The standard startup option grant is a bet on a single event: a sale or an IPO that turns paper into money. Strike price, vesting cliff, four-year schedule, the whole apparatus exists to let an employee buy into a future liquidity event at today’s price. It is a well-designed instrument for the thing it is designed for. The problem is that a bootstrapped agency or a profitable software company that intends to stay private is planning for neither a sale nor an IPO, which means the instrument is aimed at an event that will never arrive. Handing those employees stock options is offering them a ticket to a train that does not stop at their station.
This is not a niche problem. A large share of real companies are profitable, privately held, and have no exit on the roadmap, and they keep reaching for a VC-shaped tool that does not fit. The companies that have thought hardest about it landed somewhere else.
Why the option grant breaks outside venture
The clearest statement of the mismatch comes from Jason Fried, who worked through it in public in 2011. In a Signal v. Noise post titled An alternative to employee options/equity grants, Fried describes 37signals examining whether to start an equity program after employees asked. They consulted other owners, their sole investor Jeff Bezos, and their accountants and lawyers. The conclusion: “options/equity doesn’t really mesh well with an LLC corporate structure,” and the complexity was “both psychological (company dynamics) and economic.” The deciding factor was the one that applies to most bootstrapped companies: “since we have no intention of selling 37signals or going public, the two scenarios where options/equity really make sense, the complexity became too hard to justify.”
That sentence is the whole problem in miniature. Options make sense in exactly two scenarios, and a company committed to staying independent has ruled out both. The grant becomes a liability instead of a benefit: it carries administrative and legal overhead, it creates expectations of a payout that the company has no plan to produce, and it can sour into resentment when employees realize the equity is theoretically valuable and practically inert. The right move is not a worse version of options. It is a different instrument entirely.
Revenue share and the Founder Earnings problem
The first alternative people reach for is revenue share: pay the employee a percentage of revenue rather than a slice of a future sale. It is simple to explain and it pays out continuously rather than at a distant event. It also has a sharp edge that the investor world learned the hard way, and the lesson transfers directly.
The edge is the gap between revenue and what is actually distributable. Calm Company Fund, formerly Earnest Capital, built an entire financing structure around naming this problem. Its Shared Earnings Agreement, or SEAL, is built for companies that, in the fund’s words, “do not fit the venture capital model.” The SEAL pays investors a percentage of what it calls Founder Earnings, and the definition is the instructive part. Money that comes in, the fund notes, gets split into three things: “founder(s) salaries,” “dividends,” and “retained earnings.” Traditional equity investors are entitled only to dividends, but an owner “can draw arbitrary lines between salary, retained earnings, and dividends,” which the fund warns “can devolve into proxy battles over what is a fair salary.”
That warning is exactly the risk in employee revenue share. A percentage of top-line revenue ignores costs and can pay out while the company loses money. A percentage of profit invites arguments over what counts as a legitimate expense versus a discretionary draw. The SEAL’s answer, defining a clear earnings base that sits above salary games, is the design problem any revenue or profit arrangement has to solve before it is fair to either side. Tellingly, even Calm Fund found its own structure heavy: in a March 2024 essay, founder Tyler Tringas wrote that the SEAL “is likely too complex for many cases” and that the fund had moved most recent investments to a simpler SAFE plus a Shared Earnings Side Letter. Complexity is itself a cost, and it argues for the plainest structure that is still fair.
Profit-sharing, the way 37signals actually does it
The alternative 37signals settled on is the cleanest working example of the genre, and it has two distinct parts worth separating.
The first is an annual profit share. As Fried described it in a LinkedIn post relayed in a 2025 writeup, “For years we’ve had a profit share system in place where we take 10% of our annual profits and distribute them to our employees based on their tenure.” His framing is deliberately concrete: “Real cash, every year, directly to our employees,” and “given that we’ve been profitable for 25 years, it’s not a maybe-one-day-dream, it’s been an annual reality.” For 2024, per the same post, the company distributed six-figure profit shares to 20 employees, with others receiving five-figure shares and newer pool members four-figure shares. The exact total is not something we can verify, so we will not assert one, but the structure is clear: a fixed slice of real profit, paid in cash, weighted by tenure.
The second part is a contingency for the event 37signals does not plan for but cannot rule out. In the 2011 post, Fried laid out the just-in-case structure: “At least 5% of the ultimate sale price (or, in the case of an IPO, the fair market value of the capital stock) would be set aside for an employee bonus pool,” with each current employee credited “one unit for every full year” of tenure. Note what this is. It is not equity. It is a contractual promise of cash tied to a hypothetical sale, weighted by seniority, simple to administer, and rewarding the people present at the time rather than anyone who held paper and left. That is phantom equity in everything but name.
A fixed slice of real profit, paid in cash, weighted by tenure. That is what survives when the exit is removed from the plan.
Phantom equity, named properly
The 37signals bonus pool has a formal version, and it is the structure most non-VC companies should look at first. Phantom equity, also called phantom stock or shadow stock, is described by the law firm Suo & Co. as “a contractual arrangement that mimics the benefits of stock ownership without transferring actual shares.” Employees get phantom units “notionally linked to the value of a share,” but the units “do not confer legal ownership, voting rights, or dividends.” Instead they “promise a future cash payout based on the increase in the company’s valuation over time,” typically tied to a liquidity event or to “predefined financial or operational milestones.”
That last clause is what makes phantom equity work where options do not. Because the trigger can be a milestone rather than only a sale, a company with no exit plan can still attach a real payout to a real event, a revenue threshold, a profit target, a defined anniversary. The employee gets upside that tracks the company’s value without the firm issuing shares it does not want to issue.
It is worth distinguishing phantom stock from a close cousin that gets confused with it. As the advisory firm Reins explains, profits interests units, or PIUs, are real LLC ownership in future profits and appreciation, and can only be granted by a partnership or an LLC taxed as a partnership, never by a C corporation or an LLC taxed as one. PIUs give actual ownership; phantom stock only simulates it. The same source notes phantom stock is the more affordable and simpler of the two to set up and maintain, which is usually the deciding factor for a small team that wants owner-like incentives without restructuring its cap table or its tax status.
A decision framework
The choice is not which instrument is best in the abstract. It is which one matches the company’s actual shape, and the shape is defined by two questions: is there a realistic exit, and is the company reliably profitable.
If there is no realistic exit and the company is consistently profitable, annual profit-sharing is the strongest fit, because it pays from money that actually exists and does not depend on an event that will not happen. The 37signals 10-percent, tenure-weighted, paid-in-cash model is the reference design. Keep the earnings base clearly defined to avoid the salary-versus-distribution fights the SEAL was built to prevent.
If there is no exit but the company wants to attach upside to growth milestones, phantom equity tied to revenue or profit targets gives that without issuing shares. If a sale is genuinely possible but not the plan, the 37signals approach of a profit share now plus a phantom sale-bonus pool covers both cases at once. The legal structure constrains the menu before preferences do: an LLC taxed as a partnership can consider PIUs, while a C corporation that wants owner-like incentives without real shares is steered toward phantom stock by default.
What does not belong on the menu is the reflexive option grant. It is the right tool for a company racing toward a sale or an IPO, and the wrong one for a company that has decided, as Fried put it, that it has no intention of selling or going public. The instrument should match the plan. When the plan is to stay private and profitable, the thing that survives is the one 37signals has been paying out for 25 years: a fixed slice of real profit, in cash, weighted by how long you have been there.
