Open for Business: Employees with benefits

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Open for business

Paul Graham coined the term 'ramen profitable' to describe the sort of start-up companies that can quickly reach profitability because they have low overhead and few expenses. I think of OpenNMS as 'sushi profitable'--that is, profitable enough to provide a few of the finer things in life. Like employee benefits.

When your company reaches sushi profitability, you’ll need to consider employee benefits--health insurance, a 401(k), and a stock option plan. These may sound like things only available to larger companies, but by leveraging the do-it-yourself nature of the open source way, even small companies can provide solid benefits to their employees.

Note: All of the companies mentioned in this column are provided as examples only, and do not represent an endorsement by either the author or this website. Also note that I am not a lawyer, nor am I certified to provide any type of financial advice. I'm just relating what we did in the hopes that others might find it useful.

Health insurance and the single worker

The first company I started was initially just me, and I needed health insurance. The process was pretty straightforward. I contacted a large, local health insurance provider, filled out an application, and they sent a nurse to my house to take my weight and draw my blood. Based on that information they quoted me a price.

There are a couple drawbacks to this. First, since there is no group policy to spread out the risk, if you are not in great health (for example, if you’re older, overweight, or have a lot of pre-existing conditions) you will end up paying more. Second, unless your premium is extremely high, or you have health related expenses that represent a large percentage of your income, your premium payments will be post-tax. As long as you can afford it, it is important to maintain some coverage—in case of an accident and so that a lapse doesn’t result in denial of a claim for a pre-existing condition.

The advantages of group coverage

However, once a company has more than three or four employees, you can qualify for a group plan. Not only do these plans offer rates based solely on employees’ ages, but any premiums can be paid with pre-tax dollars.

The way we found our health care solution was the way I've learned to make most decisions since I started working with open source software--I asked others. Many people recommended that I find a health insurance broker--someone who could examine our situation and then suggest a few options. A good broker will also handle most of the communication between you and the insurance company. At OpenNMS, for example, all I have to do is send in the checks.

In the beginning we had a standard insurance plan, with in-network and out-of-network rates and co-payments. I believe that the health of my employees is very important, so the company pays 100% of their premiums for medical and dental insurance. This is for the individual only--if an employee wants coverage for other members of their family, it is available (paid in pre-tax dollars), but the employee pays the extra costs. We also, through our broker, later added short-term and long-term disability (the latter requires that you have been in business for several years), as well as life insurance.

Insurance contracts have to be renewed each year. Unfortunately, two years ago our rates went up nearly 50%. We asked our broker for options, and that’s when we learned about high-deductible health plans (HDHP) coupled with a health savings account (HSA).

A high-deductible health plan carries a lower premium than a standard health plan. The amount of the deductible can vary, but in our case we went with $2,500 per individual, and $5,000 per family. That amount is the employee’s responsibility, but, after the deductible is met, most medical expenses are covered at 100% (though, again, this can vary).

Adding a health savings account (HSA)

Twenty-five hundred dollars might sound like a lot because, well, it is. So, at the same time we switched to an HDHP, we also opened an HSA for every employee. The company funds this at the rate of $2,500 a year, thus covering the individual’s deductible. Employees can put in more money if they like (tax deferred) which helps those who choose family coverage.

This combination of an HDHP with an HSA hasn’t stopped our premiums from increasing, though it has kept these increases smaller. It has also allowed OpenNMS to continue to cover 100% of our employees’ health insurance. And it puts some of the power for managing healthcare costs back into the hands of the employee through the HSA.

In many ways, an HSA functions like a flex benefits plan, with one important difference. With flex benefits, an employee puts aside a certain amount each year to cover anticipated medical expenses, but that money has to be spent within the year or be forfeited. Not so with an HSA. Money deposited into an HSA has no expiration date, and it can earn interest, increasing one’s health care assets over time. Finally, at retirement, an HSA can be converted into a standard retirement account, such as a 401(k).

Get 401(k)... from your local Costco?

Several years ago, when we decided that we wanted to provide a 401(k) benefit, we went where everyone goes when thinking about retirement plans--Costco. Seriously, one of my employees pointed out that Costco sold a retirement plan for small companies. Actually, Costco resells a service called Sharebuilder that is managed by ING Direct. This has changed in the years since we did ours, as the Costco website now references Intuit, which resells a plan managed by Morningstar.

There are two main things to look for in a 401(k) plan. From the employee's perspective, they want a lot of options with low management fees. This is the money that the provider of the 401(k) takes out periodically as recompense for managing the funds. The second consideration is the amount charged to the company for monthly maintenance fees. The Sharebuilder plan was reasonable on both counts, and I was able to provide this benefit for less than $100/month.

One note on 401(k) plans: there are rules to prevent these plans from being used solely by the owners and managers of a company. Owners are identified by having a certain amount of ownership or stock, and I believe highly compensated employees are identified by a certain salary range. In order to encourage investment by less well-compensated employees, there are ratio tests that must be performed, and owners and managers can only contribute based upon the contributions of the company as a whole.

This is extremely complicated, especially when a company is small and consists primarily of owners. There is a way around this by leveraging safe harbor provisions. We instituted a profit-sharing plan where the company contributes three percent of the salary of each employee into their account once a year. This removes the ratio tests and allows every employee to contribute as much as they want (up to the legally imposed limits for the account, of course).

Fairly distributing stock options

Finally, we broach the topic of profit-sharing. Most employees in small start-up companies are interested in some form of incentive stock option (ISO) plan. These were popular during the first tech bubble, around 2000, when many companies were structured for a quick exit via some sort of liquidity event.

While this is still the plan for a lot of companies, it has become less so in recent times as businesses focus more on reaching profitability than solely on building a company for acquisition. The fact is that ISOs are a pain to create and manage, and unless you have both a good lawyer and money to spare, they may not be worth the trouble.

We have yet to formalize our own stock option plan, but I like the one adopted by the company 37signals. They wanted a simple plan that would reward seniority, and they came up with the following:

  • At least five percent 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.
  • Each current employee will be credited with one unit for every full year they’ve worked, starting after the first full year. The maximum amount of units one person could earn would be five units. So if you worked for two years you’d get two units. Three-and-a-half years, three units. Four years, four units. Five years, five units. Seven years, five units. And so on.
  • They would divide the total employee bonus pool dollar amount by the total number of units held by all employees. This would determine the unit value.
  • Each person would receive stock shares equal to the unit value multiplied by their units.

I think this sounds like a good plan. I'm not sure I completely agree with the numbers (I'm thinking more like 10 percent, going up to ten years), but I do think it makes more sense than the lottery around stock options, as well as their tax consequences. (I was involved in an IPO in the first bubble and the less said about the alternative minimum tax, the better.) It seems to reward service equitably--unlike stock options which tend to be larger for early employees--and it is much simpler than other alternatives.

Don’t think that just because your company is small that it can't have big-company benefits. By applying the same ingenuity that you bring to your business, you can create a benefits solution that well-serves both your people and your company.

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