From: allin
Stock-based compensation (SBC) in tech companies, while initially conceived as a means to align employee incentives with company growth, has evolved into a complex financial practice with significant implications for shareholders and corporate efficiency [01:04:54].
The “Magic” and the “Grift” of SBC
Initial Purpose and Alignment
SBC, typically in the form of stock options or shares, was historically viewed as part of the “true magic of Silicon Valley” [01:05:08]. It encourages individuals to join startups and take risks by offering them a share in the company’s success [01:05:10, 01:05:21]. This model ensures that if the company performs well, employees “get rich for taking that incremental risk” [01:05:24].
Accounting Practices and Hidden Expenses
Over the last 15 years, the use of SBC has shifted dramatically [01:05:34]. Companies started using stock as a way to “hide an expense” [01:05:54]. Instead of paying employees a high cash salary (e.g., 500,000) supplemented by a large amount of stock (e.g., $3.5 million) [01:06:02, 01:06:09]. This stock, even if immediately vested and sold by the employee, represents a “real expense of the business” and to shareholders [01:06:20, 01:06:22].
Despite a 2004-2005 accounting statement (FASB 123) requiring GAAP EBITDA to include the cost of SBC, companies began “adjusting it out” when reporting adjusted EBITDA [01:06:55, 01:07:17, 01:07:39, 01:07:41]. This practice became prevalent when interest rates were low, and tech stocks were performing well, as “nobody wanted to rock this boat” [01:08:02, 01:08:07].
Consequences of Unchecked SBC
Employee Bloat and Dilution
The practice of relying heavily on SBC has led to a significant increase in employee headcounts and, consequently, an explosion in stock-based compensation [01:08:25, 01:08:27]. This rapid growth in employee numbers and SBC was particularly noticeable at companies like Salesforce, which quadrupled its employee count from 19,000 in 2015 to 80,000 last year [00:54:13, 00:54:22]. Similarly, Meta went from 10,000 to 80,000-85,000 employees, and Google reached 185,000 [00:55:02, 00:55:06]. This surge in SBC can lead to significant shareholder dilution. For example, shareholders of Salesforce or Expedia experienced about 25% dilution over 15 years, meaning 25% of their potential upside was effectively given away [01:09:25, 01:09:31, 01:09:35]. In an extreme case, Coinbase reportedly had SBC equivalent to 70% of its revenue [01:08:40, 01:08:47].
Lack of Accountability
The prevalence of SBC has been described as the “greatest grift in the history of Silicon Valley” due to poor accountability for the expenses incurred by adding more employees [01:04:30, 01:04:33, 01:04:36]. This disconnect means that companies did not have to account for these expenses as cash, which “led to the bloat” [01:10:10]. Boards’ compensation committees often approve these plans if they align with what “everybody else is doing” [01:10:51, 01:10:55].
Calls for Accountability and Reform
Shareholder Demands
Shareholders are increasingly demanding greater transparency and accountability regarding SBC [01:04:19]. They want profitability to be the primary strategy [00:53:30]. Companies like Meta and Salesforce have started scrutinizing every dollar of investment and focusing on operational excellence and automation [00:53:05, 00:53:13, 00:53:17].
Proposed Solutions
To address the issues of SBC, several solutions are proposed:
- Include SBC in financial reporting: Companies should include SBC in their reported metrics, similar to how Booking.com includes it in every metric, resulting in only 5% dilution for its owners over 15 years [01:09:00, 01:09:13, 01:09:20, 01:09:22].
- Focus on Free Cash Flow Per Share: Bonuses for management should be based on free cash flow per share, not adjusted EBITDA metrics that exclude SBC [01:11:16, 01:11:20].
- Set Dilution Limits: Public companies should aim for a “gold standard” of 50 basis points (0.5%) annual dilution from SBC, a level achieved by companies like Apple, Booking.com, Visa, and Mastercard [01:11:32, 01:11:34, 01:11:37].
- Reset Valuations and Refresh Equity Pools: In cases where companies have grossly inflated valuations, it’s crucial for founders to “reset the valuation,” “refresh the equity pool,” and reissue options to employees to keep them motivated, even if it’s a “bitter pill to swallow” for existing investors [00:32:31, 00:34:28, 00:35:01, 00:35:02, 00:35:04].
Company Examples and Contrasts
High Dilution Companies
Companies like Salesforce and Expedia have experienced significant shareholder dilution (around 25%) due to their SBC practices [01:09:25, 01:09:28, 01:09:31]. This is often tied to their rapid employee growth without corresponding increases in profit to satisfy existing shareholders [01:04:05, 01:04:14, 01:04:16]. Coinbase is an extreme example, with SBC constituting 70% of its revenue [01:08:40, 01:08:47].
Low Dilution Companies
In contrast, companies like Booking.com, Apple, Visa, and Mastercard maintain very low shareholder dilution (around 5% or 0.5% annually) [01:09:20, 01:09:22, 01:11:32, 01:11:34]. These companies represent a model of disciplined SBC and strong financial performance, where “it’s very hard to both have huge margins and grow at mediumly high double-digit rates” [01:51:10, 01:51:16].