Founders' Stock Red Flags - Keep Your Law Firm on Your Side

Lately, I’ve seen startup law firms yielding founder rights to future investors by proposing incorporation documents that are detrimental to founder interests. Photo © Aleksvf | Dreamstime.com

Attorney Mary Russell counsels individuals on startup equity, including:

• Compensation Counsel on Job Offers

• Legal Counsel on Job Offers

• Legal Counsel on Other Equity Choices

You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.

I help founders protect their personal equity interests, from incorporation through financing and exit events. Lately, I’ve seen startup law firms yielding founder rights to future investors by proposing incorporation documents that are detrimental to founder interests. These choices are being made by company counsel and signed by founders before a company has investors.

Here are some of the red flag terms I call out for my clients:

1. Founders waiving stockholder statutory information rights;

2. Requiring board approval for transfer of shares;

3. Adding Company repurchase rights for vested founder shares upon termination of employment;

4. Using stock option structure rather than restricted stock at founding;

5. Setting the purchase price of shares higher than necessary;

6. Adopting a stock plan for future employee grants that has off-market, anti-employee terms;

7. Failing to provide for any vesting acceleration related to a change of control, or limiting double trigger acceleration of change of control to apply only if the termination event is within 6 or 12 months of the change of control rather than at any time after it; or

8. Adding Company rights to terminate unvested shares or options at the time of a change of control.

I’ve seen some of these terms even from classic Big Law startup-focused firms in recent months.  Limits on founder shares are often negotiated between founders and investors at the time of financing – not before. This is usually done through a stockholders agreement, such as a ROFR Agreement or Voting Agreement. It is premature for founders to restrict themselves – or for a company’s law firm to restrict founders – by adding pro-investor terms to the incorporation documents.

The founder’s task is to communicate to company counsel that they want standard, pro-founder terms in the incorporation documents and provide feedback if they see that company counsel has added pro-investor terms have been included before negotiation with investors.

Attorney Mary Russell counsels individuals on startup equity, including:

• Compensation Counsel on Job Offers

• Legal Counsel on Job Offers

• Legal Counsel on Other Equity Choices

You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.

*Thank you to JD McCullough for edits to this post. JD is a health tech entrepreneur, interested in connecting and improving businesses, products, and people.*

Considerations for founder restricted stock purchase agreements.