Legal Advice on Taking Equity As Compensation When You go to Work for a Company

January 25, 2013

On a business/company start-up email list I subscribe to, someone asked for advice in the  negotiation of taking equity as compensation (either equity alone or equity and salary) when you go to work for a company. Here is one item that is often overlooked: after you get an equity offer from the company, have them put it in writing, and get it reviewed by an attorney. Too often I see poorly worded offer letters that include vague phrases that only lead to confusion or disappointment later.

For example, the offer letter might say that you will get three percent of the company. What does this mean? Three percent as of the date of the offer? when the options vest? before or after that next major round of equity financing? When calculating percentages, the company includes actually issued stock. Does it also include vested stock options? issued but not yet vested stock options? You get the idea.

Make sure your attorney reviews all of the related documents. Even though it may cost you a little more, it will be worth it in the long run. In law the fine details matter. More often than you would think, I find unpleasant legal terms in the related documentation that my client needs to know about. For more discussion on this issue, see my blog article The Lesson from Skype: Don’t Count Your Stock Options Before They Hatch.


Washington Marijuana Startups present interesting legal issues

December 11, 2012

Washington has just passed new legislation that makes possession of small amounts of marijuana legal within the state. The legislation also authorizes the state to develop a system to license businesses to grow and sell marijuana. Many of the new marijuana businesses may be mom and pop operations. But the market potential is huge, estimates vary up to $6 billion per year in Washington alone. That is attracting venture capital and high tech entrepreneurs who intend to apply high tech startup business methods to marijuana sales. See Investors see profit potential in new pot law and Former Microsoft Exec plans high-end marijuana business.

Most of the legal issues for marijuana businesses will not be new. Regulations for marijuana sales will probably be similar to regulation of alcohol sales. Most marijuana business start up legal issues will be similar to the already existing high tech startup legal issues. There will be issues of management, ownership, control and funding. Intellectual property protection will be important, especially branding, which is a form of trademark law.

But there will be new challenges as well. For example, marijuana possession and sale remain illegal under federal law. Contracts to perform illegal acts are generally not enforceable. Would an agreement to run a marijuana business be unenforceable because it is against federal law, even though it is legal under state law? It may turn out that such an agreement is enforceable in Washington state courts, which apply state law, but not in federal courts, which may be included to apply federal law. To be safe, it is probably best to include a clause in any marijuana business contract that states that the contract is governed by Washington state law and that any lawsuit brought to enforce the contract must be brought in a Washington state court. I am sure that other unusual legal issues will arise as well. I will try to write about them as they arise. 

Please join the discussion. What do you think? Given the risks involved, would you invest in a marijuana startup? Would you work for one in return for equity? Does it make sense to apply the high tech startup business model to marijuana sales?

Update January 28, 2013: See also Pot entrepreneurs seek funding from investors.

 


The Lesson from Skype: Don’t Count Your Stock Options Before They Hatch

August 30, 2011

Founders of startups and senior executives who join startups often place too much value on their stock options. Stock options are extremely risky. You may count on your stock options as a possible way to make you rich some day, but you should be very careful if you are counting on them to be part of a reasonable compensation package.

There is the obvious problem that the stock in the company may never be worth anything. But there are many other potential problems with stock options as well. A recent case is illustrative.

It was rumored that one or several senior executives of Skype lost their stock options when Skype agreed to be acquired by Microsoft earlier this summer. As best I can tell many employees of Skype had the right to purchase shares of Skype in accordance with a stock option agreement. That agreement was subject to the terms of the standard company-wide Stock Option Agreement. This is very common. The company-wide stock option plan in turn was subject to the terms of an investor stock plan. There was a provision in the investor stock option plan that allowed the investors to buy back the vested stock options of former employees of Skype at the stock election price. So if you had a vested option to buy 100 shares at $1 each, and the shares were now worth $100 each, the investors could buy back your stock options at $1 per share, wiping out any value you had gained in the stock options. At least one former employee appears to have lost his stock options this way. It is also rumored that a number of senior executive were recently fired and that they too will lose their stock options.

Yee Lee, the individual who appears to have lost his stock options in Skype had written about his experience in a blog. The letter Ricardo Velez, Skype’s associate general counsel, sent him is available here, and his stock option agreement is available here.

(Mr. Lee might still have legal recourse. It is possible that Mr. Lee could argue that the contract terms that forfeited his stock options were unconscionable, or that he had an implied contract right to the options that superseded. I am interested to see if he fights for his options.)

I have read blog comments that this situation is unusual. I do not agree. I have reviewed many stock option plans for clients. The company-wide Stock Option Plan is often subject to the terms of one or more other documents. I always ask the clients to get me a copy of those documents so that I can review them. Sometimes the client thinks I am just trying to run up my fee. But as the Skype case demonstrates, it is important to follow up on the details. In my experience it is rather common that the Stock Option Plan or the additional documents contain one or more legal conditions that could potentially make the client’s stock options worthless. It has also been my experience that the company is not gong to make any changes in these documents for just one person. It is a take it or leave it offer. My standard advice to clients is to insist on enough salary or outright stock grants to make the job worth taking, and consider the stock options as a potential bonus that may or may not come to be. Or accept the risk that you are taking a large risk and that the risk factors are mostly beyond your control.

Do not rely on the fact that you are friends with the people in charge of the company. They may be your friends now. But when there is a large amount of money at stake, friendships tend to fade fast.

If you think the company has value, you should try to stay with the company until you can cash out. As one Skype representative has been quoted as saying in response to the Skype situation,

“You’ve got to be in it to win it. The company chose to include that clause in the contract in order to retain the best and the brightest people to build great products. This individual chose to leave; therefore he doesn’t get that benefit.”

Of course every situation is different. There is less risk if you are receiving stock options in a public company with a large number of shareholders, positive financial track record, and is not likely to undergo a major change in order to raise capital. There is more risk in a start up that has yet to make a profit, and has no market for its shares, and is likely to restructure itself through a merger or sale, or other stock manipulation, in order to raise capital.

Stock options are still a great way to get rich. But they also remain a very risky way to do so. If you go the stock option way, be aware of the high degree of risk involved.