Beware of Promises

by Foley & Lardner LLP
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In the early stages of a new venture, things move quickly. An entrepreneur will talk with many different potential team members, some of whom aren’t a good fit, some of whom become co-founders and valued long-term partners, and some of whom may seem like a good fit but ultimately don’t come aboard or add value. These early conversations often include a discussion of equity allocation. While an entrepreneur may think that a casual chat or email exchange regarding equity in a to-be-formed entity (contingent on performance or otherwise) may be nothing more than that, the other party to the conversation may think otherwise.

If everything works out well and the team member comes aboard and produces, there is no problem (especially if the equity is subject to vesting once actually granted). However, if the team member ultimately doesn’t join the venture, leaves in the short-term (especially before an entity is formed), or doesn’t produce what the entrepreneur expects, these early conversations about equity could result in a serious problem for the entrepreneur and, ultimately, the venture.

Offers for equity don’t need to come with formal agreements or even be in writing to be legally binding, so a possible team member who is offered equity in a company may have a claim to that equity even if the team member doesn’t come aboard, deliver, or work out. Further, even if there is no “offer” of equity or “acceptance” of that offer in strictly legal terms, any communication that even implies that an offer was made could be sufficient to allow the failed team member be a thorn in the entrepreneur’s side, an impediment to getting the venture funded, or a major problem on the eve of a liquidity event.

Accordingly, entrepreneurs should beware of promises for equity or any communication that might even be remotely construed to imply a promise to grant equity. When it comes time to discuss allocation of equity, the entity should be formed, the equity should be granted promptly, and appropriate vesting terms should be put in place.

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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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