a16z Podcast - a16z Podcast: Is It Possible to Achieve Equitable Equity for Startup Employees?

Episode Date: August 7, 2015

There's been a lot of activity lately around trying to improve equity compensation (for example, by removing tax liabilities that handcuff them). Or by making equity more equitable in other ways; as former Groupon CEO Andrew Mason observed, "When startups grow into unicorns, the distribution of employee earnings follows a common pattern: the founders make more money than they could spend in infinite lifetimes, a handful of early folks achieve financial independence, and everyone else gets a nice bonus, but nothing life changing." It's admittedly a very rarefied problem yet one that plagues a number of startup founders and employees who put in a lot of work to make the startup a success ... but end up with less than others in the same company. And it's a problem that has long plagued Mason, who shared his views on something he calls "progressive equity" to help more startup employees achieve financial independence if and when their companies exit through an IPO, acquisition, or other liquidity event. Can it work? Should it? a16z General Partner and co-founder Ben Horowitz joins Mason on this episode of the a16z Podcast to dissect the idea. The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments and certain publicly traded cryptocurrencies/ digital assets for which the issuer has not provided permission for a16z to disclose publicly) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

The content here is for informational purposes only, should not be taken as legal business, tax, or investment advice, or be used to evaluate any investment or security, and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Welcome to the A16Z podcast. I'm Michael Copeland. If you are lucky enough to be a part of a company that goes from zero to a monster with an IPO or some big liquidity event, along the way, it's not usually the case that the distribution of the wealth created is equitable. A few people make out like bandits, deserving or not, while others, many of whom put in the work to make the company a success end up with very little. That was the case with Andrew Mason

and his first company Groupon. And frankly, it bugged him. So while building his next company, Mason also designed a system for equity distribution that he thinks is fair, something Mason calls progressive equity. Ben Horowitz, who has seen plenty of bad ideas to make equity distribution more equitable, he actually loves this one, joins Andrew Mason on this segment of the A16Z podcast to dissect Mason's idea and the admittedly very high-quality problem that underlies it. I am Ben Horowitz, and I'm here talking to Andrew Mason, and today we're going to talk about a concept that he invented called Progressive Equity and Megadonks, and we are very excited to have him. Andrew, thank you for coming. Thanks for having me. It's good

to be here. So, you know, this is one of these things where I get kind of emails all the time about new kinds of employee incentive plans and so forth and like how the old ways of incenting people will never work and there's a great better way. And usually they're just chock full of holes and ridiculous. But this one, I thought, was ingenious. So if you want mine kind of taking us through kind of the problem as you saw it and then the solution that you came up with? Sure. Well, there are a number of different challenges, I think, in coming up with an equitable system for distributing equity among the people that are involved in a company. This particular progressive equity thing solves one of those challenges,

which is if you're lucky enough to be part of a company that grows, to be quite large and is worth more than a billion dollars. Typically, if you look over the last 10 years or so, or farther back, at the distribution of ownership, take out investors for a minute and just look at the distribution of ownership among the people that actually work at the company, the founders, and the employees. You have a couple of people who end up making enough money to live a million lifetimes. And then you have a handful of people that achieve some kind of financial. financial independence. And then there's this long tail of people that do well. And they get a nice

bonus. Maybe they can buy a house, but they've still got to work. And this happened to us at Groupon, and it was kind of frustrating because I felt like there were all these other people there. I felt like I was frankly ending up with more money that I wanted or knew what to do with. And there were all these other people who had put in enormous effort. And I looked for ways that I could at that point, even give some of my equity to them to kind of fix the distribution. And it ends up being a real challenge. Yes, yes. I am familiar with that challenge. So what progressive equity is, is a system that's basically like a progressive tax. It's an income redistribution system within the company that as the company becomes more and more valuable, it redistributes percent

ownership away from the highest percent owners and towards the lower percent owners, so the more valuable the company becomes. The mechanism by which it works, you could do it different ways, but we tried to keep it very simple. There's some number which we've determined to be a financial, independence threshold, which is a number that we say, once you've made this amount of money, you have enough that you never need to think about money again. Right.

Maybe this is a good time to pause and just point out the absurdity of the fact that we have to think about solving problems like this in this world, what to do when you make too much money. Or that we even call it a problem. Yeah. So I don't know how to get around that. there's the 18-year-old version of me sitting in the corner shaking his head, completely ashamed of what he sees in this chair. But I'm going to just look away.

Yes, power through it. Yeah. Anyway, so you have this financial independence threshold, and that's some number. In the blog post where I read about this, I didn't feel comfortable, actually. Everybody has to figure that out on your own. You can talk to your financial advisor or whatever. but our company came up with a number. I'm going to use a fake term that I was calling megadonks.

And I said, I think I said 50 megadonks was the financial independence threshold. So once you have enough equity or once your company is valuable enough that your total ownership is greater than 50 megadonks, all of your value beyond that is basically taxed at 50%. So you get half of it and the other half goes into a pool that's redistributed to the rest of the employees pro rata with their ownership. And that's basically how it works. And when you did that, did you, you know, you made it pro rata with the ownership. Did you think about making it not pro rata with the ownership, i.e., like completely leveling it once it became progressive?

Well, I think the idea would be that your ownership percentage, the, employee ownership percentage is reflective of the impact that they have on the company, which is a whole other problem. Yes. And sometimes it is, sometimes it isn't. Sometimes it is. And I'd argue that's even a, that's probably a more pervasive problem in companies and one that this doesn't do anything to solve at all.

Yeah, you're always, I mean, part of it, because people get equity when they're hired. Right. You know, not based on their work. Right. And it's amazing that how weak that correlation is, between what people get when they're hired and how well they do, you know, once they get there and how hard they work and how much effort they put in. Yeah. I mean, I'm sure you had a similar experience, but I remember at one point looking at the cap table and seeing how much all the different employees owned and if you just put it in line by ownership and then if you line it up by impact. I had that day. Yeah. Well, it's like tears. It's just like the saddest thing in the world.

So I guess that's why I thought to do it pro rata is that separately you should solve the problem of figuring out how to properly distribute among employees to reflect impact. Yeah. Yeah. Interesting. So one of the things you kind of obfuscated in the blog post and then again here, but is a really kind of. kind of important thing is the threshold in that if you set it too high it actually becomes meaningless on several levels and that like Facebook didn't actually have this problem because everybody made so much money because like the company just ended up being so like incredibly

valuable so you know if you had set it at like a whatever 10 billion dollar level it doesn't matter like at all even though like it would have paid out um It just wouldn't have made any difference to anybody. And then on the other hand, if you set it too low, then it's going to hurt your executive recruiting. Because, you know, with Google offering people like $100 million to stay at Google, you know, if you're offering, if you say, okay, the threshold is $10 million, then are you going to be able to recruit executive? So how did you think about that balance and how did you get to the number? and then I imagine every employee that you have knows the number or do only the people who would potentially get taxed or how do you do that?

All the employees know the number. So there's two different ways that I think people tend to think about financial independence. When I say there's you never have to work again and that's a different threshold, I think. Like if you're careful about how you spend your money, you never have to work again. What I'm talking about is financial independence, which is, the point at which you impulsively buy, or you buy a motorcycle with the same degree of carelessness that you buy a cup of coffee. And so in terms of the downside of executive recruiting, I mean, I just think anybody that feels like, you know, you're capping me out

or you're taxing me. I don't know. Like, that person's an asshole. I don't really want to work with them. That's a good test. How about, you know, there's kind of a philanthropic side. So if you look at, okay, Mark Zuckerberg, who probably made as much money as anybody, and not that he hasn't bought stuff, but he's also, like, given away, like, a colossal amount of money. Did you think about, okay, for that case, you know, for redistributing it to employees, are we going to ultimately kind of, if over a certain amount, what actually happens is it all goes to charity, then how do you think about that?

I thought about that a little bit, and I actually, it's a really good point. Like, arguably it's better for one benevolent person to end up with all this money instead of just distributing it evenly among all the employees so that they can all buy, you know, slightly nicer cars and other, you know, materialistic things. Right. So I think that's a really good point. It still felt like in principle something that was good to do. but I think that's potentially a really good argument to not do something like this.

So then you kind of have this one-time event where like the tax is paid and everything is distributed and then you kind of switch into kind of old world, so to speak. do you worry about like what that does to the culture because like you have you know rolling into whatever an IPO or a gigantic secondary or potentially a sale I imagine this kind of extra mega group you know we're all on this together incentive and then that's just gone and so how do you think so how do you think about that and then would that like make you want to like defer a big secondary or an IPO because you're going to lose like what really is in a way of magical incentive for the company because like here you've got this thing where you know nobody else is going to give me some of their stock like nobody else who I'm going to work for is going to go okay here's like half of my stock and I'm giving it to you like that's a that's really a kind of a special thing

and then you've got that special thing all the way through the company and then it's over. Right. Yeah. I never liked the fact that the way that it's structured is that there's this event and then it's over. One of the reasons that I published all the legal documents that we came up with was partly in hopes that someone would take them and find ways to improve upon them. That was the best thing that we could figure out how to come up with that was in line. and with the law and was not a major, didn't put employees that were under this program at a major tax disadvantage or anything like that.

So it does have this one-time event. Those are definitely potential issues that we may end up being lucky. If we're fortunate enough to actually trigger. Then we may end up dealing with some of those things. But I'd love to see if there's a way. to have the same effect where you're redistributing value

but it's not all tied up in this one-time liquidation event. Yeah, interesting. And then do you worry about people in advance of the event who would be on the getting tax side

attempting to game the system by like maybe there's a small secondary sale that we can execute where I can unload as much of my stock as possible because then I won't have to pay the tax or kind of like in real life how progressive tax ends up working.

Yeah, yeah. I want to say that it's that it's structured in a way that we can avoid some of that. Like we can't like in order to trigger the, so I think like one of the restrictions on the RSUs that, that, and the triggering of the redistribution of the, of ownership is that the secondary sale needs to be at least 15% of the company or $35 million or something like that. Right.

So you're saying that, you're saying that employees might, like senior employees might lobby for a secondary that smaller than that? Right. Exactly. So, you know, oftentimes what I see, you'll do a big round. Let's say the company does a big round of financing at a billion-dollar valuation, and, oh, you're a unicorn. And then there's all this demand in the secondary market, and people are calling them and saying, hey, can I buy your shares? And now they're thinking, okay, if I sell them now, I get an added benefit if I don't have to pay the tax. Well, I think the way that it's structured is that all of that, it's accumulated value over time.

So it doesn't matter if you sell. Right. So it shouldn't matter. Oh, okay. And then another thing that you've done, which is kind of interesting in today's environment, is you said, if you leave at any time before the tax is paid, whether you're vested or not, you lose all your progressive tax winnings. Right.

So this redistribution pool that you would benefit from, just because it felt like it became very complicated to do it the other way. And this does feel like a benefit for people who are going to – there's very – for most people, there's no downside and only upside. Like, again, a company needs to be extraordinarily valuable for the average employee that's owning, you know, a tenth of a percent of the company to reach the financial independence threshold. So that hasn't been an issue when we've talked to our employees because most people

see it as the whole thing is no downside and potential upside if I stick around long enough or whatever. Right. It's better than anything else in the market. market. But, you know, potentially if people, other companies adopted it, then it might become a thing. And how is it, I guess, like, have you felt like people get it in the recruiting process and join the company? Is it a big draw for new employees? You know, so far in our company, because we're small and we're kind of weird. Yeah. Well, you're running it. Like we're doing, not just because of

that it's like we're building this platform for audio tours which just sounds it's awesome and it's going to be huge but it sounds it sounds weird um but it tends to people that have been attracted to it have tend to be attracted to it for a passion for the problems that we're solving and this is a nice bonus so we haven't gotten into the phase of the company yet where we're attracting people who are like which post product market fit pre-IPO um gravy train can i jump on to that's going to get me to the point that I never need to work again in a shorter period of time as possible. And that's probably where I start to see this being a major recruiting advantage. Yeah. And so do you worry about it being a major recruiting advantage in that sense

and that that's one of the, you know, one of the, and you know, like you were CEO of Groupon, so you completely understand this dynamic. But is that, you know, one thing you hate to have and the company is a bunch of people joining for all the wrong reasons because there's no way that they join for the wrong reason and then kind of become part of the right culture and although like every time I tell CEOs this they just ignore me and they go well we need like boss level engineers like I don't care if they have the wrong ambition I'm like okay but does that you know because it does tend to take away from what you have which is like a kind of weird, exceptional culture of people who really are on this problem and are there on a mission.

Well, I think there's two potential ways that this policy could appeal to a potential recruit. One would be in the purely mercenary, this is a place where I could potentially make more money. And, yeah, that, I mean, we have to be realistic about the fact that that's a motivation for people. but I agree it's we wouldn't want people joining for that being the primary motivation. The other way to look at it is, oh, this is a company that in principle thinks that the more, that values the input or the impact of employees and is is putting thought and effort into making sure that employees are rewarded in that and that the spoils. don't end up going, being completely lopsided, but they're reflective of the impact. And I want to work in the kind of company that thinks about their employees that way. And I want to work in the kind of company where I have the opportunity to own more,

where I am incented to make the company more valuable because I get to own more of it as it becomes more valuable. Now, do you worry at all about the kind of company policy seeming like a political policy where you – because, you know, once you get into politics, you get this like weird kind of religion and it's like, oh, those guys over there are communists or so forth. Because, you know, you've called it a progressive equity system and, you know, progressive taxes. You have a better name for it? Well, I think it's a great name. because it's very descriptive. And I, you know, I tend to agree with it, but I, you know, particularly in Silicon Valley today, there's a whole kind of class of kind of people with a much sharper libertarian bent

who might think, okay, I already live in a progressive tax system. Do I want to live in a progressive equity company? And I think you've observed, the thing that I observed, which is, the you know what you get paid has to do with a lot of things other than your effort and skill um and like that just is the way life is and i often you know my mom was a nurse and like she was like a phenomenal nurse she couldn't in her entire lifetime make what i can make in a year as a venture capitalist even if i was a crap venture capitalist um and value to the world you know like there's one person like saving your life and there's another person doing like what I'm doing

and I'm like, okay, that doesn't seem like fair. But, you know, on the other hand, capitalism works a lot better than communism. You know, communism in practice sense of being like a massive concentration of power. And Joseph Stalin was not a nice guy and whatnot. So how do you, how do you think about kind of, you know, because you don't really want to enter that debate as a CEO you actually want anybody you know be they like a libertarian or a right-wing Republican or a left-wing Democrat like you'd like them all to feel welcome in the company you don't want them to feel like okay I'm going into a world where they're going to hate me I agree like I um that was a concern just from a from it's there it seems like there's

no upside in in mentally anchoring this system to a particular political point of view, which it isn't anchored to a particular political point of view. And I called it progressive equity because it was descriptive and I was lazy and didn't think of a better name. Yeah, yeah, that's good. But, but argue if I was really being, if I was really, if I was like writing a book about this or like, or like actually like going out and. trying to market it or something like that, I probably would have taken the time to come up

with a more agnostic title for it. Probably like three musketeers equity, you know, all for one, one for all. Something more like team-oriented. Yeah, no, I agree. But I think from an employee perspective, I think once you talk to employees about it, they get it pretty quickly. And there's nothing about it that's anti-capitalist. So, you know, in a world where you've got incidents like when the secret guys bought Ferraris off the secondary and like all the employees were very depressed and upset about that and just, you know, kind of a general, you know, less loyal kind of company environment, partly due to all the opportunities and so forth, but it's very difficult to build a great company if the people in the company.

don't love the company and want to stay there a long time. And I would just say in closing that congratulations on like a really creative step to figuring out how to put that together. And I'm hoping it works. It is a great experiment, but really, really thoughtful. And congratulations. And thank you for coming, Andrew. Thanks. My pleasure.