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

Stock Option Counsel - Legal Services for Individuals.  Attorney Mary Russell counsels individual founders and executives on equity offer evaluation and negotiation, stock option exercise and tax choices, and sales of startup stock.  Please see this FAQ about her services or contact her at (650) 326-3412 or by email at info@stockoptioncounsel.com.

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 $300 million investment with standard start up investor rights of 1X non-participating liquidation preference, any acquisition below $300 million valuation would provide $0 to common stockholders. Or, 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 - Legal Services for Individuals.  Attorney Mary Russell counsels individual founders and executives on equity offer evaluation and negotiation, stock option exercise and tax choices, and sales of startup stock.  Please see this FAQ about her services or contact her at (650) 326-3412 or by email at info@stockoptioncounsel.com.