Negotiating Restricted Stock Agreements - Preparing for Series A
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Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice. |
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Whenever drafting, modifying, or reviewing a founder stock purchase agreement with vesting schedule (also referred to as a restricted stock purchase agreement or stock restriction agreement) I typically aim to procure a document that will be agreeable to venture capital firms upon Series A. The reason is because a term in the Series A term sheet will condition the deal upon the investor's approval of a stock restriction agreement. If the founders do not have restricted stock agreements, the investors will require that they be executed as part of the transaction. If they are in place, the investors will determine whether they are satisfactory as is, or whether they would like to modify the agreements or execute new ones.
In reviewing stock restriction agreements for approval, the VC will be concerned with founder walkaway and terms that make exit more difficult (by making the company less appealing to acquirers or underwriters). Future VC rounds are important to firms, too, but are relatively un-impacted by terms of a stock restriction agreement. If terms are “standard” and not too much stock has vested, then the VC may approve the document as is. If, on the other hand, founders have passed the one year cliff and/or some of the other terms are concerning, the VC will likely demand new stock restriction agreements.
It works to the founders' benefit to have a stock restriction agreement survive Series A, since a few months will have elapsed from the vesting commencement date. Furthermore, in order to change the terms of the agreement, each of the founders must rescind the original agreement and enter into new ones, which could feasibly cause problems.
"Standard” terms are one way to ensure that VC’s will be okay with the agreements. However, individual founders, especially when represented by counsel in the formation transaction, often request revisions to such terms. Whether the reader of this article is an individual founder representing their individual interests or an officer or director representing the company's interests, understanding the VC's concerns may lead to more productive negotiations.
Walk Away - The primary purpose of vesting stock is to prevent a stockholder from walking away from a venture. The four year schedule with one year cliff is the conventional standard, based on the premise that a tech startup is generally in the formative stage for the first year and the value of the company is based on the founders' contributions during that stage. Thereafter, the company grows in value incrementally based on the continued contributions of the founders. Among founders, stock which vests on other time schedules or upon performance metrics is more commonly issued. These creative stock grants are less likely to be approved by VC's. However, if the vesting is such that it unquestionably protects against walk away and incents founder contributions, founders will have a strong argument for its implementation.
Acquisition - Acquirer Appeal - Acceleration Provisions - In some acquisitions, the acquirer may not be interested in keeping the company intact, and thus may not care about the founders' continued involvement. However, if part of the appeal to the acquirer is the founders' involvement, they will want the stock restriction agreement to continue to bind the founders to the existing company, the acquiring company, or a newly merged entity. As such, standard language provides that stock issued pursuant to such a transaction is subject to the same vesting restrictions.
If the stock restriction agreement does not already provide one, Individual founders often desire a "double-trigger" acceleration provision. This provision accelerates the vesting of all or some of the unvested stock upon: (1) a change of control, the definition of which includes acquisitions; and (2) involuntary termination within a specified time frame. This protects founders from being forced out of a company without their full ownership interest because the new management wants to squeeze them out.
Another acceleration provision is referred to as "single-trigger". This provision provides that upon a change of control (by itself), all or some of the unvested stock becomes vested. This provision is troubling to VC's because the provision makes the company less appealing as a target company for an acquisition, because the founders may get a big bump in equity upon acquisition, which could diminish or extinguish their motivation to stay with the company.
IPO - Underwriter Appeal - Market Standoff Provision - All issuances of stock by a startup should be issued with a market standoff provision (also referred to as lockup). Standoff provisions may be in the stock restriction agreement or some other document, such as a founders agreement. Such a provision will prevent holders from selling stock upon a public offering and for some period thereafter, usually 180 days. Underwriters want the security of pricing the offering knowing the amount of stock going to market. If a holder of stock unloads a big chunk, the supply is larger than the underwriters account for and can depress the value. The standoff provision allows some time for the price to stabilize before introducing new stock to the market.