CFI dcast: Beyond One Size Fits All for Startup Employee Options

Do we need a new pay system for the way startup employees are compensated? While many people agree that the current 90-day exercise practice — an outdated relic of when companies used to go public/get liquidity in a much shorter timeframe — is far from ideal, neither are some of the other solutions proposed so far. Because incentives matter, and behavior follows incentives. Which is fine as long as you know all the implications around what you’re incentivizing for and it aligns to what you want as a founder for your company and employees.

So “let’s get it out from under the rug, let’s talk about it, and let’s design a system that works for whatever you want your company to be”, argue CFI partners Ben Horowitz and Scott Kupor in this episode of the CFI Podcast. The discussion goes beyond just the question of a 10-year exercise to other configurations — such as Snapchat’s model and Tesla’s model for timing options, as well as radical experiments like “progressive equity“. What are the tradeoffs of each approach? How does the type of company you’re building (a complex hardware or infrastructure-heavy startup for example) change things? How does the broader environment affect all these considerations (and might plans to create a new long-term stock exchange help)?

Finally, is it fair to treat tenure as a proxy for the actual value a particular employee contributed to building the company? Or to optimize for earlier vs. later employees, particular if the earlier ones de-risked the company and later ones helped scale it? And what do different employees want — more options, more RSUs, cash, more ownership, more stability, more mobility? All this and more in this episode…

 

TRANSCRIPT

SC: Hi everyone. Welcome to the CFI Podcast. I’m Sonal and I’m here today with our co-founder, Ben Horowitz and our managing partner, Scott Kupor, and we’re here to talk about a controversial and important discussion around stock options for compensating employees, and the nuances of timing the vesting of them. Well, let me just give some more context. We recently wrote a post that talked about some of the problems with the current 90-day system and what’s great about this is it’s generated a lot of healthy discussion, but let’s first start off with where we agree in broad strokes.

Ben: Well, I think, look, it’s important to go back when you look at a system redesign to how did the original system come into place. So it started in the 80s with the advent of stock options, and the original motivation for it was actually very smart in that when you’re talking about software engineering, yes you can build a product to do something, but how you build it matters even more than what the actual functionality is at the end, and to get kind of to a level where people are really invested in what they’re building, it made sense to make the people building that software be owners in the company. That was a great innovation, and as part of that, the ownership agreements were written in a way that was compliant with the then-accounting laws.

The then-accounting laws basically said that if you gave an employee more than a very short window to exercise, you would potentially create a very large accounting charge which would make it impossible for the company to ever go public or be acquired or anything like that, and that you wouldn’t be able to predict earnings and all kinds of other things from a technical accounting standpoint. That was just the way it was and nobody questioned it from its origin to the early 2000s, and then following the great stock option scandal of the early 2000s —

SC: What was that scandal, by the way? I don’t know what you’re talking about.

Ben: Well, it was a stock option pricing scandal. So basically people were saying that companies were picking non-random dates to price their stock options, and a bunch of people went to jail and people got fined and all that kind of thing. So they changed the law, and the new law kind of made it okay to have a longer exercise period, but nobody changed the practice. Wait a minute, if you’re rich and you have 90 days to exercise, that’s fine because you can buy your stock options, but if you’re not rich, then you can’t, and so now we’ve created this class thing. That class thing always existed. There was just no way to solve it until more recently.

SC: What do you mean by “the class thing”?

Ben: So basically if you have money, then you can pay to purchase your shares, and if you don’t have money, then you can’t afford to pay, and they expire after 90 days. So a lot of the employees are employees who, for whatever reason, didn’t have enough cash, couldn’t basically acquire their ownership position. Now, the acquisition of that ownership position has risk in that you’re buying the stock at that price, and so if the company fails you lose your money. So the option is actually more valuable. It’s better to have 10 years to vest even if you’re rich.

SC: Right, because you have the optionality to sort of exercise at the best possible time.

Ben: Right, exactly. So Adam D’Angelo solved that rich/poor dichotomy by introducing the 10-year vest; however, created a new set of issues, which Scott outlined in the blog post. The issues are, one, you’ve made compensation packages far more valuable in that a 10-year option is much more valuable than having to buy the stock in 90 days no matter who you are. Then there are a couple of knock-on effects, one is that the stock in your company in the old model, when somebody would leave, would typically basically come back into the pool, and that just meant the overall dilution over a long period of time would be lower, which affects all owners and employees. So employees who got, say, .1% of the company would actually get less of the company in a 10-year exercise scheme than in a 90-day exercise scheme.

So then that kind of goes to the question of, well, rather than making one fix now that we have the new accounting law, should we take a step back and say, “Well, the accounting law changed and we didn’t reexamine it, and the time to go public changed and we didn’t reexamine it, and we also live in a much different world than in the 80s. Should we take a look at how you design an employee stock option program now?”

Scott: I think Adam did a great job introducing a new concept, and certainly lots of companies implement the 10-year extension period, and we felt like there hadn’t at least been a discussion of all the issues that this principle raised. So that was really the motivation behind doing it.

At a high level, the biggest thing that’s changed is we used to have four-year options with this 90-day option to exercise in a period where companies used to go public in four or six years on average. And so what would often happen is an employee’s options would be fully vested, they might choose to leave the company at that point in time, but often they had an option for liquidity, meaning they could exercise the option within that 90 days and then they could turn around and immediately sell the stock because often times the company was public at that point in time, and so there was already a liquid market.

And what we have today is because the IPO timeframes have been so elongated now, not only is the stock illiquid, and therefore if you exercise in that 90-day window you take risk obviously for the stock, but it also means that if you allow people to extend for this 10-year period, then you do have lots of stock that may dilute the ability of existing employees to be able to get incremental stock options, the ones who are still there working on behalf of the company. So it’s really this change in the IPO timeframe I think that really causes a lot of the kind of dichotomy that we’ve been trying to discuss here.

SC: Is it really a tension between early employees and late employees? Because on one hand, frankly, those early employees took on a hell of a lot more risk to take a chance on the company and actually de-risk and build something that later employees want to come to. So are we in essence pitting, when we talk about this longer period, are we really pitting early employees against later employees? Is that the red herring in the conversation? Or is that the crux of it?

Ben: I think that’s not correct in the following sense, in that early employees also get more stock options than later employees. Generally the way it works is that if you come in early you get a bigger package. Depending on the company, some companies do that in a way that turns out to be very fair, and other times they get it wrong. It’s kind of a complicated equation because you don’t know what’s going to happen along the way.

Scott: The other thing on early versus late employees to remember is there has always been an imbalance or dichotomy in early or late employees. One, which Ben mentioned of course, that certainly early employees, rightly so, get more stock because obviously they’re taking on higher risk. The other thing that the early employees typically have available to them is what’s called 83B, which allows them to essentially early exercise their options when the strike price is still very low and therefore the cash out of pocket required to do so is relatively minimal, and they also don’t have a tax event at that point in time. So what often happens for early employees is they eliminate this 90-day exit window issue because they’ve already early exercised their stock at a point where the stock price was cheap enough that it was financially viable for most people to do so. So that issue has always existed; we’ve always had this early versus later employee issue if nothing else then in the form of this 83B.

Ben: I think the big thing is, what are you designing the company around, and why do people have ownership, and who do you want owning the company both as kind of the founder, and then also from the employee’s perspective — the employees who stay the entire time, the employees who stay for four years, the employees who stay for one year — and I think you really have to take all that into consideration as you design the program.

We had a program designed with a set of accounting rules and, as Scott mentioned, a kind of expectation of when it would pay out that are no longer valid. So you kind of have to go back and look. One of the things we take for granted that’s also in there is, okay, one year cliff, four years is vested equally, is the fourth year more valuable? Is the third year more valuable? These are, I think, important questions in that what you’re really trying to do is to get people to take ownership in the company and build the company. And as the person who founds the company, what do you think that means? What is the tenure that you want for ownership?

We’ve seen people experiment with this model. Snapchat I think is doing a very interesting innovation by having most of the vesting occur later in the fourth year as opposed to in the first year, and that’s just a way of saying, “Look, if you’re here, that fourth year is just more valuable to us.” I think objectively it is, but that’s not reflected either in the current compensation scheme.

Scott: The other that I think is also interesting is Tesla, which goes less to vesting but more towards how you think about sizing option grants based on seniority and tenure of employees, and one of the things that Tesla does is instead of the typical practice which is most people a very significant grant the day they join the company and then over time they might get some refresher grants, but those refresher grants are often a fraction of what their initial grant was.

Tesla kind of reverses that and says, “We don’t really know that much about the employee day one when they come here. We’ll know more over years one, two, three as they actually perform,” and so what they often do is give a smaller package up front and actually give people who perform well more options later in their tenure to recognize the fact that, you know, their contribution is much better known at that point in time, and therefore it makes more sense to have an option package that reflects their actual contribution to the business.

SC: So it strikes me that that there’s a conflation between tenure and value that an employee contributes. So someone could contribute tremendous value to a company in year one or year four, or in year 10. You just have as a proxy, they’ve been here for one year, four years, 10 years, whatever the period is. Is there a way to sort of decouple the tenure from the actual value contributed?

The kind of employee you attract, say, in the first five years might be very different than the employee you attract in the last five years. I mean there are so many different factors that come into play as we talk about this. Because essentially no matter what model you set up for it, it seems like you have an adverse selection problem where you’re either optimizing very much for the type of people who don’t want mobility, because frankly if I were a startup employee, after vesting I have earned that. Those are mine. Why wouldn’t I want to be mobile? And wouldn’t you want an employee like me who wants to be mobile and has the type of talent that can go anywhere?

Ben: Well, I think there are a few parts. So one, the knowledge is actually very valuable. If I write a complex software system and I walk out the door, there is some of that knowledge I will transfer, but a lot of that knowledge walks with me. One of the things you’re trying to value with tenure is knowledge, not actually the value of the work in a single point in time.

SC: Just one thing to probe more on this idea — the value for Silicon Valley, the whole thing that built the value, the non-compete, etc. — is this mobility of employees. So what if I contribute disproportionate value to a company in the first two years, and someone else who came along and stuck around for 10 years did a good job but did not even create nearly as much value as I did. So why can’t we optimize for that?

Ben: Yeah, that’s a great question. I don’t know if it’s a dirty little secret, the obvious big secret is that the system is actually much more unfair than you’re giving it credit for. It’s unfair in the following sense: that your stock option package that you got before you put that two years in where you did 10X what everybody else did was set on work you did before you even got there.

SC: You’re right. No one even knows that value.

Ben: Yeah. So if I came from some Canadian company that nobody ever heard of and you came from Google and you got 5X the stock option package walking in the door than I did —

SC: And yet you created more value —

Ben: And I come in and create more value — I don’t get paid for that today, independent of mobility. That is a very difficult issue because it has to do with your market value. People do things to build their market value, and once they have it they’re not going to take the job for less than that, and they could take a job, got a big package, come in and not perform whereas somebody who, for whatever reason, has lower market value is going to get an unfair treatment. That’s really —

SC: That sucks, yeah.

Ben: Maybe there’s a theory that reconciles that. I don’t know what it is.

SC: I mean because on the back-end trying to have a founder then make up for that, say, initial market value and then try to disproportionately say, “I’m going to give you some extra stock options or make an exception,” that can also lead to favoritism and other issues.

Ben: Well, I think the big problem is you don’t have infinite stock. So absolutely you can give a performance grant, but there’s no company that I know of that allocates more money to performance grants than new-hire grants. So the new-hire grant where you know the least about the employee is kind of where most of this happens. And look, it’s not a statement of mobility or making somebody an indentured bond servant or anything like that.

SC: Yeah, that’s the part that I resist. I don’t want to be stuck in one place for like 10 years.

Ben: Yeah. You ought to design it so there’s compelling compensation for those kinds of employees. Particularly if those are the kinds of employees that you want; then you ought to incent that. On the other hand it depends on position, too. You might want somebody to come and do that in one kind of job, but if they’re the architect of —

SC: The infrastructure.

Ben: –The core of the database infrastructure or whatever, then maybe a year is not long enough to do that job correctly. Maybe it’s a four-year job. Maybe it’s a three-year job.

SC: That’s a great point.

Ben: Whereas there may be a very specific kind of thing that you can come in and get it done in six months. So compensation is complex. And I think you have to embrace the complexity rather than just rail against people who point out that it’s complex.

SC: You’re not arguing that someone who’s vested should not get their options, obviously.

Ben: Absolutely you should be paid for the work that you’re doing. But there’s a question for the company of, how do you want to pay people? Maybe the right scheme — and I’m not proposing a scheme — but maybe the right scheme is to pay much more cash early and then make ownership a later, binding thing, because ownership is significant in other ways, in that it has to do with the governance and the ability of the company to do everything from raise money to acquire companies to do all kinds of things over time.

So what is the threshold for ownership? I think it’s one thing in a world with 90-day exercise and another thing in a world with 10-year exercise, and not saying that means you have to be on 90 days. It just says if you’re going to be on 10 years, you’ve got to deal with that fact and not just sweep it under the rug. Let’s get it out from under the rug, let’s talk about it, and let’s design a system that works for whatever you want your company to be.

SC: So whatever you’re optimizing for basically as a founder?

Ben: Well, yes, what do you want the incentive on the company to be? How much do people have to care about the actual company themselves? If we’re just talking pure compensation, then I think cash is actually a better vehicle than stock, because one, stock is variant and you may not get paid not because you can’t vest, but because the thing goes to zero. Is that really your fault as an employee? Probably not. It’s probably the CEO’s, probably the founder’s, fault if the thing goes to zero, not your fault. So why are you penalized on that?

So that kind of gets into, are we really doing the right thing by paying everybody with large upfront option packages? Or should we have more cash up front, more ownership back unloaded for the people who are like, “Well, forget mobility, whatever. This is my mission, to build this thing”? Should those be the people who are owning it?

SC: Okay, but as a startup this is the one piece of leverage you have. You don’t have a lot of cash in the early days, and the one thing you can do —

Ben: Not necessarily true. I mean, if you can sell your stock, then you can have cash. If you can’t, you’re giving them valueless stock, potentially.

SC: Okay, so then why not give people restricted stock units? Why not just give RSUs instead of options? Wouldn’t that be sort of like a middle…?

Scott: You could do that, but it’s just not as valuable, is the honest answer. An option has more value typically than an RSU. Early in the days people want to optimize for that option value. So you could certainly do that, you’re right; you could give people RSUs early on and that would kind of change the dynamic. I think that would probably be a less attractive compensation measure for many employees relative to getting an equivalent number of options, because they’re just not as highly valued in terms of how the mechanics actually work for an RSU.

Ben: Right. When you’re Google and your RSUs are equivalent to your stock price and your stock price is exceptionally high, then the RSUs become extremely valuable, but if you’re a company that did a round at $15 million pre, and the RSUs are at the bottom of the preference stack, they’re a lot less valuable. You’d have to give less just because the option equivalent, the options have much more upside because you get more of them. So I think most employees who join a company and want ownership in that company would prefer options.

RSUs are kind of closer to a cash instrument. You might think of them as a hybrid, but it’s certainly a mechanism or tool in the toolbox. Again I think what you want to go back for is say, “Who do I want to own the company? Who do I want to work here? What’s fair compensation across the board for them? What does it mean to the people who stay with the company when a company leaves?”

One other tricky thing about the 10-year option vest — whether you want to stay or leave, whatever, I’m not making a moral judgement on that, I’m just saying — do you want a financial incentive for people to leave? If you have a 10-year exercise, there is potentially an incentive for people to leave in a sense that I can walk out with my stock that I have and I can get a brand new offer from a new company, whereas if I stay, maybe I get a promotional grant that’s equivalent to a new offer of a new company, but that’s a pretty rare thing.

SC: The flip side of that is, then do you want someone who feels trapped as an employee, who can’t necessarily move as easily because they’re essentially, for lack of a better phrase, handcuffed to the company for X amount of time? So then I guess the question I’m trying to get back to is this idea of adverse selection…

Ben: I think that’s right, that if you have stock that you will get if you stay, but not get if you leave, then you have that issue as well, that you may be incentivized to stay even if you don’t want to be there. You may have a financial incentive.

SC: Right, then you actually become less like “dead equity”. You become like a dead zombie just hanging around the company, to be honest.

Ben: No, absolutely. And look, we’ve seen that behavior for sure.

Scott: Yeah. No matter how you slice it, incentives do matter. So there’s no question that if you incent people, whichever way you go to incent people, the behavior will follow. So certainly now with the 10-year option I think you do create an incentive, and that may be fine. That may be an incentive that you’re okay with. If somebody’s here for four years and they want to be mobile after that, that’s okay, but I think you just have to recognize that you are creating that incentive and you have to be willing to understand the implications of that incentive you’ve created.

Ben: Right, and it may be something as simple as, “Okay, dang, I don’t want to incent people to leave after four years, but after six years I’d be fine with that,” and then you probably need to set your vesting schedule that way. These are just the issues that now become issues that weren’t issues before we make this change.

SC: Okay. Just to sum up then so far, it’s very clear that, we all agree that the 90-day vesting schedule is broken. We also all agree that everyone — the founder, investors, the people building the company — everybody is pro-employee. I mean, the employees are the heart and blood of the business. They’re the ones who create the value in the end.

So where I think the disagreements are really playing out is in the nuances of how to approach the solution, and it sounds like we don’t actually have a specific solution in mind. What we’re really saying is it really depends on what you’re optimizing for as a founder. So what are some of the broader principles and mindsets that we should then bring to this discussion if you are a founder trying to figure out the right way to go about this?

Ben: Well, different companies are different. So you have to start with, okay, what do I want, and then what does what I do incent everybody who’s applying for a job, everybody who has a job, and then whether or not they should leave that job. Then who do I want to own the company at the end of the day? I mean I don’t know what the best answer is, and it’s different depending on your ability to raise cash and other things as well.

So it really probably needs to not be one size fits all. I think that if every company had a different scheme you do get into a weird thing for potential employees and recruiting. So I think we might do a disservice to the industry by doing that, but there might need to be, say, four or five standard flavors depending on how you think about your company, what kinds of employees you have, and we already do have very big differences in that, if you’re a consumer internet company like WhatsApp, that’s going to be very different than if you’re a very complex hardware company like Tesla. Your ownership in Tesla as an employee is just going to be a different thing than it is going to be in WhatsApp.

SC: We actually call it the “WhatsApp effect” here, that you can actually build that scale of a business with like 10 engineers.

Ben: Yeah, for that business you can, but you can’t build Tesla with 10 engineers. So these things matter as well. So Tesla’s option plan cannot be the same as WhatsApp’s, or it probably should not be.

Scott: The other principle to think about — and people may differ on how they decide to implement it — is as best as you can, I think you do want to match the timing of how you think about people vesting their equity to as much as you can when liquidity happens in companies. And again remember, if you go back to where we started, it may just be now we might need to think about ownership and vesting periods differently, because you want to tie as much as you can the contribution of the employee to the overall creation of the actual equity value for the business.

So maybe an answer is to think about, gee, people should get more options, even more options than they do today. But with the understanding that they vest over a longer period such that it ties more closely to when you think a liquidity happens, and then you don’t have this issue of people leaving or not in terms of whether you need to change the actual exercise period, because you’re trying to more formally match again vesting with when there actually is a liquid market into which people could actually vest and exercise and sell their shares.

SC: So the overall theme is, there are plenty of different solutions that founders can have — and yes there are certain issues if not everyone standardizes, because while you can each experiment there becomes a sort of arbitrage between companies around their compensation and options package — but at the end of the day the real theme is to take a systemic approach to the problem and think about all the factors from not just a single employee, not just a founder, the large company you’re building, the ecosystem you’re living in, and not just have a simple solution without thinking through all the possible repercussions, and that seems to be the broader theme. And we actually in our own portfolio have a huge variety of how different people handle this. They have the freedom to do whatever they wish. So then why this rhetoric of this conversation being investor-anti-employee in the first place?

Scott: It’s really a question of, as Ben said, as a founder, what are the incentives you want. The only role that venture capitalists play in this, of course, is venture capitalists sit on boards of companies and they help the CEO kind of think about and manage option pools, but whether this happens or not is going to be driven by CEOs of companies, not venture capitalists, and there’s nothing that the venture capitalists stand to gain in this context other than what Ben said, which is can we all think about what is the optimal structure to actually help create bigger and more valuable companies over time, and in that case I certainly think the venture capitalists are 100% aligned with the founders in that respect.

Ben: Look, I have been an employee at a startup. I’ve lost options over the 90-day exercise window that I couldn’t afford, I really couldn’t afford. I’ve got three kids and I’m 26 years old, and all that kind of thing. So I understand the issue on that end as well. But I think what we’re really talking about here is how do you build a great company. None of these options are worth anything if the company fails. So the design of the option plan to make the company successful is every bit as important to the employees as it is for the employees to actually get their fair pay for their fair work. So you can’t divorce those two topics.

Sonal: The other important idea we haven’t talked about, and if Shannon were in this room with us (our head of the People and Practices group, but she’s on maternity leave) — I think the thing that she would say, and this is the most important thread that I’ve seen come up in posts like Adam D’Angelo’s and other conversations — is communicating in a very transparent way to employees early on what they’re getting into so that they know exactly what the tradeoffs are depending on the model.

Ben: Yeah, I think that was probably the biggest sin of the 90-day exercise era, is that a tiny number of employees actually understood that that was the case. I know I didn’t understand when I was an employee. It is in your agreement, but half of the language in a stock option agreement if you’re a young kid who wasn’t trained in this kind of thing was, like what is an exercise period? I thought that was like some kind of aerobics or something.

SC: Yeah. In fact Shannon often says they have this myth that if you work at a startup you’re going to become a millionaire, and that’s actually not always the case.

Ben: Yeah, it’s not often the case. I think that’s a big thing, educating people on what their compensation package means. If you actually did that and it was actually transparent, then you might learn something as well about what an employee would really prefer, and maybe it is longer exercise times and many more stock options, or maybe it’s more cash or maybe it’s who knows…

SC: It’s a two-way learning because, if the whole point of this conversation is that as the founder you’re incentivizing for what you’re valuing, then that employee hears that in that conversation as well in that discussion of that plan.

Ben: Oh, absolutely. I think personal situations have a lot to do with how you think about compensation, whether you’re committed to the long-term success of the company and that is your mission or not, if you’ve got one living situation. I’ve hired people who are rich who have no commitment to the company who want all their compensation in stock, and then I’ve hired people who are totally committed who need cash to be a bigger component, and so I think it’s important to recognize that. Not everything is in the payment instrument.

SC: One of the most valuable points that Adam D’Angelo makes, is that every company should have the choice to set up their own plan. And you guys are all saying the same thing actually; it should be something that you think through as a founder. You shouldn’t be sticking to a standard that’s sort of a relic of old times. But I do wonder, Ben, what would you do differently if you were the CEO of a company today?

Ben: If I was doing it now — and this is for a company that I would run, so this is not necessarily what anybody should do for their company or anybody needs to do for a company we invest in, and I want to make that clear — the things that I would likely do differently given what’s changed is one, I think I would give bigger stock option packages. I think I would correspondingly have the length of the kind of vesting period be longer. I would have it be more back-end loaded.

SC: What do you mean by back-end loaded?

Ben: Back-end loaded meaning similar to Snapchat. So maybe rather than vesting in a four year context, 25, 25, 25, 25, it might be a five year context that was more whatever, like 10, 10, 10, 20, 50 or something. I haven’t designed it or anything. Then I think that once you do that, I think a 10 year exercise probably works or some kind of castle equivalent payout so that people do get paid if they vest their stock, and then I would absolutely train all managers how to explain this correctly to employees.

SC: So there’s more transparency.

Ben: When they came in, yes, because I think that’s a very, very big deal. And I think, look, by back-end loading it you can give larger stock option…

I want to say I’m not giving larger stock option packages because I’m the most generous person in the world. That’s not really how it works. The way it works is everything you give out dilutes everybody else who’s there. So there is no free lunch in that sense. What I’m saying is because the vesting is back-end loaded and the stock is going to go disproportionately to the people who stay longer, I can then afford to give out bigger packages because the people who leave after a year are not gonna walk away with that much stock. They’re gonna walk away with 10% of what they got.

SC: Okay, so two really important themes that came up for me in the nuances of this conversation that I think are lost in the current dialogue…Actually the CEO of Quora (I forgot to actually say who he was!) — Adam D’Angelo, has written about this in the past, and Ben, you actually called out his work in a class you taught at Stanford, in Sam Altman’s How To Do A Startup class about two years ago, which I’ll link to in the blurb for this podcast if people want to chase down all these links — but I think the broader question is experimentation, that it’s time to now experiment with new models, because it’s very clear we don’t have, as you’re saying, depending on what you’re optimizing for, one clear standard model.

So one of the experiments is a 10-year vest. Another experiment is Andrew Mason’s idea around progressive equity, which we actually talked about with him on the podcast.

Ben: Yes, is probably the most radical — which again has nothing to do with investors — but in Andrew’s model he basically puts a kind of cap on what the CEO, the founders, and executives can make, and it’s a dollar cap, and once they hit their dollar cap which is whatever their financial independence threshold is, and I think it was $50 million or something like that at his company, then all the rest of their ownership kind of goes into an employee pool. So it helps to, a little bit, spread the wealth, but the idea is just more like what does it mean to whom and what’s fair. And I think these are really complicated equations in general, but I thought that was certainly an interesting innovation.

One of our CEOs has been talking about, would employees rather just have the one thing they don’t get, which is liquidation preference? — would they rather have the liquidation preference value than the option value, which is essentially the same as saying would they just rather be compensated in cash. I think there are definitely employees that would prefer that and there are employees that would prefer not to have that, and I think another thing that affects it is just how expensive things are in Silicon Valley these days. So rent has gone up, has doubled in San Francisco in the last four years; that changes your attitude about how you want to be compensated. So we’ve not taken that into account either.

Scott: A rather interesting thing to think about is what Eric Ries has been talking about, which is this concept of a long-term stock exchange. The reason it’s relevant in this context is one of the things that Eric does talk about is aligning incentives between investors and managers of the company, and one of the ways he proposes to do that is to have longer vesting periods, to have compensation programs that are much more tied toward long-term goals for the company as opposed to things today that are tied to relatively short-term goals like what quarterly results look like. And in return obviously he’s expecting investors also to take a longer-term view towards managing the company. But it goes to the broader point we talked about earlier, which is if you want to build a big company one of the things to think about is how do you align compensation such that you’re ultimately trying to incent building a big company over a long period of time.

SC: All right, you guys. Really interesting discussion. It’s the beginning of many conversations because I think we are aiming to start, not end, the conversation with a definitive solution… Well, thank you for joining the CFI Podcast.

Ben: All right. Thank you.

Scott: Thank you.