Double Trigger Acceleration and Other Change of Control Terms for Startup Stock, Options and RSUs
What does double trigger acceleration mean? It protects unvested shares from cancellation in a change of control by immediately accelerating those shares if the individual is terminated as part of the change of control. Founders, executives and key hires, including employee-level hires at early stage startups, negotiate for Double Trigger Acceleration in their equity grant documents at the offer letter stage.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Originally published June 5, 2018. Updated July 27, 2023.
Change of Control Terms for Startup Stock, Options and RSUs
Startup stock, options and RSUs vest over time. Since they vest over time, some may not be vested when the company has a change of control (aka merger or acquisition). What happens to the unvested shares at change of control? It depends on the fine print in your equity documents.
Founders, executives and key hires, including employee-level hires at early stage startups, often negotiate for Double Trigger Acceleration to protect their unvested shares. Advisors and some founders and rare executives may negotiate for Single Trigger Acceleration so that their shares immediately vest at acquisition. However, these protections are not often negotiable for employee-level hires except at very early stage companies. Their equity will be governed by the general terms of the Plan, which will likely be either an unfavorable Cancellation Plan.
Single Trigger Acceleration
The ideal change of control acceleration term is Single Trigger Acceleration - so that 100% of unvested shares vest immediately upon change of control. Investors and companies often argue against this term because the company may be an unappealing acquisition target if its key talent will not be incentivized to stay after closing. This is especially true for technical talent at a technology company.
Advisors, some founders and rare executives may negotiate for Single Trigger Acceleration if they can make the case that their role will not be needed after change of control. 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. Founders and executives sometimes argue for Single Trigger Acceleration based on 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.
Double Trigger Acceleration
The next best term is Double Trigger Acceleration, in which unvested equity immediately vests if both of two triggers are met. First, the company closes a change of control. Second, the individual’s service is terminated for certain reasons (most often a terminated by the company without Cause or a voluntary resignation by the individual for Good Reason).
Founders, executives and key hires, including employee-level hires at early stage startups, negotiate for Double Trigger Acceleration in their equity grant documents at the offer letter stage.
The key argument for Double Trigger Acceleration 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 elsewhere to join, they advocate for Double Trigger Acceleration to protect their upside in the event that the equity becomes valuable. A grant of 1% with Double Trigger Acceleration is more valuable because of that protection of the upside. A second key argument for this term is based on “aligning incentives.” If individuals on the team could lose valuable unvested equity by achieving a prompt acquisition, their incentives would not be aligned with the company’s goals of closing that deal. 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:
Full acceleration so that a qualifying termination at any time after acquisition accelerates 100% of unvested shares;
Application to a qualifying termination in anticipation of, or for a certain protective period of time prior to, change of control;
Application to terminated by the company for Cause (narrowly defined, not to include arguable performance terms);
Application to a resignation by the individual for Good Reason (defined broadly to include a change in cash compensation, a reduction in duties or reporting structure, a geographic change, and anything else that would amount to constructive termination for the individual);
A broad definition of change of control including a sale of substantially all the company’s assets;
Immediate vesting at closing of the change of control if unvested shares would otherwise be cancelled without payment under a Cancellation Plan term. More on this here from Cooley:
Often overlooked, however, is that in order for double-trigger acceleration to be meaningful, the option grant or equity award must actually be assumed or continued by the acquiror in the transaction. This will not always be the case in a transaction – aquirors often have their own plans and ideas for incentivizing their employees. If an unvested option or equity award terminates in connection with a transaction, then technically, there will be no unvested options or awards to accelerate if the second trigger (i.e., the qualifying termination) occurs after the transaction.
Continuation Plan
If the startup’s Equity Incentive Plan includes a continuation term, the value of the unvested shares continue to vest after change of control so long as the individual stays in service after the closing. We’ll call this style of plan a Continuation Plan. The unvested shares are likely to be converted into another form, such as RSUs in the acquiring company or cash deal consideration. But the value is protected so that the deal value per share paid to vested shares at closing will be paid to these unvested shares on each subsequent vesting date. If the individual is terminated or resigns for any reason, they would not be paid out. 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.
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. Whatever the form, it would continue to vest over the remaining portion of the original vesting schedule.
Without the Double or Single Trigger Acceleration protections described below, the individual could be terminated for any reason, at any time, and would 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 unvested 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).
Cancellation Plan
Most startup Equity Incentive Plans allow the company to cancel unvested shares without payment in an acquisition. 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 even if it was immensely valuable based on the deal price/share.
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. When startup candidates encounter this term in their offer negotiation document review, their best course of action is likely to be to negotiate for Single Trigger Acceleration or Double Trigger Acceleration for their individual grants.
Negotiating Change of Control Terms
The availability of Single Trigger Protection or Double Trigger Protection and/or the distinction between a Cancellation Plan and a Continuation Plan is a factor in assessing the risk of joining a startup. If the fine print protects 100% of the unvested shares, the shares have a higher potential upside for the employee or executive. Without these protections, it may make sense to negotiate for a higher cash package or a higher number of shares to balance risk. Check out more on my blog about market data for startup equity offers and other key terms that affect the risk of startup equity including clawbacks and tax planning for stock options.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Part 3: FAQs on the Menu of Startup Stock Option Exercise Strategies
Wondering when to exercise stock options at a startup? Here's the menu of startup stock option exercise strategies including early exercise of stock options and extended post-termination exercise periods. Plan ahead to protect your equity stake. Photo by Kaboompics.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.
When to exercise stock options?
Thanks for the great feedback on this post: The Menu of Stock Option Exercise Strategies. I’m delighted that people are using it to plan their startup stock option exercise strategies at the offer negotiation stage to save themselves from the unhappy surprises associated with startup stock options.
I’ve had some great questions on the menu and wrote this Q&A in response. Enjoy!
Why don’t you talk more about Incentive Stock Options (ISOs)? The recruiter told me not to worry about my startup stock option exercise at hire because the options are ISOs.
Founders, recruiters, human resources employees and hiring managers often use the “ISO status” of startup stock options to obscure this issue and falsely reassure hires to get them to sign offer letters without a viable option exercise strategy in place.
There are some benefits to Incentive Stock Options. These are relevant if you are following the exercise as you vest strategy or the exercise at termination of employment strategy. The basic difference is that gains on exercise of ISOs are taxed at AMT rates and exemption amounts rather than the ordinary income rates that apply to NSOs. However, this ISO benefit does not change the fundamental risk associated with startup stock options: If the FMV increases dramatically during your employment, the tax cost to exercise can make exercise impossible even with ISOs! More here on this $1M problem.
Why do I need to plan for this at the offer letter stage? Wouldn’t the company want to “help” me avoid forfeiting my vested startup stock options by extending the post-termination exercise period if I leave the company?
The post-termination exercise deadline is not often changed after hire. If an individual does not have (or press) the negotiating power before they join to inspire the company to extend that deadline, in the vast majority of cases they will not have that power at the time of termination or resignation.
My clients often hear founders declare at hire that their companies could not possibly extend the post-termination exercise deadline in the original option contract. In the next breath, those founders promise that their companies would “of course” extend it in the event of a termination or resignation. This is not, in my experience, a realistic promise.
Why? The “company” in this context is the venture capitalists who likely control its board of directors or the law firms who protect their interests. The post-termination exercise deadline is, from their perspective, a feature not a bug. When companies make offers, they assume that only a small fraction of vested options will be exercised (in large part because of these early termination features). Since this is part of the venture capitalists’ economic calculus and method of maximizing returns for their investors, they’re not in the business of helping people out of it.
Why do I need to plan for this at the offer letter stage? The company promised they will let me sell some of my equity stake each year through a tender offer.
You will almost certainly not get a written commitment from a company for a right to pre-IPO sales. Access to an employer-sponsored tender offer will depend entirely on a company’s decision to arrange it, investor interest to fund it, and a company’s decision to let any individual take part in it.
When tender offers are available, they are almost always limited to some small percentage of vested holdings. Given this limited liquidity, most people who have the opportunity to sell a portion of their shares in a tender offer do not use the funds to exercise the remainder of their options. They could, but they do not.
Why? Once those funds are in the bank, these individuals immediately start to think of the funds as “my money.” It seems to them too risky to take funds that they want to use today to buy a house or diversify their portfolio and invest those funds in the exercise price and associated tax bill to exercise their remaining options.
This is a personal choice, not right or wrong. I’m offering it here to show what I have seen as a common phenomenon. Individuals are faced with the problem of a huge expense in front of them to exercise their vested options and pay the taxes associated with the exercise. What happens in practice is that if they do successfully cash out some of their shares, they keep the money and are left with the remainder of their options still subject to forfeiture. Then they encounter this forfeiture problem when they either (1) are subject to option early expiration at termination of employment termination or (2) the approach of the end of the original, non-extendable, 10 year term of the option.
Why do I need to plan for this? I’ve heard there are “services” who will help me sell my equity stake on the secondary market or offer me a non-recourse loan to exercise when I get in this situation down the road.
This method is rarely available. Why? A lot of reasons. Here’s a few:
Investor interest is limited to a few choice companies.
Information asymmetry.
Company transfer restrictions (which also apply to loans in most cases).
For those who are able to access these sources of pre-IPO liquidity, in spite of these and other challenges, they only operate as a “service” for those who have time and other good choices on their side. Those who are caught without time and other good choices will see offers of deal terms that are obviously made with that vulnerability in mind. Calling this market an option exercise strategy would be like calling a payday loan a monthly budget.
Happy strategizing!
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.