Startup specialist firm Beauchamps Solicitors join us to answer startup legal queries.
This month’s legal query comes from Dublin TravelTech contenders Indigo:
How does giving a vested equity stake to a top new hire work, and what is the norm?
NB: This article is intended to outline what ‘vesting’ means in the context of employee share ownership, as it relates to key employees & founder shareholders.
Stock, or share, options are a common way to bind founder shareholders to the company after a VC or other third party investment, and are also a common employment benefit (and retention tool) for key employees. Whilst there are several different forms of employee share ownership schemes, the most popular is the employee share option scheme (ESOS).
An ESOS involves the creation of options granted to employees, giving them the right to acquire shares in the employer or in a related company at a later date. The price of the shares is usually market value at the time of the grant of the option, so that when the option is exercised, the key employee will benefit from the growth in value of those shares between the grant of the option and the exercise of the option. The specific terms of the scheme and the type of scheme to be used are a matter for negotiation between the founder or key employee and the company and /or investor.
The period between the grant of the option and the time when the founder/employee may exercise it (i.e. request the transfer of shares to him or her), is known as a vesting period. A one year vesting period is common. Alternatively, options can be subject to a ‘vesting schedule’, such that the option holder will become entitled to exercise the options gradually over a period of time, e.g. quarterly over four years. Usually, the option holder will have to remain an employee in order to exercise the options and if he or she leaves employment before exercising the option, the rules of the ESOS may provide that the option lapses entirely or that the option holder may retain the vested portion of his or her option.
The rules of the ESOS may also provide that, in addition to the vesting schedule, the founder/key employee cannot claim ownership of the options, and the options may not be exercised, until certain events (or ‘targets’) have taken place. Even if the options are exercised and the founder/key employee now owns the shares, restrictions may be placed on the sale of those shares until the target has been achieved. Examples of targets are the achievement of certain sales figures, the occurrence of a trade sale or IPO, or more personalised goals.
The term ‘vested’ relates to options which the option holder may exercise and “unvested” refers to options which are not yet exercisable because the targets or time periods have not been met. These terms may also be applied to shares where the founder/key employee owns shares in the company which have restrictions on them (eg restrictions on transfer or dividend). The restrictions may be released gradually over time or on the occurrence of a target event, or a mixture of both. The purpose of these restrictions is to retain the founder/key employee in the company. As a rule, options are only exercised immediately prior to an IPO or a sale of the company, which allows the option holder to fund the price of exercising the option from the anticipated proceeds of the sale of the shares.
There are also various other types of employee share ownership schemes, including growth or flowering share schemes. As with all benefits given to employees, share schemes have tax implications and both tax and legal advice should be obtained before implementing a scheme.
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NB: While all reasonable care has been taken in the preparation and completion of this article, no responsibility is accepted for any errors or omissions. This article has been prepared for information purposes only and does not constitute legal or other advice.