Being Equitable with Employee Equity

I continue to be troubled about (a) the Skype vested equity snafu and (b) Twitter CEO Dick Costolo's comments about how employee stock sales on secondary markets have to be reined in.

Reading-mangaThe Skype stories suggest that the company played fast and loose with the term "vested." As it turned out, even "vested" shares were subject to repurchase by the company at the employee's cost, if an employee quit before 2014. In hindsight, Skype might have played more fairly if it had avoided the term "vested" until the shares had cleared the final hurdle. And yet, reading the relevant Skype documents, it does appear that the terms were disclosed in advance (assuming the documents were available to employees).

And here's both the question to, and the answer given by, the Twitter CEO, pertinent to what I want to revisit today:

MIGUEL HELF: "As the CEO of a very fast growing company that's hiring a lot of people, trying to retain a lot of people in a very competitive market, how do you see the secondary markets, the trading in private shares that your employees can engage in? Is it helpful, is it a distraction? How do you communicate to employees about it, and do you have any specific policies?"

DICK COSTOLO: "It's a distraction. I mean, the simple answer is it's a distraction. I think that we and Zynga and Facebook have had to retroactively put lots of policies in place to sort of constrain that. One of the concerns is because that's sort of a brave new world, you worry about people who might be buying through those second markets, whether they're accredited investors, what they've been told by the person who might be trying to sell them the stock, and who's going to get in trouble at the end of the day if it doesn't all work out with them. So, they're definitely a distraction, and I think that going forward private companies and their investors will do things in advance of forming the company that restrict those transactions."

What will those restrictions look like? Will they apply to founder, angel and VC equity as well? In addition to the option plan documents, essential reading now may include other corporate documents and policies that could impact the value and marketability of vested equity.

Employees and prospective employees might do well to take a crash course on employee equity and industry practices before signing up in reliance on option grants.

I might like to give such a course, or write a manual for one.

The manual I would write would have two covers. The front would read, "The Top X Things You as an Employee Should Look for in Your Company's Stock Awards." The back cover would read, "How to Keep Faith with Your Employees by Letting Them See the Company's Capitalization as You See It." You could read the book starting from the front cover, or, alternatively, Japanese style from the back, but either way you'd end up in the same middle: tools with which to uncover a sober understanding of the ground rules of the particular employee option plan hammered out between the founders, C-level management and investors of your emerging company.

I'm not talking about taking the risk out of accepting options as a material part of compensation. Whether a company is going to succeed or fail is something I'll assume an adult can guess for herself.

I'm talking instead about failing to understand how the equity plan is structured, and how awards under a given plan relate to a company's charter and other corporate documents. These documents are all written and are all available for inspection - or should be.

I'll need to work on how to organize the manual and prioritize the concerns, but here in random order is a beginning checklist:

  1. What is the liquidation preference overhang on the common stock?
  2. Is there a management incentive or retention plan for C-level execs that operates (at least from the perspective of common stock) as senior equity?
  3. How was the exercise price determined?
  4. What is the vesting schedule and how does it work?
  5. Under what circumstances might the purchase shares be repurchased?
  6. If there are repurchase rights, how is the repurchase price determined? Does it depend on the circumstances of one's departure from the company?
  7. What contractual restrictions are there on the private resale of my shares, over and above the restrictions imposed by securities laws?
  8. Do the restrictions in the trading of my shares apply equally to founders? To angels? To VCs?

More to come, I think. This is about understanding the features and restrictions of securities the way a sophisticated investor might.

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