Have an Offer Letter from a Startup? The Equity Issues are Between the Lines

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.

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If you have an Offer Letter from a startup, you may notice that it’s light on information about stock options. You may see a few sentences noting that (1) the company will recommend to the board that the grant be made at the first market value on the date of grant; (2) the option will vest monthly over four years with a one-year cliff; and (3) the option will be governed by the company’s equity incentive plan and your stock option agreement. It sounds simple. But the key issues are hidden between the lines.

CHANGE OF CONTROL PROTECTION FOR UNVESTED SHARES

A standard vesting schedule does not provide protection for unvested shares in the event the company is acquired. If you are joining in a senior position or as an early stage employee, consider negotiating for a double trigger acceleration upon change of control to protect the right to earn unvested shares. The most robust double trigger language would provide that 100% of unvested shares will accelerate if you are terminated or constructively terminated as part of or at any time following a change of control. See this blog post for more information on change of control terms for startup equity offers.

CLAWBACKS OR OTHER RED FLAGS

The equity incentive plan and stock option agreement are usually not provided with the Offer Letter unless requested, as the official equity grant is not made until after the start date. 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 incentive plan and stock option agreement may give the company the right to forcibly repurchase shares from the employee after termination of employment, even if they are vested shares of restricted stock or vested shares issued upon exercise of options. See this post for some examples of how those clawbacks may be drafted. Clawbacks dramatically limit the value of the equity, as the most significant increase in the value of startups has historically been at the time of an exit event. If this term, or any other red flag term, appears in the form documents, it makes sense to negotiate these out of the deal or provide for alternative compensation to make up for the potential loss in value before signing the Offer Letter.

TAX STRUCTURE

The Offer Letter may not include the terms of the tax structure, but if you have any leverage on those terms the Offer Letter negotiation is the time to address them. The right tax structure will balance your interests in total value, low tax rates, tax deferral, limited tax risks and investment deferral. This balance is different at each company stage. For example, at the earliest stage startups you may be able to meet all those goals with the purchase of Restricted Stock for a de minimis purchase price. At mid-stage startups you might prefer to have Incentive Stock Options with an extended post-termination exercise period to defer the investment until a liquidity event. At late-stage startups you might prefer Restricted Stock Units for a full value grant. See this blog post on Examples of Good Startup Equity Design by Company Stage.

GRANT TIMING

The company will set the exercise price at the fair market value ("FMV") on the date the board grants the options to you. This price is not negotiable, but to protect your interests you want to follow up after your start date to be sure that the board makes the grant of the options soon after your start date. If they delay granting you the options until after a financing or other important event, the FMV and the exercise price will go up. This would reduce the value of your stock options by the increase in value of the company’s common stock during that time.

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.

Negotiation Rhythms #3: Sales & Threats

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.

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Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel. You are welcome to contact Stock Option Counsel at info@stockoptioncounsel or (650) 326-3412.

There are two ways to increase or decrease another party’s limit in a negotiation – sales and threats.[1] The picture above takes some of the mystery out of the salesman and the thug -- they're both just working as negotiators to change the perception of the current offer in comparison to the other party's BATNA – Best Alternative to Negotiated Agreement.

Selling improves the perception of the quality of the present offer so that the outside alternatives are unattractive by comparison. Threats decrease the attractiveness of outside offers or the possibility of making no deal and sticking with the status quo.

Threats

An ongoing employment lawsuit over no-hire agreements among Silicon Valley companies featuring Steve Jobs provides a strangely relevant example of the power of threats. 

Edward Colligan, former CEO of Palm, has said in a statement that Jobs was concerned about Palm’s hiring of Apple employees and that Jobs “proposed an arrangement between Palm and Apple“ [2] to prohibit either party from recruiting the others' employees.

That would have been a simple offer of an agreement (however illegal that arrangement might have been) if Colligan had access to the undisturbed alternative of not participating and keeping the status quo.

But Colligan has said that Jobs’ next negotiation move was to make the alternative of nonparticipation very unappealing with the threat of patent lawsuits that would cost Palm and Apple a great deal of money. Jobs followed this threat with a reminder of just how unpleasant such litigation would be for Palm, considering the fact that Apple had vast resources to endlessly pursue the lawsuits: "I’m sure you realize the asymmetry in the financial resources of our respective companies …."[2]

Even though most of us don’t use threats in a negotiation, it’s part of the logic of negotiation rhythms. 

Selling

Selling is the more common (and generally legal) way to address the fact that the other party has choices outside the present negotiation. As we discussed in the prior posts, a party's price or terms limits are defined by his or her best alternative outside of making an agreement in the present negotiation. Selling moves the limit when it can make the present offer more appealing than what had been perceived as an outside alternative.

Many people resist “selling themselves” in a salary negotiation because they are embarrassed to discuss their “value.” The logic of BATNA and negotiations provides some relief from this embarrassment, for it reframes “selling” from bluffing and puffing to describing and distinguishing one’s past experience and intended role in the organization.

Since the employer’s limit is not defined by an individual’s value, but by the employee’s differentiation from the field of candidates, the task of negotiating becomes more fact-based and less fear-driven. This logic encourages progress from the attitude of “Oh, they see who I am and hate me,” toward the sales approach of “Oh, it seems they need more information about what I offer in terms of my past experience and my role going forward.”

As an employee’s offer of services becomes distinguishable from the employer’s alternatives, the employer’s perception of the BATNA will change.

Consider an employer who believes there’s an equal candidate available for $120,000 and is entertaining another’s proposal to perform the role for $140,000. Without “selling” the offer of one’s services, the employer has no information with which to make a distinction between the two alternatives. The process of selling oneself to the employer is not to prove one’s inner worthiness at $140,000, but to show and tell that the employer is choosing between two distinguishable candidates. 

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(For those still interested in threats, distinguishing one’s skills is a form of a threat when it comes to negotiating with a current employer. Every element of the description one’s current performance and ongoing role is a threat of what the employer would have to work without or try to replace.)

What an employer would have once considered a better alternative – such as another equal offer for $120,000 – loses its appeal in light of the truth (sales pitch) of the $140,000 offer. If they are no longer equal in the mind of the employer, he or she must consciously decide if the other candidate at the lower price is still a better alternative. While there is no guarantee that the employer will prefer to pay more, the process of selling pushes the employer to the choice based on the true distinctions in the qualities of the candidates.

 

[1] Roger Fisher, William Ury and Bruce Patton, Getting to Yes: Negotiating Agreement Without Giving In. Gerald B. Wetlaufer, The Rhetorics of Negotiation (posted to SSRI).

[2] http://vrge.co/USNorq

 

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.