Since startup employees and executives earn, or vest, their equity over time, a company may be acquired before they are fully vested. The treatment of unvested shares in an acquisition affects the risk calculus of joining a startup, as the right to earn 100% of the shares gives the equity a much higher potential upside than the right to earn only a portion of the shares.
Founders, executives and key hires, including employee-level hires at early stage startups, can negotiate for Double Trigger Acceleration to protect their unvested shares in the event that the individual is terminated after an acquisition. Advisors and some founders and executives may negotiate for Single Trigger Acceleration so that their shares immediately vest at acquisition. However, protective terms for unvested shares are not negotiable for most employee-level hires. Their equity will be governed by the general terms of the Plan, which will likely be either an unfavorable Cancellation Plan or a more favorable Continuation Plan.
Some equity incentive plans allow the company to cancel unvested shares without payment in an acquisition. In fact, in recent years I’ve noticed that this is the most common treatment in Silicon Valley-style startup employee equity plans. We’ll call this type of plan a Cancellation Plan. Under a Cancellation Plan, unvested equity can be cancelled and replaced with $0, even if the unvested shares had significant value at the time of the acquisition. For example, if an employee's total number of shares was worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 at closing. The unvested value of $100,000 could be cancelled without payment even if the employee stayed on as an employee after the acquisition. In another example, if the employee was within the first year of service and had a one-year cliff vesting schedule, 100% of the grant could be cancelled without payment.
As noted above, the distinction between a Cancellation Plan and the more protective Continuation Plan is not usually a negotiable term. The exception to this would be at a startup with employee-friendly founders and executives who are willing to advocate for changes to their plan with the board and stockholders.
Other startup equity plans prohibit cancellation of valuable unvested equity without payment. We’ll call this style of plan a Continuation Plan. Although unvested equity that is worthless based on the acquisition price could be cancelled, valuable unvested equity must be continued or substituted for cash or equity awards with the same value as the deal consideration for the shares being cancelled. If the deal does not provide for such continuation or substitution, unvested equity will be accelerated so that it becomes 100% vested and paid at closing.
In the same example as above, if an employee's total number of shares was worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 at closing. But the unvested shares would be replaced with a substitution or continuation award in exchange for the $100,000 in unvested value. That might be in the form of cash to vest over time, continuing awards in the original company, or new equity in the acquiring company's equity.
Under a Continuation Plan, the payment for unvested shares still must be earned over the original vesting schedule. So without the Double or Single Trigger Acceleration protections described below, the individual could be terminated for any reason, at any time, and lose the unvested shares. However, those who stay at the acquiring company under a Continuation Plan will continue to earn the deal consideration for their shares. (But beware. Those with unvested equity under a Continuation Plan may also be asked to sign new employment agreements forfeiting these rights as part of the acquisition, since the company’s leverage of termination is significant).
Double Trigger Acceleration
Founders, executives and key hires, including employee-level hires at early stage startups, negotiate special vesting schedules to protect themselves from losing unvested shares. With Double Trigger Acceleration rights, if an individual is terminated without cause after an acquisition, unvested equity immediately vests. It’s called Double Trigger Acceleration because vesting occurs immediately (faster than the original schedule) when two triggers have occurred - first, the acquisition and, second, the termination.
One key argument for this term is based on risk. If an individual at any level of the organization is taking a significant risk to join the company, such as sacrificing significant cash or other compensation for the equity, they advocate for Double Trigger Acceleration to protect their upside in the event that the equity becomes valuable. A second key argument for this term is based on “aligning incentives.” If the team could lose valuable unvested equity by achieving a prompt acquisition, their incentives would not be aligned with the company’s goals. Double Trigger Acceleration rights bring the individuals' incentives in alignment with the company's goals.
This Double Trigger Acceleration protection is negotiated at the offer letter stage and included in the final equity grant documents. The key negotiable terms in this clause are (1) full acceleration so that a termination of the individual without cause at any time after acquisition accelerates 100% of unvested shares; (2) application to a constructive termination in the event the individual resigns for good reason; (3) a narrow definition of “cause” and a broad definition of “good reason”; (4) a broad definition of acceleration (known as “change of control”) including a sale of substantially all the company’s assets; (5) application in the event that unvested shares would otherwise be cancelled under a Cancellation Plan; and, perhaps, (6) application to termination in anticipation of, or for a certain protective period of time prior to, an acquisition.
Single Trigger Acceleration
Advisors and some founders and executives may negotiate for Single Trigger Acceleration to immediately vest at acquisition. This is usually rejected by investors and companies as they argue that the company is an unappealing acquisition target if its talent will not be incentivized to stay after closing. This is especially true for technical talent at a technology company.
The key argument for this term is based on the need, or lack of need, for the individual’s role after acquisition. For example, advisors naturally negotiate for Single Trigger Acceleration because their primary role is to advise a company at the startup stage. They would not be necessary after an acquisition as they’ve fulfilled their purpose by that time. Others may make similar arguments as above under Double Trigger Acceleration along the lines of aligning incentives. For example, I’ve worked with a CFO who negotiated for 50% Single Trigger Acceleration because he was hired with the express purpose of improving the company’s financial position to achieve an acquisition. Those with similar arguments may even negotiate for Single Trigger Acceleration to apply at IPO, which would be a very unusual term but a logical incentive for certain hires.
Negotiating Change of Control Terms
As noted above, acceleration terms are not “on the table” in most startup equity offer negotiations. However, the availability of acceleration protection and/or the distinction between a Cancellation Plan and a Continuation Plan is a factor in assessing the risk of joining a startup. Without these protections, it may make sense to negotiate for a higher cash package or number of shares to balance risk. Check out more on my blog about considerations in defining the right startup job offer and other key terms that affect the risk of startup equity including clawbacks and tax structuring.
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 email@example.com.