Tech companies love share-based compensation – but how risky is it to employees?

You’re a burgeoning technology company’s CFO. You ensure every penny is reinvested into the company, and you want to hire talented (read: expensive) people, but you’re as obsessive about your burn rate as an Olympic wrestler is about her weight.

Enter share-based compensation, which has long been one of the main tools in the recruiting arsenal in the technology industry.

Share-based compensation: the currency of motivation

In an industry that is always short on talent (especially on the engineering side), fast-growing companies must figure out how to attract and retain highly-skilled employees. By allocating stock to employees, companies can offer future returns in lieu of current income. Employees are incentivized to stick around for that stock to vest, while possibly earning multiples of value if the company is eventually bought out or goes public. The company uses options as a currency rather than real money, so their cash position is stronger than it would be otherwise.

It seems to be a win-win. But might some companies be going too far with their share-based compensation schemes?

Looking at 10 prominent public technology firms, most companies offer a relatively reasonable level of share-based compensation. At Netflix, for example, the company allocated nearly $89 million in shares to its employees in the first 9 months of 2015. If that’s spread across its 2,189 full-timers, that averages out to $40,596 per employee. That $89 million is also around 1.8% of its revenue (companies are now required to expense options, which is why they may be moving toward restricted stock – but that’s another conversation altogether).

On the other end of the spectrum is Twitter. In the chart above, Twitter is clearly an outlier when it comes to share-based compensation.

Twitter had revenue of about $1.5 billion through the first 9 months of 2015. Over the same period, employees were granted $524 million of share-based compensation – or 35% of the revenue generated. If spread across the company’s 4,200 full-time employees, this works out to nearly $125,000 per employee. This is second only to Facebook’s $185,312 per employee, though Facebook only allocated about 18% of revenue to share-based compensation.

Capital in the 21st Century (in Silicon Valley)

This presents a double-edged sword. Twitter is giving its employees a rather substantial share of the company, which should incentivize workers to stick around and work as hard for the largest possible upside.

On one hand, most wage earners get nowhere near this kind of ownership option, so it is heartening to see the owners of capital distribute more than just wages (for the sake of the argument, let’s leave aside the fact that workers at a company like Twitter are probably already in the top 10% of wage earners). In an era where capital is consolidating in the hands of fewer and fewer, a company with an aggressive share-based compensation plan pushes back against the existing trend.

On the other hand, this places downside risk squarely in the hands of the employees. Giving away more than a third of revenue in shares is clearly unsustainable. There will be an institutional investor vs. management battle at some point over dilution, especially as pressure builds for the company to actually post positive earnings. Employees who have earned a large chunk of shares will likely also tire of being diluted – and that’s if the company’s equity value goes up.

If the total value of equity goes down, existing shareholders will bear much of the burden. Because shares vest over time, employees can’t exactly create a perfectly offsetting hedge against their potential ownership in case of a decline in value. And this doesn’t even mention opportunity cost to employees.

Twitter is clearly taking their own path when it comes to compensation. They’ll be fighting the big kids in the market, but it’s a risk that may be worth taking, especially to draw in talent that could easily move down the peninsula to Menlo Park. And in the end, this may all be irrelevant – they can always sell to Apple/Google/rumored purchaser du jour.