Changes and trends in private company equity incentive plan terms over time

A client who remembered equity plans from Silicon Valley in years past asked about what has changed in private company equity plans over time. This can be a big topic, with some changes driven by securities compliance considerations, some by accounting (for those of us who remember when options were “free” of compensation expense in the days before SFAS 123R now ASC 718), and some by tax rule changes (what did any of us do before Code Section 409A?).

A few of the high, or low, points we discussed for private company equity compensation plans:

• The days of technology company equity incentive plans having automatic single trigger acceleration on a change of control are now behind us. While this term is still seen, in most cases it is viewed as providing for a potential windfall and any acceleration that might apply where awards are not assumed in a change of control is usually discretionary.
• All awards, vested and unvested, are now typically forfeited for a cause termination. In some cases, there are terms attempting a claw back of equity benefits, but these can get complicated under state wage and hour laws very quickly.
• For those working with private equity backed companies, vesting is now commonly divided between time-based and performance based metrics (measurements of investment return).
• While it is still a divided practice, it is common for a company to have a right of repurchase for shares obtained by exercise of options, vesting of restricted stock awards, or settlement of RSUs on termination of employment for any reason. In many cases, the repurchase price will be effectively a forfeiture for a cause termination or restricted covenant violation, but fair market value is typical for terminations without cause or voluntary resignation.
• Drag-alongs, requirements to sign stockholder’s agreements, and sometimes voting agreements are now common.
• Stock pyramiding, net exercises, company loans to pay the exercise price, and early exercise are minority practices.
• Many private companies start out with options and restricted stock awards at their early stages, but they can quickly progress to using more complex incentive awards like restricted stock units (“RSUs”) often with complex vesting schedules (“double vested RSUs”). These more complicated awards can be appropriate tools for certain incentive goals, but they are harder to administer correctly and require more attention to payroll tax considerations (due at vesting, not settlement of an RSU) and Code Section 409A compliance.
• Companies are generally more able to allow founders and key service providers to sell some of their shares when the company value is going up to investors or back to the company in connection with financing rounds. This used to be quite rare.

In general, the good old days where equity incentives were low cost to the company and on favorable terms for the service providers have been restrained by the current business practices and more complicated compliance rules, but equity incentives still remain the best chance many service providers have of a home run with a successful company.