Part 2 - Examples of a Clawback Clause for Startup Stock
Working for a startup? Learn how a clawback clause, forfeiture term or repurchase right limits the value of startup equity. Plan ahead to protect your equity stake.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
What is a Clawback Clause?
Startup hires expect that they will be able to keep their vested shares if they leave the company before an exit event. That’s not always the case. Learn more in Part 1 of this series - Clawbacks for Startup Stock - Can I Keep What I Think I Own - about how a clawback clause limits the value of startup equity.
In this post, we will share some examples of a clawback clauses or clawback provision that would allow startups to take back vested shares or options.
What is an Example of a Clawback Clause?
Equity Incentive Plan I
The company reserves the right to include clawbacks for vested shares upon an individual's termination of employment:
Repurchase Right. The Company (and other designated Persons) may repurchase any or all of the shares of Stock granted to a Participant pursuant to an Award or acquired by the Participant pursuant to the exercise of a Stock Option upon such Participant’s termination of employment with, or Service to, the Company for any reason to the extent such a right is provided in an Award Agreement or other applicable agreement between the Company and the Participant.
Such terms could be included in any agreement with the individual, such as a Stock Option Grant Notice, a Stock Option Agreement, a Stock Option Exercise Agreement, a Termination and Release or Severance Agreement, a Restricted Stock Agreement, an RSU Agreement, an Employment or IP Agreement, or a Stockholders' Agreement.
Equity Incentive Plan II
The company reserves the right to implement a policy in the future to clawback vested or unvested shares, and you’re agreeing that such a change will apply retroactively to your shares:
Clawback Policy. The Awards granted under this Plan are subject to the terms of the Corporation’s recoupment, clawback or similar policy as it may be in effect from time to time, as well as any similar provisions of applicable law, any of which could in certain circumstances require repayment or forfeiture of Awards or any shares of Common Stock or other cash or property received with respect to the Awards (including any value received from a disposition of the shares acquired upon payment of the Awards).
Stock Option Agreement
The company reserves the right to change its bylaws in the future to clawback vested or unvested shares, and you’re agreeing that such a change will apply retroactively to your shares:
Right of Repurchase. To the extent provided in the Company’s bylaws in effect at such time the Company elects to exercise its right, the Company will have the right to repurchase all or any part of the shares of Common Stock you acquire pursuant to the exercise of your option.
These two terms allowing retroactive changes push the limits of Delaware law on company repurchase rights. However, I advise my clients to negotiate these out of their documents before joining a company to avoid litigation at a later date.
Restricted Stock Unit Grant Notice
In order to vest RSUs, the time-based vesting requirement (the "Time Condition") must be met, and the Company must have an IPO or a Change of Control (the "Performance Vesting") prior to the 7 year expiration period of the RSU. This is a normal structure for a startup RSU grant due to tax planning. However, in this example, if the IPO or Change of Control does not occur by the individual's last date of employment, the RSUs are cancelled and never vest:
Vesting Conditions. Any Restricted Stock Units that have satisfied the Time Condition as of such date shall remain subject to the Performance Vesting set forth in Section 2(b) above, but shall expire and be of no further force or effect on the first to occur of (a) the date on which the Grantee’s Service Relationship with the Company terminates, or (b) the Expiration Date.
Employment and Confidentiality Agreement
The company reserves the right to terminate vested options in the event of a breach of the agreement:
Breach of Confidentiality Agreement. If the Optionee breaches the provisions of the Confidentiality Agreement, then any outstanding Options held by such Optionee at the actual time of such termination shall thereupon expire, terminate and be cancelled in respect of all vested and unvested Option Shares.
Breach of Non-Competition and Non-Solicitation Covenant. If the Optionee breaches the Non-Competition and Non-Solicitation Agreement, then any outstanding Options held by such Optionee at the actual time of such termination shall thereupon expire, terminate and be cancelled in respect of all vested or unvested Option Shares.
While these two examples from employment and confidentiality agreements apply to restrictions on exercising options, similar terms may also apply to repurchase or forfeiture of vested shares for violations of such agreements even after termination of employment. More on this here from the National Association of Stock Plan Professionals in June 2023.
Other Clawback Clauses
These are only a few examples of how clawbacks might appear in an equity offer. There are more ways they can appear in the fine print. And, practically, an option exercise deadline acts as a clawback as well. Having only 3 months to exercise options is a standard market term, but it often acts to prevent employees and executives from exercising their vested shares. More on this in:
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Thank you!
Thank you to JD McCullough for editing this post. He is a health tech entrepreneur, interested in connecting and improving businesses, products, and people.
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:
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:
Requiring board approval for transfer of shares;
Adding Company repurchase rights for vested founder shares upon termination of employment;
Using stock option structure rather than restricted stock at founding;
Setting the purchase price of shares higher than necessary;
Adopting a stock plan for future employee grants that has off-market, anti-employee terms;
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
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:
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.
Skype Repurchase Rights = Vampire Capitalism
I agree that it is unethical as it goes against the expectation of employees as to how their contributions are valued. If they don't know about it before they choose the company, they are making a choice without an essential term of the deal.
And it goes against the most idealistic ethic of Silicon Valley – that capitalism should be used by groups to organize and cultivate their own creative efforts rather than as a tool of vampires.
But it is not illegal. And I've seen worse in my Stock Option Counsel practice (twice this month alone). Congratulations on paying attention.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Quora Question:
What does it say about a company that has a Skype-like repurchase right in their stock option agreement? The company that I work for has a stock option agreement that has a Skype-like repurchase clause (See: Upgrading Skype and Silver Lake to Evil), basically allowing them to buy back exercise stocks at 1.5x FMV within 90days following the employee's end date/exercise date. I have never seen anything like this, is this to protect them/screw ex-employees? It basically mean my vested stocks can be easily bought back at 1.5x? Isn't it unethical?
Stock Option Counsel Answer:
I agree that it is unethical as it goes against the expectation of employees as to how their contributions are valued. If they don't know about it before they choose the company, they are making a choice without an essential term of the deal.
And it goes against the most idealistic ethic of Silicon Valley – that capitalism should be used by groups to organize and cultivate their own creative efforts rather than as a tool of vampires.
But it is not illegal. And I've seen worse in my Stock Option Counsel practice (twice this month alone). Congratulations on paying attention.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.