UK Life Sciences and Healthcare Newsletter - May 2021: Equity Incentives: Single and Double Trigger Vesting

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Share options or other equity incentives (such as growth shares) are an effective way to align the interests of investors with those individuals managing the company on a day-to-day basis. As a result, they are a common feature in venture capital-backed companies in the life sciences and health care sectors in the UK and equity participation in such a company can be an important component of an individual’s compensation. Indeed, especially at more senior levels, it can be the single most valuable element of a compensation package.

When equity incentives are awarded to an individual by a company, the terms governing the grant of those equity incentives will often provide that these incentives will ‘vest’ according to defined criteria. Grant documents will typically provide that the incentives will vest over time, for example. This means that the individual’s entitlement to the economic benefit of the incentives will accrue gradually over a period of time (usually on a monthly or annual basis over three to five years, the ‘vesting period’). Usually, if the individual leaves the company during the vesting period, i.e. before all the incentives have vested, then (depending on the reason for the departure) they will likely lose the benefit of (at least) the unvested portion of the incentives.

The phrases “single trigger vesting” and “double trigger vesting” refer to two scenarios in which vesting will be accelerated due to events affecting the company and/or the individual. The result of this acceleration is that some or all of the incentives will immediately be treated as fully vested, such that the individual will receive the full economic benefit, whether or not the original vesting period schedule has elapsed.

Single Trigger Vesting

‘Single trigger vesting’ refers to a vesting acceleration on the occurrence of a single event. Usually that event is the sale of the company, or a transaction that realises the value of most of the company’s assets.

Single trigger vesting acceleration is rare in the UK venture capital market. Although clearly an attractive proposition for the individual (usually founders or key management), who might argue that they should be incentivised to achieve an exit (especially ‘ahead of schedule’), single trigger vesting is generally regarded as an unattractive proposition for the investor. This is largely due to the perceived challenges of retaining and motivating key individuals who have received significant financial proceeds as a result of a transaction. A buyer may well query the possibility of, and the additional expense required to motivate and retain these individuals following the deal, which will make the company less attractive as a target. This is especially true where particular individuals are crucial to a company’s future performance, and where the equity incentive stakes triggered on an exit are very significant, and so the package required to motivate the individual in question is commensurately more expensive for a buyer.

Double Trigger Vesting

Vesting acceleration on a double trigger basis requires two events to both occur. Usually those events are: (1) a sale of the type described above; and (2) the termination of the individual’s employment with the company, without “cause” (which can be negotiated, but typically implies a bad act on the part of the relevant individual). On an exit that occurs part way through a vesting period and where double trigger vesting applies, the individual commonly will receive the benefit of any vested incentives, but unvested incentives will not accelerate and will continue to vest according to the original vesting period schedule, unless the second trigger occurs, causing acceleration.

Accelerated vesting on a double trigger basis is more common than single trigger vesting in the UK venture capital market, as it strikes a compromise between rewarding the individual for a successful exit, while continuing to incentivise their performance in the period following the transaction. This is also more palatable to a potential buyer than single trigger vesting, on the basis that it makes it more straightforward for the acquirer of the target to retain and motivate key individuals.

From the individual’s perspective, double trigger vesting can often represent a fair result: not only does the opportunity to earn further equity incentives by service continue, but should the second trigger occur (dismissal without cause), then acceleration occurs and the opportunity for further vesting is not lost. This can be particularly important in the context of an individual who might expect to be dismissed following a transaction as part of the company’s integration into the buyer’s group.

From a founder or employee’s perspective, it will be important to understand exactly how the second trigger of dismissal without cause is defined to ensure that it operates as intended and is not able to be circumvented. Ensuring that the incentive scheme will continue following the transaction is also important – it is often the case that schemes may be wound up on a transaction, in which case the individual will lose their incentives, no matter how the second trigger is defined.

In each case, the structure (from both a legal and tax perspective) of equity incentive schemes are nuanced, and not “one size fits all.”

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