OpenAI’s Innovation with Profit-Based Compensation

Wednesday, July 12, 2023

Just over two weeks ago, Levels.FYI published details about OpenAI’s use of Profit Participation Units (PPUs) and how they differ from traditional stock options or restricted stock units. In this blog, we highlight some of the advantages and considerations for organizations looking to offer PPUs.

The key distinction between PPUs and other equity-based awards like Restricted Stock Units or stock options is that PPUs give employees a share of future profits, not a share of ownership in the company’s long-term value (as determined by publicly traded stock). This is why PPUs are such a unique fit for OpenAI, given their “capped profit” legal structure which funnels any profits over a certain threshold back to the OpenAI Nonprofit entity originally founded back in 2015.

Essentially, if OpenAI succeeds, the employees share in that success, but only up to a point, allowing the organization to remain mission-driven. It’s also important to point out that just last month Reuters reported Sam Altman as saying OpenAI has no plans to go public any time soon. As a result, there are very few ways to provide a sense of ownership to existing or potential employees. Phantom equity would not be a strong alternative, since it is taxed at ordinary income rates vs. typically lower capital gains rates for profit shares.

Another major advantage of offering PPUs is they don’t require the employees to spend any money in order to realize the gains like they would with stock options or an employee stock purchase plan. This greatly simplifies the typical conversion problem employees run into when looking to purchase shares and then immediately exercise.

While there are a number of advantages that make PPUs the right fit for a unique company like OpenAI, there are some considerations as well:

• Profit is a fickle metric to use as the sole success criteria for employee incentives. It is obviously subject to millions of decisions that happen throughout the year, and there can be situations where one bad decision in the upper ranks of management ruins a year of profit for the whole organization. Research from Harvard Business Review showed that some approaches to profit-related pay resulted in “employees being less committed and trusting management less.” This can be best offset by clear accountability for decision making and layers of review on major financial decisions.
• One key factor in the eventual value of PPUs for any individual employee will be the total number of PPU’s OpenAI accumulates as they continue to hire. This can also have unintended consequences, as the organization needs to maintain a workforce size that allows them to capitalize on their opportunities in the market but not over hire and dilute all the PPUs across the board, or worse, impact their overall profitability.

Inventive incentives like PPUs at OpenAI will, no doubt, continue to receive increased attention as the company continues to grow. What do you think? Will the unintended consequences of a sole focus on profit hurt or help the company’s success in the long run?

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