You’ve Got VC Money: Equity Compensation Best Practices

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You’ve Got VC Money: Equity Compensation Best Practices

Adopt an Equity Incentive Plan

Now is the time to adopt an equity incentive plan if you don’t already have one. Your investors likely made it a condition of financing to adopt a plan with a certain size of share reserve and certain forms of award agreements. A typical available share reserve is 10–15% of the total outstanding stock of the company. The board and the stockholders will need to approve the plan.

Providing employees and other service providers with equity is a common way for a startup to incentivize its talent and align its interests with company stockholders. Just as with the issuance of any securities to investors, the board must approve the issuance of any equity grants. There are several different types of employee equity used by U.S. C corporations: stock options, restricted stock awards, stock bonus awards, and restricted stock units (RSUs).

Read more on equity awards in our “The Human Capitalist” series.

Note: You Can’t Pay Employees Solely With Equity

Under state and federal wage-and-hour laws, employers generally must pay base salaries in cash and comply with all minimum wage-and-hour, withholding, and other applicable laws regarding employees.

Benchmark Your Equity Grants

There are no one-size-fits-all rules for deciding how much equity to issue to your employees and service providers. This will depend on each person’s seniority, experience, role in the company, and negotiating position. It also depends on investors’ appetite for equity compensation.

BEWARE: We generally do NOT recommend using a dollar-value equivalent of equity awards because doing so requires you to make many (often wrong) assumptions and representations about the current and future value of the company.

The only tried-and-true method of determining equity compensation is by benchmarking the employee/contractor against similarly situated individuals in the market. There are several tools that can do this. We’d be happy to help you and your board make this market determination.

Establish a Standard Protocol for Granting Equity Awards

When the company wants to issue stock options, restricted stock, or other equity to its employees or other service providers, the board must approve the grants in each case. This is often done at a regularly scheduled board meeting, but may also be done by unanimous written consent.

It is important that you notify your Perkins Coie team of the proposed grants with enough time before the approval is sent to the board (or the board meeting). The information your legal team needs beforehand is the same whether this is done at a board meeting or by unanimous written consent of the board, but the timeline may differ.

Here’s what you (and your Perkins Coie team) need to do when granting employee equity:

  • About a week before the board meeting. The company management will provide Perkins Coie’s legal team with a list of proposed option/equity grants and employee/consultant terminations since the last board meeting. This will allow us to both prepare the board resolutions and ensure the cap table has been updated to properly reflect the terminations. Please allow us ample time to ask follow-up or clarifying questions. The most common cause of an equity grant hiccup is clients’ providing incomplete approval lists the night before a board meeting.
  • Use the template charts below. To make things easy, please provide the information for the equity grants and terminations in the applicable charts below.
  • One or two days before the board meeting. Your Perkins Coie legal team will send management a package containing the proposed resolutions (approving the grants), along with anything else to be approved. This should be distributed to the board in advance of the meeting (at least the night before). This will give the board time to review.
  • At the board meeting. The board must approve the proposed resolutions. The board may want to see a slide that shows who is getting how many options and if anyone is on an unusual vesting schedule.
  • Act within a week after the board meeting. The Perkins Coie legal team will send management all the option grants and will earmark the approved options in the cap table. While specific protocols vary, typically the CEO (or other executive/equity administrator) will approve and/or apply signatures to documents or via Carta or Shareworks.
  • Once a signed option agreement has been returned/accepted. A Perkins Coie paralegal will save it in the company’s records and update the cap table.
  • Inform accountants. Certain accounting charges need to be recorded when options are issued, so management should make the CFO and accountants aware of the grants.

Use These Template Charts for Equity Grant Information

Here are some template charts containing the information needed by the board and the Perkins Coie legal team regarding your proposed equity grants:

OPTION GRANTS
Optionee Name Role State/Country of Residence Number of Shares Vesting Schedule Vesting Start Date Acceleration upon Change of Control
Please use legal name (no nicknames) as this will be the name in records.
Employee, founder, consultant, advisor, board member, etc. Needed for securities laws compliance purposes. Self-explanatory. Typically four years with one-year cliff for employees. Typically date of hire. Typically none. Sometimes double-trigger for C-level executives and single-trigger for independent board members and advisors.

 

RESTRICTED STOCK GRANTS
Participant Name Role State/Country of Residence Bonus Award or Purchase Award? Number of Shares Vesting Schedule Vesting Start Date Acceleration upon Change of Control
Please use legal name (no nicknames) as this will be the name in records. Employee, founder, consultant, advisor, board member, etc. Needed for securities laws compliance purposes. It’s a bonus award if no purchase price is paid. Otherwise, it’s a purchase award. Self-explanatory. Typically four years with one-year cliff for employees. Typically date of hire. Typically none. Sometimes double-trigger for C-level executives and single-trigger for independent board members and advisors.

 

RESTRICTED STOCK GRANTS
Optionee Name Role Date of Termination Reason for Termination
Please provide exact name from cap table. Employee, founder, consultant, advisor, board member, etc. Last day of providing service. If an employee is transitioning to an advisor/consulting role (or vice versa), please indicate as such. For cause termination, at-will termination, resignation, etc.

 

Establish a Standard Protocol for Employee/Contractor Termination

The termination of an employee or contractor has significant consequences for equity they may hold. Prior to terminating an employee or contractor (or switching an employee to contractor or vice versa), please immediately notify your Perkins Coie legal team of the change in status and the applicable information in the above template “Terminations” chart.

The Perkins Coie legal team will process the termination in the cap table after receiving notification from the company. You may also request an option termination report, which will provide you with the details of the option grant, including the number of vested and unvested shares. While it’s not required, we advise our clients to provide the following to the terminated service provider: (1) the number of vested options, (2) the last date they may exercise their option (usually 90 days from termination), and (3) that the service provider should consult a tax advisor prior to exercising to understand how the exercise would affect their personal tax situation.

Establish a Standard Protocol for Option Exercises

To exercise an option, an optionee must complete the exercise notice provided by Perkins Coie, provide payment to the company (usually by check or wire), and comply with other applicable requirements.

Send your Perkins Coie legal team a copy of the paperwork (including proof of payment) as promptly as possible and no later than 48 hours after receipt so the legal team may update the cap table.

There are also tax and accounting events that the company will need to record (even if an ISO is exercised), so you need to inform the company’s CFO and accountants of the exercise as well.

Note that if the option holder has been terminated, the company must receive both the executed notice and the payment prior to the end of the applicable post-termination exercise period. Late paperwork cannot be accepted.

Don’t Allow Electronic Option Exercises

If the company has elected to allow “in-app” electronic option exercises through Carta, then the exercise process and payment of the exercise price will be handled by the optionee through the platform. The optionee will enter the required exercise information and payment details, and the company will then be asked to approve the exercise before the exercised stock is issued to the optionee.

However, we generally do not recommend allowing electronic option exercises because it limits the company’s control if there are any “black-out dates” when the company should not or cannot accept an option exercise (e.g., shortly before or after a financing or some other material transaction), which can lead to inaccuracies in the cap table and cost time and effort to clean up. This method can also prevent or hinder the company and the Perkins Coie legal team from ensuring the proper paperwork is delivered to and signed by the option holder at the time of exercise.

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