The C-Level View - Fine Print Issues in Startup Executive Equity Grants

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

For executives trading significant cash compensation for startup equity, the fine print of the equity documents can significantly change the risk/reward profile of the deal. Be on the lookout for value-limiting terms in the Equity Grant Agreements, the Stock Plan and the Certificate of Incorporation.

Equity Grant Agreements

The Equity Grant Agreements and Stock Plan are usually not provided to the executive with the Offer Letter, as the official equity grant is not made until after hire. However, these agreements contain important details about the grant, so it makes sense to review them before agreeing to the number of shares or signing the Offer Letter.

For example, the Equity Grant Agreements may give the company the right to forcibly repurchase shares from the executive after termination of employment, even if they are vested shares of restricted stock or vested shares issued upon exercise of options. This dramatically limits the value of the equity, as the most significant increase in value of startups has historically been at the time of an exit event.

They may also require the executive to agree to future retroactive changes to the terms of the equity. For example, they may include the executive’s agreement to be bound to repurchase rights that might appear in future changes to the bylaws or the executive’s agreement to sign onto exercise agreements or stockholder agreements in the future which may have onerous terms.

If the Equity Grant Agreements have repurchase or other forfeiture rights for vested shares, it makes sense to negotiate these out of the deal or provide for alternative compensation to make up for the potential loss in value. If the Equity Grant Agreements have commitments to be bound by unknown future terms, it makes sense to remove these commitments and have all relevant terms provided up front.

The Stock Plan

The Stock Plan (otherwise known as an Equity Incentive Plan) can have some of the same red flags addressed above under Equity Grant Agreements. They may also have other onerous terms especially relating to treatment of executive shares in a change of control. The company may reserve the right to terminate, for no consideration, all unvested options at change of control. This could be a significant cancellation of value and could seriously decrease the executive’s leverage in negotiation of post-acquisition employment terms.  Also, if an executive has negotiated for favorable double trigger vesting acceleration upon change of control rights, this term could invalidate that benefit, as cancelled unvested options would not be available for acceleration in the event of a post-acquisition termination.

If the Stock Plan has this or other onerous terms, it makes sense to negotiate for modifications in the Equity Grant Agreements or for a grant made outside the Stock Plan with terms crafted for the individual executive. If the Stock Plan has a company right to cancel unvested options at change of control, it makes sense to address this directly in the language of the executive’s vesting acceleration upon change of control term so that the cancellation cannot occur without a corresponding acceleration of vesting.

Certificate of Incorporation

The Certificate of Incorporation will outline some key economic rights of investors, including their liquidation preferences. Executives joining established startups can be misled by their percentage ownership if the investors have significant liquidation preferences, either because of significant fundraising or onerous investor terms. For example, in a company with $50 million investment and outsized investor rights of 3X participating liquidation preference, the investors would take the first $150 million in acquisition proceeds and participate with common stockholders in the distribution of the remaining proceeds.  

If investor liquidation preferences are high, it makes sense for an executive to negotiate for significantly more shares to balance the risk or negotiate for a management retention bonus to be earned upon acquisition to make up for the loss in equity value due to these preferences.

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

 

Is the battle for talent delaying unicorn ipos?

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Frederic Kerrest, Chief Operating Officer and Co-Founder of Okta lists recruitment as one of a few factors that influenced their choice to delay their IPO. 

There’s a few reasons specifically that we thought about when we went through the calculation [of taking another private financing rather than having an IPO]. Five or ten years ago, companies like us would have gone public at this point instead of doing this financing round, because it’s about the same amount of money you would raise in a typical IPO.

First of all, it’s interesting for potential employees who want to come join the company. The opportunity to join a pre-IPO company is something that’s interesting to them, even if it’s just 6 or 9 months before.
— Frederic Kerrest, Chief Operating Officer & Co-Founder, Okta
Do you think it’s harder to hire certain folks if you were public as opposed to being pre-public?
— Dan Primack, Fortune
I think it’s a slightly different kind of person who wants to join a pre-public versus a ... public company. They have different profiles, they’re looking for different things. They’re looking for different things in terms of the company, in terms of the job, in terms of other things.
— Frederic Kerrest, Chief Operating Officer & Co-Founder, Okta

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

In the News: Startup Employees in the Dark on Equity

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Mary Russell, an attorney who founded Stock Option Counsel to help employees evaluate their equity compensation, says the first step is for employees to make sure any equity is theirs to keep. Some companies have repurchase rights in their equity agreements that give them a right to buy back shares and options from any employee who leaves; and some give founders or investors broad latitude to change the terms.

“If the company can take back employee shares it dramatically limits the value of those shares,” says Ms. Russell. “It’s the sort of thing an employee needs to know about when they go into a job.” She says it’s as simple as asking whether the company can take back vested shares.
— Katie Benner, The Information

See Katie Benner's full article, Startup Employees in the Dark on Equity. The Information is a subscription publication for professionals who need the inside scoop on technology news and trends. 

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

VIDEO Startup Stock Options: Negotiate the Right Startup Stock Option Offer

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

 

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

VIDEO Startup Stock Options: Startup Valuation

Stock Option Counsel for individual employees and founders in all matters relating to startup stock options or other employee stock. This video describes startup valuation for employees in a thoughtful, accessible way. 

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Founders: Kurt Vonnegut's Caution on Corporate Attorneys

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Kurt Vonnegut, Author

Kurt Vonnegut, Author

If you are a founder with some suspicions about the motivations and allegiances of your company's law firm, you may appreciate the wisdom of Kurt Vonnegut.

Vonnegut has a great bit in God Bless You, Mr. Rosewater about the worst motivations of corporate lawyers. 

The book is about money, sort of. Here's the opening line:

 

 

 

 

 

A sum of money is a leading character in this tale about people, just as a sum of honey might properly be a leading character in a tale about bees.
— Kurt Vonnegut, God Bless You, Mr. Rosewater

The Rosewater family had a great fortune. It was held by The Rosewater Foundation, for the benefit of the family's heirs, and managed by a law firm called McAllister, Robjent, Reed and McGee. An associate of the firm, Norman Mushari, was Vonnegut's embodiment of the worst motivations of corporate lawyers.

No one ever went out to lunch with Mushari. He took nourishment alone in cheap cafeterias, and plotted the violent overthrow of the Rosewater Foundation. He knew no Rosewaters. What engaged his emotions was the fact that the Rosewater fortune was the largest single money package represented by McAllister, Robjent, Reed and McGee. He recalled what his favorite professor, Leonard Leech, once told him about getting ahead in law. Leech said that, just as a good airplane pilot should always be looking for places to land, so should a lawyer be looking for situations where large amounts of money were about to change hands.

”In every big transaction,” said Leech, “there is a magic moment during which a man has surrendered a treasure, and during which the man who is due to receive it has not yet done so. An alert lawyer will make that moment his own, possessing the treasure for a magic microsecond, taking a little of it, passing it on. If the man who is to receive the treasure is unused to wealth, has an inferiority complex and shapeless feelings of guilt, as most people do, the lawyer can often take as much as half the bundle, and still receive the recipient’s blubbering thanks.
— Kurt Vonnegut, God Bless You, Mr. Rosewater

Vonnegut's wisdom is a good reminder to founders that their company's attorneys may be representing the company's money rather than its founders.

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.