January 15, 2023
5 mins

Equity payments for everybody & everything?

Originally published in December 2022 here

When WeWork founder Adam Neumann got 350m USD for his Project Flow from the famous venture capital company a16z valuing pretty much a pitch deck at around 1bn USD, it caught everybody’s attention. If you read their blog post announcing their investment, it seems that a16z bets on a new kind of “rent-to-own” model for housing. So the idea is that people don’t simply buy housing (100% equity ownership), nor are they simply renting it (0% equity ownership).

Likely Project Flow will offer something in between - for example 10% of your monthly payment may go into some form of equity ownership (maybe token based?) allowing you to benefit from future value uptake or even gaining significant ownership when you are long enough in your house or apartment. (It remains to be seen though how exactly Project Flow will implement the “rent-to-own” model and how different it will be to existing competition like ZeroDown or Divvy Homes - these companies just let you save towards your down payments via rent and once that is done they sell you the house normally - which is kind of boring :)

The point is that equity is not a 0 or 1 thing - you can also have all kind of models in between. This is true not only for buying assets, but also for getting paid.

Especially startups but also bigger tech companies have been using equity payments as part of the total compensation since around 50 years. So a typical startup compensation would be up to 30-50% of the total compensation in equity. So if you get 100k base salary you would get up to another 100k in equity at the current valuation of the company. Of course in startups this equity part of your pay is highly volatile: it may very well be worth $0 in a few month or millions in a few years.

Arguably this model has been tremendously successful and is one of the main reason the Silicon Valley (where this model was pioneered) was so successful. Unfortunately the model currently being used via ESOPs or VSOPs is highly complicated and does not really work well with the European Tax systems. For example right now in Germany you would need to pay taxes on your ungained profits if you get ESOPs - and that’s one of the reason why these employee participation programs are not as popular in Europe as they are in the US.

So benefits from having a higher ownership share include:

  • As it is the nature of capitalism, most value is generated on the “owner” level of capitalism. So having more people be owners will decrease wealth inequality
  • Better alignment of incentives / motivation: If you own part of the company you will have their best interest in mind.
  • Better distribution of resources on a society level: people have a higher incentive to work on companies with rising valuations (vs. just sitting in big companies which have nowhere to go) - this could contribute rejuvenating especially Western economies.

So in this article I want to explore if such an equity inclusive model could be simplified and applied to a much wider range of things to buy or getting paid? If you go one step further: should there be a mandatory minimum equity payment share for everybody the same way there is a minimum social security insurance for everybody (at least in Europe?)

The logic would be: The minimum mandatory social security insurance ensures that if things go really wrong you have a safety net. Why not also have a minimum equity share which makes sure that everybody can participate if things go really well?

So how could this work? Let’s first look at the “getting paid” side of things:

  • Government could pass a law that at least 10% (or whatever is a good number) of total compensation needs to be in company equity. Of course there will be exceptions (e.g. non-commercial hospitals, …) but let’s ignore those practical problems for now. The total compensation of the employees is not changed - just 10% of the total compensation payment is paid in equity at the current valuation which is updated at least once a year.
  • To do this companies will issue new shares - so existing shareholders are simply diluted. This way there is no limited pool of options/shares which have a finite end.
  • Employees (not the companies) can opt-out of the program and get paid directly in cash at the end of the year. However the companies need to publish the share of employees opting out - if it is very high the company will look bad because their own employees don’t believe in their company. Also we know from things like organ donations that having a good default massively increases the participation of people (e.g. if you have to opt-in only 10-20% become organ donors, if you have to opt-out >95% stay organ donors).
  • Tax laws are changed that you only pay taxes on the equity part if you “cash them out”.
  • Additional fairness/efficiency upside of such a model: Over time / multiple generations people (like heirs) who have nothing to do anymore with the company will gradually phase out due to dilution of their shares.

Now let’s look at the “buying assets” side of things - let’s take “housing” as an example but this could also be applied to other assets such as cars etc. Could such a model also be applied here?

  • Here again the government could pass a law that 10% (or whatever the number is) of the total rent needs to go into ownership of the house/apartment you are currently owning. You could also argue that the 10% needs to be on top of the current rent - but I could also imagine to have a multi-year transition period in which this 10% is priced in over time.
  • Make it easy to also allow a higher share of monthly payments to go into equity.
  • These X% equity share will then pay into ownership of the apartment over time - again by diluting the current owners. So when you live in an apartment for 20 years plus with 10% of your rent into equity you will have gained something around 5-20% of ownership in the apartment you lived in (pending valuation development, rent etc.)
  • When you move out the majority owner has the right to buy the shares back at current market valuation (but is not required to do so). Same way: Having shares may also give you some additional rights like the rights of first refusal etc. when the apartment is on the market for the renter.
  • Of course this whole idea only makes sense for buying long-living assets and not for consumables like a gym membership.

So what did we learn after this little though experiment? I do believe that having a sensible regulation around “minimum ownership requirements” could make sense and should be further explored. Anybody interested to write a PHD about this? Any political party wanting to push for this? :)

PS: This was the first article which I have written with the assistance of GPT-3 using https://lex.page/ - while i did not like a full sentence GPT-3 generated, it did lead to some interesting ideas and inspired further research - I can recommend :)