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Based on the entire article, I don't agree.

1. They don't plan to exit, which is why they pay well and have good benefits. It says right in the article that this shouldn't be factored into fair compensation; it's extra. Equity is factored into compensation if it's worth anything, or it's valued at $0 and not factored in. So an employee at 37signals is making more right now because of this 'exit benefit' than they would if they had equity.

2. The article says it's a 5% minimum and gives an example of a spinoff sale where 100% was distributed. If the company is successful, having a fixed share in this pool increases in value every year, just like equity. If it's not too successful, than the value stays steady; a startup giving away 5-10% every year not successful should be diluting its employees.

3. Early employees often don't realize much of their equity for a variety of reasons. Often, these reasons aren't really understandable by the employee when they took the job. The system in the article is very easy to understand.

Being upfront about good, full salaries and benefits and throwing this on top just to make sure, in the unlikely event of an exit, there's a simple system to make sure employees aren't left out and have a much easier transition does indeed sound like a great alternative.

I'll add another:

4) a bonus paid at time of exit will be subject to regular income tax, while options can (but don't always) benefit from long term capital gains tax.

Rough example: if an employee were to benefit to the tune of $1M due to sale of company, under this system, they would be taxed in the highest bracket, at 39.6%, plus FICA withholdings, so they'd end up getting less than $600K from the sale. If they had options instead, and had held them for at least a year, they'd pay 20% in capital gains, so they'd walk home with $800K.

Your plan is costing your employee $200K+ in this scenario, with no commensurate benefit to the company.

If you don't want to give options, why not do profit sharing instead? Let current employees who have been with the company longer than 1 year enjoy some cut of the profits each year the company has them?

> If they had options instead, and had held them for at least a year, they'd pay 20% in capital gains, so they'd walk home with $800K.

That isn't the case. They would be taxed as regular income if you waited to exercise them until the exit.

In order to be taxed as long term capital gains they'd need to exercise them and hold them for a year. When they exercise them they would be taxed as regular compensation based on the fair market value. That isn't without its risks - if the value of the options declines it's possible to lose money.

I should have said "if they held exercised options." You are absolutely right if not exercised, and right that there are always risks of declining value if held. It is possible, btw, to exercise options prior to exit.

In practice, there is often a mandatory holding period for sale of options after IPO and even after sale of company when stock is converted to stock in the acquiring company, so that risk doesn't disappear by virtue of choosing to not hold.

Personally, I'd take the risk of decline in value over the non-risk of a guaranteed 20% reduction in value, but undoubtedly you can find examples of companies which do lose more than 20% over the 12 months after exit.

My point is simply that the arrangement to pay out bonus in the event of an exit begins in the hole 20% over the arrangement to give out stock. And the worst part of this is it doesn't even accrue 20% more to the company or to other stock holders -- it just evaporates due to bad tax planning. I guess those who experience this can take some solace in their loss buying more roads, missiles, schools, corporate tax breaks, or whatever preferred tax policy they'd like to imagine contributing to.

I'm not anti-tax. Taxes are good, and people should feel good about paying them, mostly. But low long term capital gains exist for a reason. The government is incentivizing the exact type of investment that stock options can represent.

YMMV. In some countries you have to pay taxes when you receive options -- as opposed to when you exercise them. This can make it impossible for some people to receive options, as they may not be able to afford the taxes.

If my company offered to reward me with a brand new car I might not be able to accept it because of the requirement to pay the taxes - but I wouldn't think that the tax man was being unreasonable.

I don't really understand why you'd expect the tax code to allow you to receive options tax free? If they have a fair market value then receiving them as part of comp should be taxed as such.

We did something like this, and the goal was absolutely not "to incentivize people to create value for the company."

For a venture-backed startup, that can make sense, but for us it didn't. The company already had value when people joined and not only was "an exit" not guaranteed, it was quite unlikely. We built the company to run it indefinitely. I believe I used a phrase like "In the very unlikely event that the company changes hands.." to introduce this bonus.

Because of those differences, this isn't compensation or incentive and, as you noticed, it doesn't try to be. Think of this as electively sharing a neat event with those who have invested part of their career in the company.

Well-put. I'll only add that even with options,

  3) Past employees who might have made significant contributions and created tons of value get nothing

is an issue because ISO options expire at most 90 days after termination. Some companies have begun to provide terms that allow employees to exercise their options for much longer (7 years in Pinterest's case I believe), but this is far from a universally accepted practice.

Yes there are a bunch of companies with extended exercise windows now [1]! I'm a huge proponent of extended exercise windows and would personally never work at a company that didn't offer that.

However, even ISOs with 90 day expiry periods are way better than this. If you are presently employed at the company at the time of IPO/acquisition then you don't have any issue with the 90 day window, and if you do run into the 90 day window at least you have the choice to exercise them or not. And if early exercise is available then you could exercise options early on when the company is worth very little and then not have to worry about the 90 day expiry period later.

1: https://github.com/holman/extended-exercise-windows

Also, every plan allows for exercise of vested options. While this might not be tax advantageous you can use the options and get the stock at a sweetheart price. If you believe in the company this still seems like a good deal.