A few years ago at one of our annual company meetups, the topic of options/equity came up. We’ve never had an options/equity program, but some employees were wondering if we could explore the idea.
So David and I started thinking about it. We consulted some other business owners, Jeff Bezos (our sole investor), and our accountants and lawyers. We wanted to get a pretty full picture of the implications of an equity program.
The more people we talked to, the more complex it started to sound. The complexity was both psychological (company dynamics) and economic (options/equity doesn’t really mesh well with an LLC corporate structure). 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.
However, we were determined to come up with another way so everyone could participate in the unlikely event of a sale or IPO. You never know, so we wanted to have a system in place just in case.
Some of the considerations included:
- It needs to be simple to administer. The closer we could get to zero administration, the better.
- It should be easy to understand and explain.
- 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.
- It should reward seniority. The longer you’ve been here the more you would participate in the upside.
- The plan would be consistent from day one until the last day. Some companies grant lots of options in the early days and then barely trickle them out later. We wanted the same opportunity for all new employees forever.
- We didn’t want to discriminate by position. Every employee, no matter the position, participates in the same way.
There were other considerations as well, but those were the key things we kept in mind as we developed the program.
Here’s what we came up with in the event of a sale or IPO:
- At least 5% of the ultimate sale price (or, in the case of an IPO, the fair market value of the capital stock) would be set aside for an employee bonus pool.
- Each current employee will be credited with one unit for every full year they’ve worked at 37signals, starting after the first full year. The maximum amount of units one person could earn would be five units. So if you worked at 37signals for two years you’d get two units. Three-and-a-half years, three units. Four years, four units. Five years, five units. Seven years, five units. Etc.
- We would divide the total employee bonus pool dollar amount by the total number of units held by all employees. This would determine the unit value.
- Each person would receive the unit value multiplied by their units.
We’re pretty happy with how this turned out. We think it’s a simple, clear, and fair system. And it’s a great alternative to the organizational complexity of option grants, acceleration, strike prices, conversion into shares, private markets vs. public markets, dilution by outside parties, partial vesting, etc.
One other thing: We treat this entire idea purely as a bonus in the unlikely event of a future sale/IPO. We don’t even discuss it with new hires. It’s not part of the overall compensation package (we don’t pay a smaller salary and try to make it up for it with this program). I wouldn’t be surprised if many employees have forgotten about it or don’t even know about it at all.
Tim Jahn
on 15 Aug 11I love the simplicity of this. I think it achieves much of the same value (ie, rewarding employees too if a sale happens) without the craziness of options and equity.
That being said, I think this option works for (and attracts) a certain type of person. The person looking for options/equity and the big sale would probably go elsewhere.
Which is good for you. :)
James Gibson
on 15 Aug 11It’s great to think these things through.
Do you guys also offer some type of profit sharing program with similar guidelines?
Seth
on 15 Aug 11Interesting idea Jason, but I always thought that the idea of offering options and equity was a great motivator to get employees emotionally invested in the company. Based on your description, I doubt if your “units” system has a similar effect.
I know that for myself, I could never again work in a place where I don’t have a share of the potential profits down the road.
I agree that the typical option/stock grant isn’t that great for a LLC, especially if you’re not going to go public. The complexity is difficult to grasp and administer.
Did you guys explore anything related to revenue sharing or was that simply off the table? Are there any other “levels” of employees at 37s – or do you only have “partners” (you / dhh) and “employees” (jamis, pratik, etc)?
Greg
on 15 Aug 11If nobody knows (and cares) about it then what’s the point?
Anonymous Coward
on 15 Aug 11Current employees only?
Lets see if I got this right – a person works for 37signals for 10 years, leaves the company and you sell it the next day? And he doesn’t get a dime because he’s not current? As if he didn’t contribute to the company while working there?
Federico B.
on 15 Aug 11Jason: Why cap it at 5 years? Am I missing something or would the guy who’s been there 5 years receive the same thing as the guy who was there 10 years or w/e?
Pippa F. (not the 'Anonymous Coward')
on 15 Aug 11Don’t stamp me as ‘Anonymous Coward’, just warn me if the name is required. Or shadow it with ‘Anonymous Coward’ and I’ll leave it that way if I like it.
Really not user-friendly. Or maybe I just don’t share your sense of humor…
JF
on 15 Aug 11Jason: Why cap it at 5 years? Am I missing something or would the guy who’s been there 5 years receive the same thing as the guy who was there 10 years or w/e?
Because if you have a couple employees that have been around for a long time, it would massively dilute everyone else. I don’t think that’s necessarily the fairest way to implement a system like this. That’s why we capped at 5 units.
Tadas
on 15 Aug 11It is really simple and clear. However it is also clear that in theory people could be motivated to get rid of people who work there for too long in case they smell IPO coming… But I guess you don’t hire people who would do something like that in the first place.
My point is: bonus schemas which do not encourage team spirit, when you get less if someone else gets more, might be risky.
Gary
on 15 Aug 11wow – 5% – how generous…
Chris Gillis
on 15 Aug 11Thanks for the transparency here on your company politics but what are you guys so adamant about selling a company? I think you alluded to it 3-4 times in this small article-what’s the big deal? You may lose your passion for building web software at some point, you may want to accomplish something else, you may want to explore something that has nothing to do with this company – no ones gonna really care, but if you build your whole persona of your company around this alternative “I’m never selling this thing” people will call you out on it.
I know in your first book you quote Ian MacKaye (great BTW) when he says (in effect) -if you have a bakery and you love baking, than keep doing what your doing instead of building the business up and selling it. Thats a great lesson but its a little more personal, I don’t think you need to tell everyone all the time.
Alex Humphrey
on 15 Aug 11That is a really interesting idea. Especially for an LLP.
I like the part about most employees probably forgetting about it. Should 37 Signals ever sell/go public the employee will find themselves with a nice little bonus.
That’s the good kind of surprise that comes with massive organizational change. lol
JF
on 15 Aug 11Chris: 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.
You should work at 37signals because you like the work, you like your co-workers, you like the company, you like the customers, you like the environment, and you like what we stand for as a company. Not because we’re rushing to be sold in 3 years and this could be your lottery ticket.
There are plenty of tech companies that have a very clear goal of selling. That’s not why we’re in business. We’re just making it clear. I wouldn’t read into it any more than that.
We didn’t say never, we said no intention and unlikely.
Ryan Walker
on 15 Aug 11I’m a little surprised by the 5% as well, though you did say “At least 5%”—I would have guessed you guys would share more with the troops. But this depends on how much equity is already distributed to the core people who were around in the earlier days.
Theodore Nordsieck
on 15 Aug 11Your solution is really similar to another one I like: Mark Cuban’s Phantom Shares Proposal.
You definitely get more control over limiting things like total payouts and bonus on acquisition with your current plan. Not sure if I like that, but it’s a pretty small difference, all in all.
Anonymous Coward
on 15 Aug 115% is a pretty standard pool amount for employee share grants.
Chris Gillis
on 15 Aug 11JF – I totally agree that employees should work with you b/c of the work – I guess I’m a little shocked that people are that greedy in this business. I’d never work a crap shop if I was guaranteed in 3 years a sale would be done and I would be paid heavily – first off I’d never trust that situation, secondly I wouldn’t waste 3 years of my life.
That kinda sucks man that you are dealing with people that would just join a company to cash in…I’ve never had employees so I wouldn’t know.
...and hey all the power to you guys if you ever sell it – you built it – DO IT! I worked for a company in the snowboarding realm and the owner just loved that entrepreneurial period of the first 3 years – and keep reinventing that situation – I couldn’t blame him, its the most exciting time….I’d do it.
Leeheb
on 15 Aug 11I had 5% in a growing company once. I had a contract that gave me 5% of the gross if the company was sold or acquired. It was great!! I felt appreciated and taken care of and I worked harder to make great things there than anywhere else.
When the company was dissolved due to bad management, I felt as twice as betrayed. Mostly because I was lied to on many occasions and I was in an executive position.
While my exposure is unique, I think it promotes a certain psychology. This type of incentive gets everyone to feel like a 15 year old girl who loves their boyfriend. When they are in love everything is write in the world and the fairy unicorn rainbows can be seen on every corner; however, if anything goes wrong, we are crushed.
Not saying this will ever happen at 37signals, just stating how vulnerable this can make employees.
James Heathway
on 15 Aug 11Hi Jason,
Thanks for the write up.
Does your bonus plan include the founders, you and David, both receiving 5 units?
Regards, James
Drew Volpe
on 15 Aug 11One big downside for employees with this program is that whatever bonus they get would be taxed as income rather than capital gains.
Clay S
on 15 Aug 11Thanks for sharing. As you said, this would only happen in the unlikely event of a sale or IPO. I’m curious if you have a formalized program in place to disperse some of your annual profits (I believe you’ve used the term “millions” in profit before, but I may be misremembering)? Do you set aside a certain amount of profits each year to be given back to the team or do you kind of just play it by ear?
Or is the understanding that 99% of compensation is what was agreed on by the employee upfront and you don’t distribute any profits to the team outside of the partners?
Just curious if you can shed some light on that setup as it seems like the much more relevant one since you’re not heading for a sale/IPO. Thanks!
JF
on 15 Aug 11Does your bonus plan include the founders, you and David, both receiving 5 units?
David, Jeff Bezos, and I do not have any units from the employee pool. We do not dilute the pool.
David Ulevitch
on 15 Aug 11There are equally simple restricted equity programs that provide major tax benefits over this, without providing equity to former employees, and while still being simple.
Gary Bury
on 15 Aug 11We have a similar scheme at work but have done it the complex way for tax reasons. Like you we have no sale agenda but in the event our emplpoyees would also get 5% on sale but would pay something like 10% tax rather than 40%. My point being the complexity is worth it to increase the value to our employees.
We’re in the uk, are there no schemes in the USA that would have made the complexity worth it?
Michael
on 15 Aug 11I think that’s a nice system, Jason. Good job to you and everyone else who worked on it.
Alcides F.
on 15 Aug 11I was wondering… why the 5 units cap?
Michael
on 15 Aug 11@Pippa F Anonymous Coward is a reference to the Slashdot comment threads (or possibly something else.) It’s just amusing commentary on Internet discussion and not a personal reflection.
Just Wondering
on 15 Aug 11Are you currently hiring other than the filmmaker position?
Ben Kinnaird
on 15 Aug 11Thanks for sharing Jason – We tried a similar points based system for our quarterly bonus scheme but after a year switched to a % of salary system similar to the John Lewis Partnership as it was simple to administer and fair to any employee of any level. The bonus would only kick in after 1 year.
The change was prompted by the employees not me and as I am not part of the bonus pot, being the director, I though it was rather fair.
The difference is our bonuses are paid out each quarter. Where as for 37s I guess this is a safety blanket for employees should the unthinkable happen.
Tom K
on 15 Aug 11I missread the word seniority. I read seniority as being someone in a commanding position i.e a manager, however, in this context it purely a time based amount. Do you not feel that you would need to reward the higher echelons of your staff more as they have more experience and risk? I am a lowly 2 year producer at my company, but I still thought rank would account for something?
This scheme also works best with a 50+ person company as then you have a good number of points in total. I would imagine a 10-20 person company the units would be worth too much. I like the simplicity but I would possibly add a further layer which would be top level managers get 3 extra points, senior workers get 2 points, normal workers 1 point and interns 0 points? You would only be granted any of these extra points if you had worked for at least 1 year in the company- what do you think?
dan
on 15 Aug 11sounds like complete bullshit to me. The main issues.
Total equity pool for all employees is 5% ?? Really? Seriously?
5 year cap and you get nothing after that. So a customer support staff member with 5 years experience gets the same amount as a senior developer with 8 years at the company. Really?
I leave the company I get nothing. I can’t sell my units on secondary markets.
I can’t believe any of of the technical staff would be retarded to think this was a good idea.
Scott
on 15 Aug 11Two questions:
1. What’s the point of having this? Is intended as an incentive? A measure of goodwill?
2. This seems like an awful lot of planning ahead. Why not wait until a sale or IPO is on the table and work out a way to allow current employees to participate at that time? What happened to “Ignore the details” until you need them?
Rahul Pathak
on 15 Aug 11This is a really thoughtful approach. On the surface, it seems to favor tenure over performance, in terms of who it rewards. Do you think this is a concern? Or, do you have other ways of addressing the performance issue.
Cheers,
Rahul
JF
on 15 Aug 11Rahul: If someone isn’t performing then they won’t be working here very long.
Nick
on 15 Aug 11I’m surprised, shocked and saddened by the number of people complaining. Can you hear yourselves?
Hers’s how I read it: Employees to JF & DHH: Any thought’s of an options/equity program? JF & DHH: Not yet, let us think about it. JF & DHH come back: Well give you 5% (minimum) and try to make it fair for everyone (via units & a cap).
That’s a free gift. From them to their employees for free. And some people’s response is: Really? That’s it?
John
on 16 Aug 11This is a somewhat amateur scheme that you guys would end up changing if and when a liquidity event did occur.
Example: key developer Joe has worked for you for 10 years, but gets sick and has to leave. 3 months later you sell.
I think you guys would find a way to throw some cash his way.
David Q Hogan
on 16 Aug 11Another aspect of having shares is receiving a dividend when the company does well. Not sure how common that is.
Anonymous Coward
on 16 Aug 11Another aspect of having shares is receiving a dividend when the company does well. Not sure how common that is.
For private companies in the tech world? Show me 3 and I’d be surprised.
Rahul Pathak
on 16 Aug 11@JF: Thanks for the reply. Makes sense.
Steven
on 16 Aug 11Did you ever explore profits interest?
As an LLC you enable employees to profit if or when the company is sold.
You set a floor amount You, David and Bezos get first, then each person after the initial amount is paid, gets their “portion” of the profits.
For example if you sell for $30 million. You, David and Bezos want the first $20Million split between you three. The “Floor” in this case.
The remaining $10Million is divvied up per person based on the amount of profit interests you grant them.
So an employee is getting a share of the $10 million “profit” but not the whole company sale. Plus their non-voting shares so you do not have to have board meetings, etc.
GeeUWonder
on 16 Aug 11So let me get this straight… Employees want some sort of equity which would be normally be something like, Oh I don’t know, net income was a shit load and since you own .01% equity in the company, you get x$ at the end of the year.
Well, that is way too complicated (and I believe it is sticky). So, instead, let’s make it easy and say if we ever sell or IPO, you will get this simple plan. Which, oh by the way, there is like 1 in a million chance of the owners selling or IPO, so in reality you really aren’t getting anything. But, at least we did something.
Wow that sounds like a really sweet deal to me.
Sara
on 16 Aug 11Jason,
As an entrepreneur, I like what you’ve created here but was wondering if you can elaborate why you chose 5%. Why not 15%? Or 3%?
Thanks.
Sara
Jimmy Chan
on 16 Aug 11@Sara
There’s a lot of factor to determine 5%. Income, profit, future-plans, company size, etc
Very flexible I think.
Henri
on 16 Aug 11I thought I’d share my previous company’s bonus scheme as I think it was quite simple.
We gave 1/3 of the yearly profit to employees divided by their salary ratio. 1/3 went to the owners and 1/3 was kept in the company. This encouraged all people to work together regardless of their role.
Sasha
on 16 Aug 11An elegant solution to a complex problem.
That being said, I don’t think that limiting the number of units to 5 is a good idea. Say you have a developer that’s been working for 10 years and a cleaner that’s been working for 5 years. Under your current scheme they get an equal share of the money. How about a developer working with you for 20 years?
JF
on 16 Aug 11if you can elaborate why you chose 5%
We asked around about standard employee stock pool percentages, and it came in around 5%. That’s why we picked that number.
SweetPea
on 16 Aug 11Judging by the responses here, you may have to come up with a better plan :)
Anonymous Coward
on 16 Aug 11If the plan isn’t something your employees think about and you don’t use it as an incentive to hires, then why have it at all?
If you want to be generous and do right by your employees, then just implement your bonus program as a surprise if you ever sell.
Isn’t the entire point of having an up-front program like this that it’s supposed to motivate employees?
It’s like you’re giving up 5% for little to nothing in return, which is fine, like I said, but then make it a surprise, that way you’ll achieve the same end without the risks of having an official program that people can fight over and that you’ve spent time on creating for a hypothetical, unlikely event.
If the program is more about motivating employees then you’re letting on, then don’t be shy about it.
Ian
on 16 Aug 1137signals will be sold. 3-4 years plan.
Scott
on 16 Aug 11I agree with Ian. If it weren’t so, there’d be no reason at all to dangle this carrot in front of employees at this time.
Anonymous Coward
on 16 Aug 11I believe we’re going to see David and Jason’s visible participation slow and posts to svn become far less frequent in order to show potential buyers that the company can continue strongly forward without their presence.
condor
on 16 Aug 11We asked around about standard employee stock pool percentages, and it came in around 5%. That’s why we picked that number.
Why did you guys choose to go with default convention in this case when most of what you guys do is reasoned? Shouldn’t there be a better reason behind something so important besides ‘everyone else is doing it like this’? Comps are a lazy way to make important decisions.
JF
on 16 Aug 11Ian/Scott: You must know something I don’t!
As usual, the actual answer is much simpler:
The reason I posted this now was because I recently read a post by Jessica Mah about how her company pays people less salary in the short term in exchange for equity in the long term.
It jogged my memory about a post I’ve been meaning to write for a while about our exploration into equity/option plans and the ultimate plan we came up with. I had some spare time this weekend so I wrote it up.
So there you have it. Back to work.
yosep
on 16 Aug 11What a great post! If I were a 37Signals employee, I would be grateful for this program because I am not expecting it. The management is already doing a fantastic job of creating a company where things that should matter actually matter. And top of all that, you give me some equity?? What a great present!
@dan: I am a senior developer and I don’t think I value more than a customer service rep. I hope you should feel that way too.
smyth
on 16 Aug 11Interesting approach; the larger the number of employees at the time of IPO/sale, the more diluted each employee’s bonus is, correct?
SweetPea
on 16 Aug 11Oh gosh, yosep, just send them your resume!
Robert
on 16 Aug 11Entirely confused.
So the discussion came up. “How can we, as employees, benefit from the success of the company?” As in profit-sharing, etc.
Now, of course, you’re in no way obligated to do any such thing.
But to then say “Well, we thought about that, and we think we solved the problem – if we sell the company (we won’t!) or go public (we won’t!) – then you’ll get some share of 5% of the price. There! Awesome! How simple!”
When the practical reality of it is you basically said “No. No profit-sharing, in this sense.” (You may well offer bonuses, and such – in fact, I’m sure you look after your employees very well, this isn’t to insult your efforts at looking after people) – but it seems to me here that “you solved the wrong problem”.
Maybe it’s not that simple, or I’m misinterpreting (after all, the description in the opening paragraph offered very little detail of what was discussed)... but in my experiences, when employees of a company that has often, and vocally, expressed its intention not to sell or go public, approach management about equity and options, it’s about looking at dividends on the money that is made. Then you read the rest of the article and it’s the company patting itself on the back for coming up with a “zero administration, simple solution”... for an entirely different problem.
Definitely confused/-ing.
Abhishek Desai
on 17 Aug 11Jason, It would be really nice if you can write a post about how you guys give raise to your employees, what’s the compensation structure, evaluate performance etc.
For e.g. Joel Spolsky does it this way at FogCreek
http://www.joelonsoftware.com/articles/fog0000000038.html
Also if you guys have some kind of “HR Policy” in place, it would be nice to know that too.
It will really help companies like me to develop a system which is fair and simple.
Thanks.
yosep
on 17 Aug 11@SweetPea: Are you hiring too? :P
Ian Smith
on 17 Aug 11Not sure what objective this structure achieves.
You seem to be saying we don’t mention it to new recruits so its not a talent acquisition tool.
You are implying that staff will forget about it so it doesn’t motivate existing staff.
When it is paid out it sounds like it will be treated as income thus attracting the highest rate of tax.
Capping the number of units also seems a little strange.
I personally think there are better schemes eg an exit ratchet based on value above a threshold which means that employees are focused on building a very valuable business whether or not you sell it or not.
But I absolutely applaud the innovation.
Jeremy B
on 17 Aug 11I find this message confusing. So far your message has been ‘we’re not building a company just to sell it/IPO’. Now the message is obscured and I am unclear on what you stand for.
Is this stemming out of employee pressure to get an equity stake? Guilt from wanting to retain specific employees? What would be the consequences of making other employees partners or having a bonus scheme based on profits?
Furthermore, do you think that once you put this out to the world (which you have), you will start getting employees, including future employees, starting to pressure for ‘realization’ of that free option, through the sale/IPO?
Anonymous Coward
on 17 Aug 11Ian: It was said many times above. It’s a bonus. A bonus on exit. Cash bonuses are always treated as ordinary income.
Eric
on 18 Aug 11Did you consider awarding based on the number of quarters? You might get some resentful employees who work 2 years and 302 days only getting 2 years worth of benefit.
Granted, this is an amazing thing you guys are doing, and one shouldn’t look a gift horse in the mouth, but rounding to the lowest year might cut an employee’s bonus in half, even though he has worked through 95% of that second year.
Other than that, excellent plan!
N.H.LONG
on 19 Aug 11This plan really well yet. I still do not understand the deep
Trabajos Medio Tiempo
on 19 Aug 11Great plan, clear and straight forward… Sure enough there is some people who would like more, but hey, this is a bonus a gift, not part of the salary…
Brann
on 21 Aug 11How exactly are you planning to implement this? If and when you sell your company, the money will go directly in your pocket, won’t it? So you will have to manually give back some of your own money to the bonus pool, won’t you ?
The standard answer to this seems to be stock options with an automatic vesting if the company is sold, but since you explicitly said you didn’t want to do that because of the incurred complexity, I’m curious how you want to achieve this !
David
on 21 Aug 11Jason, sorry, I like your products and most of what you guys do at 37signals, but this system is stupid.
Option grants are common in tech because they let non-founding employees participate in the upside of a firm on the event of a liquidity event. In general, shares are given commensurate to how much risk a party took on behalf of the firm - n founders start with something like 1/n of the company each, early employees get a few percent, and later employees mostly get cash - they didn’t take any risk.
37signals is a going concern that’s profitable and probably won’t be sold. Also, the enterprise value of the firm isn’t going to increase 10x anytime soon. It would make a lot more sense if you took a page from other established, profitable businesses, and paid cash bonuses rather than mess around with shares, which as you say, is complicated because of control rights, the fact that LLCs don’t have shares, employee taxes, and 100 other things. Cash bonuses would be vastly simpler, they could reward profitability just like option grants, and are used across many other industries (finance, retail, etc.) by firms in similar situations as yours.
Gordon McLachlan
on 21 Aug 11Seems like a really nice concept although I’m surprised you guys drew it up considering you have no intention of going public. Out of curiosity, have you added it to your employment contracts or it more just an unofficial plan you guys have in place?
This discussion is closed.