Megadonks ?
I'll start with an estimate. i think i saw a retirement savings calculator somewhere suggest that one should try to save ~$2 million by retirement per person(!) (sounds a little high to me at first but i guess that's only $75k/yr for 26 years of retirement, assuming you dont make any money on investments). So if one wants to provide for themselves and a spouse, that's $4 million. Moderately fancy homes in very expensive areas can be around $5 million. So $10 million would provide for two people and a nice house in an expensive area (we havent accounted for children yet but somehow i bet you could get by on $10 million, after all, most people do). We havent yet accounted for taxes (income taxes on the initial payment (~50% including federal and state?), and also ongoing property tax on the house), so lets say $25 million, which is the threshold used by https://news.ycombinator.com/item?id=9337915 . This sounds like a lot but my sense is that for the threshold number youd rather overshoot than undershoot, and some people may have more expensive tastes than others; in fact it may even be too low.
$25 million is not that far off from the $50 million threshold used by https://news.ycombinator.com/item?id=9337837 .
So, what do others (not Andrew) think; would $25 million or so be a good threshold to use if one were actually doing this?
Dilution
Liquidation preference
Change of control
If your market salary is x and startup wants you to work for x-y cash + z equity/options/rsu, then there should be multiple scenarios in the contract when z shares will deliver you y * time worked in cash.
The thing that is so messed up is that in an actual liquidation event employee salary payable is the most senior level in the capital structure. If you are getting people to trade part of their salary for funny money it's better to have more scenarios where they are made whole than more scenarios where they hit the jackpot.
So if a scheme like this increases the odds of massive success enough, then the average return to everyone (even those 'taxed') under this progressive scheme would be higher than with a normal equity scheme and the reduced chance of a world-changing exit.
The problem Andrew is trying to solve, I think, is the core problem with fixed equity splits that give certain people an unfair share. The Slicing Pie model allocates equity fairly so no one person would have a disproportionate amount unless they made disproportionate contributions.
If you used this model with a traditional fixed split you would spread out the wealth a bit. If you used it with the Slicing Pie model you would be breaking a perfectly fair split.
While I believe the additional upside presented to employees will have a positive impact re: incentive alignment and motivation, it is TBD if the gains realized by the founders will exceed the cost to the founders - I think that will be required before massive adoption (probably the biggest challenge here is measurement of that impact).
Still, hopefully some just-plain-nice founders do this, and I hope it gets them a great team and great success.
Even without mass adoption, it would be awesome to see this get adopted by other companies who (like Detour) were started by already-exited founders who are on a second (or third/fourth/fifth) project - there are actually a lot of them, so hopefully enough are gracious enough to experiment with this AND achieve success so that there is a sound basis for adopting this more widely (of course the trade-off might not be in the progressive equity’s favor – and while I’m making caveats, serial entrepreneurs generally do better than the first time entrepreneur for a bunch of other reasons like experience/connections, so it will be hard to determine/quantify what portion of success can be attributed to progressive equity and not to other factors…still hope they give it a shot anyhow).
When is it "too late" to set this up? Does it have to be set up around the time initial shares are allocated (a/k/a company incorporation)?
This incentive plan is structured as restricted stock units that are paid out as shares upon an IPO or trade sale (called in the doc, the "Initial Vesting Event").
Tax laws in the U.S. will impose ordinary income tax on the fair market value of such shares when they are issued, which for clarity, is at the Initial Vesting Event.
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For the record, I am a bit peeved that the word "tax" is being used to describe aspects of this plan, as it may make looking up actually startup tax matters harder.
Now if there was a way to do this and get the long term capital gains tax rate vs. the ordinary tax rate. I can't think of any without paying the IRS before hand to buy your options or doing some sort of strange cyclical loan program with investors.
The Slicing Pie model ensures that each person on the team has exactly what they deserve to have. This would avoid unfair splits at the end that would need to be readjusted.
Here is an article about how it works: http://www.slicingpie.com/how-to-use-a-dynamic-equity-split-...
I assume that the Progressive equity would only be applicable to current employees of the startup.
He might not be as successful in promoting it but it is trying to solve same issue.
I also really like the idea of that, even as Founder number 1. Having a healthy, fair and equal relationship to many capable people might also be worth more to founders than another million bucks.
This is used by Coops to handle the owners shares in a tax efficient way (cooperators in the jargon).
You might want to look how coops are structured in the USA before trying to invent your own scheme
Just watch the final table of the world series of poker and you'll see what I mean. The guy who comes in second place or for that matter ninth place becomes a millionaire, yet he feels crushed and robbed by the few ahead of him.
People are generally terrible at being happy with what they have and the age old maxim is still true that he who gets $100 wants $200.
All these folks being taxed...even if they agreed initially will feel robbed by the recipients and resent them, and who knows how messy it might get. People are weird when it comes to their money.This will especially rear it's ugly head when peoples shares on paper cross their financial freedom number on paper prior to a liquidity event. (I.e. by each round of financing and a valuation is set.)
If everything else remains the same, people would be less willing to take risks and join early stage companies, instead trying to join near-IPO ones, where you can get a disproportional payout from minimum risk.
To maintain the same risk/return profile, you'd need to pay much higher fixed salaries to early employees and lower to late employees, which would probably drive the startup bankrupt on the early stage page.
One's position with respect to this thesis would determine whether you believe this equity structure is a step forward or not.