Nivi · April 27th, 2007
Our previous vesting hacks have discussed getting vested for time served, acceleration upon termination, and acceleration upon a sale. This article is a collection of four vesting microhacks you can use to supersize your vesting.
1. Reclaim a terminated co-founder’s unvested shares.
A terminated co-founder’s unvested shares are typically cancelled. The resulting reverse dilution benefits the founders, employees, and investors ratably.
Instead of canceling the shares, divide them among the remaining co-founders and employees ratably. You should argue that,
“Cancelling a terminated co-founders shares puts a lot of pre-money into the investor’s pocket. Those shares should be distributed among the founders and employees who created that pre-money valuation.”
This argument will carry more water if you offer to put a portion of the reclaimed shares into the option pool to hire a replacement for the co-founder.
Reclaiming a terminated co-founder’s shares does not create an incentive for co-founders to terminate each other. Co-founders have an incentive to terminate each other even if the shares are cancelled. In our experience, this incentive is never a factor. Founders are almost always allowed to vest in peace unless they are incompetent, actively harmful, or clash with a new CEO.
2. Run screaming from the right to purchase vested stock.
Some option plans provide the company the right to repurchase your vested stock upon your departure. The purchase price is ‘fair market value’. Guess whether the definition of fair market value is favorable to you or the company…
Founders and employees should not agree to this provision under any circumstances. Read your option plan carefully.
(Props to Suzie Dingwall Williams who already brought up this microhack in the comments.)
3. Accelerate your vesting upon hiring a new CEO.
If you are having trouble applying any of the other vesting hacks, trade those chips in for six months of acceleration upon hiring a new CEO. Investors are usually eager to bring in “professional” management. They should agree to this term because it aligns your interests with theirs.
4. Keep vesting as a consultant or board member.
If you have a lot of leverage, you may be able to negotiate an agreement to keep vesting if you are terminated but retained as a consultant or a board member. For example, the company may terminate you but keep you as a consultant to help decipher your spaghetti code.
Some companies have been known to sneak this term into their closing documents. We’re not big fans of that approach.
Again, if you are having trouble applying any of the other vesting hacks, you may be able to trade those chips in for this one.
What are your vesting micro-hacks?
Submit your vesting micro-hack experiences and questions in the comments. We’ll discuss the most interesting ones in a future article.
Negotiation microhack on vesting.
When the company is newly incorporated and founders shares are being issued (well before the VC Series A financing), consider hard-wiring some of the suggestions (vesting for time served, various acceleration provisions, etc.) into the Founders Restricted Stock Purchase Agreements.
Obviously, all of the provisions of the Founders Restricted Stock Purchase Agreements can (and will be) superceded by the Series A documents, but there’s a possibility that if you lead with something that is not outrageous in terms of vesting and acceleration, it might survive the Series A financing.
One ploy involves a response to the VCs along the lines of “Well – those vesting (and lack of acceleration) provisions are different from what the [fill in number greater than two] founders originally agreed upon. It took us several screaming matches to agree on upon these terms when we issued founders stock and there was a certain level of distrust during these arguments. I don’t know if I have the stomach to go back to [fill in name of potentially unstable founder least savvy about VC terms] to explain why we want to change what we agreed upon. He doesn’t really want to take your money in the first place, and it’ll push him over the edge. He/she’ll think that I’m trying to screw him/her over and may blow up the deal.”
Typical legal disclaimers apply to this comment.
One other thought on vesting microhacks.
Microhacks 1 (reclaim a terminated co-founder’s unvested shares), 2 (run screaming from the right to purchase vested stock) and 4 (keep vesting as a consultant or board member) all seem like fairly reasonable arguments/requests that I’ve seen granted by investors (or at least seriously considered).
Microhack 3 (accelerate your vesting on hiring upon hiring a new CEO) is something that I don’t think I’ve never seen argued for or granted. (Of course, this could mean that my memory is poor or I just haven’t run into it.) I see the argument as a logical extension of accelerated vesting for a resignation for “good reason.” If an investor agrees that vesting should be accelerated for a resignation for “good reason,” which might include a decrease in responsibilities/title, then perhaps a founder/CEO should argue that he/she shouldn’t have to quit in order get the vesting acceleration. Of course, a savvy investor that knows that the CEO needs to be replaced/upgraded would never agree to this type of “good reason” trigger.
Therefore, my point is to make sure that entrepreneurs understand which microhacks are within one or two standard deviations of normal and which microhacks will make an investor scratch their head and say, “well, that’s something I’ve never heard of. These people are crazy and pain to negotiate with.”
I’d be curious if anyone has actually received accelerated vesting upon hiring a new CEO. I think some anecdotal discussion in the comments would be helpful in gauging investor reactions to use of the hacks in real negotiations.
Yokum,
Agreed—at some point we will have to prioritize all of the hacks. You can’t win all them all.
I have seen accelerated vesting upon hiring a CEO. The investor actually suggested it because the entrepreneur was asking for over 1 year of vesting for time served. The entrepreneur conceded a little bit of his vesting for time served and got the accelerated vesting upon hiring a CEO instead.
This particular investor is very good at these types of creative solutions.
I like the notion of founder/employee shares get redistributed to other employees upon the exit of that person.
However, I’m wondering if this is really practical. Let’s say you have Founder A and Founder B. Each hold 50% of the company upon founding, with the shares worth $.01 each. This equals 4m shares per founder.
At a Series A event the founders each own 25% of the company, and the fair market value is now $.50 a share. Let’s say Founder B goes to grad school after a year and after the Series A, and his remaining 3m shares are handed over to Founder A. Since those 3m shares are worth $1.5m, Founder A is going to find himself with a rather large tax bill on that $1.5m in ‘income.”
So while I like the sound of this hack, I’m concerned that the tax implications make it unusuable.
Has anyone used this hack? Anyone an expert in tax law?
Alex
PS – Keep up the good work. Love this site.
Alex,
The typical default provision in a founder Restricted Stock Purchase Agreement is that the company gets to repurchase unvested stock at the lesser of fair market value or original purchase price. The company typically may assign this right to third parties.
If the company “passes” on the repurchase and allows Founder A to purchase unvested shares from Founder B, then there will be tax implications the the parties(potential gift or gain depending on the purchase price and FMV). As a practical matter, it may be easier to get the investors to agree that the option pool should be increased by the number of shares repurchased by the company. The company could then grant an option to Founder A at the current FMV of the common stock. It’s not the same as getting the stock for free (or nearly free), but is better than nothing.
Please chat with tax advisors/lawyers because there are nuances in every situation; typical disclaimers apply.
Thanks Yokum,
What you described was how I envisioned it would work.
Alex