In recent years, executives are increasingly being compensated through equity awards. As a general matter, equity awards most often take the form of stock options or Restricted Stock Units (RSUs), which provide additional compensation beyond an employee’s salary and benefits. These types of equity awards (often offered through Long-Term Incentive Plans, or LTIPs) are prevalent in all businesses, but are especially common among start-up companies, which aim to keep costs down as the business grows.
Employees who are offered equity typically understand that this form of compensation is inherently risky given the uncertainty of a business’s success or failure. However, the nuances of equity awards are often buried in legalese and boilerplate language, which is sometimes seemingly indecipherable for individuals not used to reading these type of documents.
At Schaefer Halleen LLC, our attorneys have extensive experience in negotiating and interpreting equity awards, as well as litigating disputes regarding equity awards when they arise. These disputes could not have higher stakes, as a turn of phrase or a single word can sometimes result in a client receiving nothing—or thousands if not millions of dollars in equity.
When considering an equity award as part of your compensation, would-be employees should be as informed as possible regarding all the details regarding their equity in a company, including reviewing plan documents if the employer is willing to provide them. When reviewing the documents, employees should pay special attention to the following key areas: (1) vesting; (2) the impact of leaving the company; (3) potential dilution of equity; and (4) liquidity events.
Typically, when employees are issued equity awards, most if not all of the equity is considered to be unvested. Portions of the equity become vested either based on the performance of the employee and the company as a whole after a given period (performance vesting) or based on the employee’s tenure with the company (time vesting). With time vesting, equity sometimes vests on a monthly or quarterly basis, while equity in other plans vests on a yearly basis. This is important to know, because in nearly all plans, your equity only vests if you are with the company on the vesting date. When vesting is less frequent, employees sometimes find themselves surprisingly terminated right before a vesting date (costing them upwards of a year’s worth of anticipated equity). And unfortunately, with some exceptions, these employees have little legal recourse.
Leaving the Company
Another important consideration is the characterization of your equity when you leave the company. In most circumstances, you retain your vested equity when you leave, but you lose out on all your unvested equity. Sometimes, however, an employee may even lose out on vested equity when they leave the company. One way this happens is if an employee is terminated by the employer for “Cause,” which should be defined in plan documents. In this scenario, years-worth of work (resulting in vested equity) can suddenly vanish based on an employer’s subjective characterization of an employee’s termination. In other situations, an employee’s right to purchase vested stock options may end immediately when terminated for Cause. If the employee had not been terminated for Cause, he or she would often have a limited period (typically 30 to 90 days) to exercise the stock options.
For these reasons, employees should become familiar with how the plan documents define “Cause.” In the unfortunate scenario where an employee believes he or she may soon be terminated for Cause, it is prudent to assess, in consultation with an attorney, whether voluntarily resigning might have the benefit of preserving your equity. And if you find yourself in a situation where you lost your equity based on a Cause termination, give one of our attorneys a call immediately.
Dilution of Equity
Employees should also be mindful about the potential for dilution of their equity. If a company retains the same valuation but issues an increased amount of shares, the value of each individual share goes down. But the potential for dilution often depends on the plan document itself. In some plans, there is a limited universe of potential stock that can be issued, and additional issuances must be approved by the company’s board of directors. In these types of situations, employees can more easily value their equity and plan for their financial well-being. In other situations, company management might have more unfettered discretion in issuing equity (often to new employees), which exposes existing equity holders to dilution risk.
Finally, employees should look into when and how they may eventually realize the value of their equity. RSUs in privately held companies, for example, have an illiquid market, and employees who hold these RSUs often do not get paid out until there is a “liquidity event.” Liquidity events are typically Initial Public Offerings (IPOs) or a sale of the company. Often times, there may even be an “expiration date,” in which case the RSUs may essentially be worthless if there is no liquidity event by a certain date. The plan documents should define these terms, and employees should be familiar with the criteria necessary for there to be a liquidity event, which will ultimately allow employees to receive actual money for their equity.
If you have any questions about negotiating an equity award agreement, interpreting your rights, or litigating a dispute regarding your equity, please contact Schaefer Halleen’s experienced employment attorneys. We have the experience to navigate you through this complicated process.