The High-touch Legal Services® Blog • For Startup Companies » Compensation

Accelerated Vesting may Mean Little if Your Employer is Acquired

Dana — Mon, 10 Jan 2011 19:45:37 +0000

This post is adapted from a question that I answered on Quora. Q. How can an acquirer make an employee with single-trigger vesting commit to a “lock-up” period to receive all his shares? Say you’re an engineer at a just-acquired startup with 0.5% of the old company, and your shares fully vested upon acquisition. The acquirer’s terms were that current employees get 50% of their payout up front, and 50% if they stay on board for 5 years. How is that possible, legally?

A. It is difficult to provide a definitive answer without looking at the relevant documents. However, I suspect that this situation is possible because 50/50 pertains to shares in the acquiring company rather than the acquired company.

In my experience, acquired companies will put some effort into converting employee equity interests directly into comparable interests in the acquiring company, but there is no guarantee this will happen.

So you may (I can’t be sure, not having reviewed the documents) have a choice: Keep your 0.5% fully-vested interest in the acquired company (which is likely to have little, if any, market value in the foreseeable future), or accept the 50/50 conversion to an equity interest in the acquiring company.

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Which Financial Information Must a Private Company Provide to Employees with Vested Stock Options?

Dana — Wed, 20 Oct 2010 20:47:33 +0000

This post is based on a Quora question that I answered (Q and A are somewhat edited). Q. Which financial information must a private company provide to employees with vested stock options?

A. In California, Corporations Code Sections 1500 and 1501 specifies records that must be kept by each corporation. Shareholders’ rights to inspect records are set forth in Sections 1600 and 1601.

I know of no comparable statutory provisions with respect to holders of vested options, however. Unless the stock option plan grants you such rights, the easiest way for you to gain such rights would be to exercise your option with respect to one share and, then, exercise your rights as a shareholder.

Watch Out for “You Don’t Own It until You Pay”

Dana — Wed, 28 Apr 2010 20:30:47 +0000

A start-up entrepreneur recently told me about the agreement he signed with the developer of his website. The agreement has what I consider, from the entrepreneur’s perspective, a most pernicious provision: Ownership of the website, and its intellectual property rights, does not pass from the developer to his client until the fee is paid in full.

I understand why developers like this type of provision: It gives them extra leverage to ensure that they are paid.

In my opinion, however, this type of provision is inappropriate, from the perspective of the developer’s client, for several reasons:

If development extends over a long time, the client is deprived of ownership rights throughout that entire period.
Sometimes a client has a legitimate dispute that justifies a reduction in payment – but the provision in question does not allow for this possibility.
There are other, less-disruptive means that can protect the developer, such as the granting of a security interest.

So here is my advice to anyone who receives a website development, or other professional services, agreement with a “you don’t own it until you pay” provision:

Negotiate that provision away, making sure that you own the deliverables, and all intellectual property rights in those deliverables, as soon as they are created.
If the service provider will not agree to this change, find another provider.

Photo credit: Sufi Nawaz via stock.xchng

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Rewarding Key Personnel: Restricted Stock or Options?

Dana — Thu, 14 Jan 2010 22:04:50 +0000

As I write this post, I am in the process of helping an early-stage client develop a stock-based compensation plan for a key officer. The principal choice was between a stock option and restricted stock.

A stock option is the right to purchase a specified number of shares at a specified price at some point in the future. The option typically “vests” over a period of years – the longer the individual stays with the company, the greater the portion of the option s/he has the right to exercise. At the end of the vesting period, the individual has the right to purchase all of the shares specified in the option.

With restricted stock, shares are granted to the individual immediately but are subject to “reverse vesting”: If the individual leaves the company, a specified portion of the stock is forfeited to the company (if the individual paid nothing for the shares) or is subject to repurchase by the company at the price the individual paid. The portion that is subject to forfeiture or repurchase declines to zero over a specified number of years.

Many companies are choosing restricted stock over stock options, and that was the choice my client made. Here’s why:

The company has so few employees that it sees little reason to incur the costs of implementing a tax-qualified stock option plan.
The officer’s input as a shareholder will be valued by the company. (A holder of restricted shares generally is accorded rights of a shareholder, including the right to vote; a holder of a stock option does not have any shareholder rights until the option is exercised, i.e., when the shares are purchased.)
Restricted shares are likely to be perceived as more valuable. If the price of restricted shares decreases over time, the shares still can have some value to the recipient. On the other hand, if the price of the company’s shares decreases below the option holder’s exercise price, the option becomes worthless.

Whatever form of stock-based compensation is selected, both the company and the individual should consult with their tax advisors before the grant takes place.

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Photo credit: Michelle Meiklejohn