Protecting Your Founder Equity

by Cooley LLP
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You and your co-founders are getting your company off the ground. Everyone is excited and in perfect alignment. You have many people to be appreciative of as you launch your venture.

Even though you may have the urge to share the potential success with everyone that has helped you along the way and to tell them all about it, there is a right way to do this with both co-founders and non-founders to avoid situations where there is confusion about the ownership of your company. Confusion about your ownership structure, or a poorly planned structure, can create unnecessary administrative hassle and legal expense, and in certain situations can ward off investors. Here are some matters to consider as you establish the ownership structure (capitalization) of your company:

Talk with your attorney

  • After a discussion with your attorney about typical ownership structure, you will be prepared to sit down with your co-founders and set up the allocation of common stock among the founders and design an option pool as appropriate. Consider having all of the founders talk with the attorney together, so that everyone is on equal footing in terms of the information they’ve received.

Think about vesting of founder stock

  • Seriously consider setting up a vesting schedule for all founders.
    • If a co-founder leaves the Company for any reason, and this happens frequently, and there is no contractual vesting put in place, that founder can take with her substantial ownership of the Company. However if they are subject to vesting, they would likely depart with a smaller piece of the company that more accurately reflects their contribution to the Company’s long term success. For example, after a year, the departing founder might have the right to depart with 25% of their stock instead of 100%.
    • Most investors are going to want to see vesting anyways, so it can be very helpful to address these matters early on and put in place an agreeable vesting arrangement that passes muster with your investors.
    • Use Acceleration to address areas of sensitivity among the founder group. Is someone concerned about getting kicked out by the other founders? Allow for some acceleration of vesting in the event of a no “cause” termination. Is someone worried about getting acquired and being “forced” to work for the acquirer to continue vesting? Consider accelerating vesting in the event of an acquisition.

There are various nuances related to vesting and acceleration to discuss with your counsel.

Keep it clean: use the right agreements

  • Properly document the ownership structure (via purchase agreements prepared by counsel) early on, both for clarity and for tax reasons.   You can generate your own stock purchase agreement in our Cooley GO Docs Incorporation Package that handle these matters . When completed, you have a clean and established ownership structure and capitalization table that you and potential investors can reference.

Be careful how you discuss equity

  • Be very thoughtful and careful about promising equity to anyone.
  • For example, if you are considering hiring an employee, or engaging a consultant or advisor, discuss potential option or stock grants in a very “prospective” manner. Use phrases like “if we engage/hire you, then upon approval by our Board, we would grant you an option to acquire 25,000 shares as part of your package.” Your attorney can provide you guidance on industry-standard amounts for options based on role and experience of the employee, consultant or advisor.
  • Before providing an email or document to an employee, consultant or advisor that describes their equity interest in the Company, briefly run the language by your counsel or make sure you really understand how this works. A little time up front can save a lot of time and expense later.

Know how the option grant process works

Make sure you understand the sequence and process for granting options:

  1. Execute an offer letter or consulting agreement,
  2. Obtain formal approval by the Board of Directors by a written consent or at a meeting after the employee or consultant starts providing services (Your attorney can prepare the minutes of the meeting), and
  3. Generate the actual option grant paperwork.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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