By Glen Caplan, Hutchison Law Group

RESEARCH TRIANGLE, NC – When it comes to startups, one type of equity does not fit all. Below, I’ve outlined several common equities that startup companies issue based on an individual’s role within the company.

Founders

Often referred to as “Founders’ Stock”, founders typically purchase shares of the company’s Common Stock at the time of inception via a combination of cash (to help capitalize the company and to cover startup costs such as legal, accounting, and other initial operating expenses) and by contributing intellectual property to the company (such as the business plan, software code, trade secrets and other inventions relating to the business).

What makes Founders’ Stock unique, is that although the founder owns the shares, can vote the shares and can receive all economic benefit from the shares, the shares are typically subject to reverse vesting – meaning the company has a contractual right to repurchase all or a portion of the shares in the event the founder ceases to provide service to the company.

The schedule by which the company’s right to repurchase the shares lapses will vary from company to company, however, a typical vesting schedule is 25% of the shares are released from the company’s right of repurchase after one year, and the remaining shares are released in equal installments over the course of the next 36 months.

This repurchase right serves several important functions:

• It is a good mechanism to deal with the free rider problem that can arise when you have multiple founders. A founder who leaves the company after just a few months probably should not have the same equity interest as a founder who continues to provide service to the company for many years – you will often hear investors refer to the working founder’s equity as “sweat equity”.
• It gives a team some period of time to attempt to work together and determine who the core team will be, without irrevocably giving away a significant equity stake in the company if a co-founder is not going to work out in the long-term.

• It protects the company’s investors who will invest in the company’s management team just as much as its technology by locking in key members of management and aligning financial incentives with those of the investors.

Employees

Employees typically receive stock options as their ownership stake. A stock option is the contractual right to purchase a certain number of shares (almost always Common Stock) at a predetermined price (referred to as the exercise or strike price) at some point in the future (generally, within 10 years of the date of grant).

Options are almost always subject to vesting – though, unlike with Founders’ Stock, the optionee cannot exercise the option until it has vested – and can be, but are not always, subject to acceleration. The vesting schedule described above is also typical for an option.

Investors

Investors will fund the operation of the company by investing cash to purchase their equity interests. More often than not, they will purchase Preferred Stock, which is a class of stock that is granted certain rights, preferences and privileges that are superior to those of the Common Stock. You may have heard how investors can impose onerous terms on entrepreneurs or even assume control of the company post-investment. The special rights granted to the Preferred Stock is how this is accomplished.

Conclusion

The information above is only a general overview of this topic. For a more in-depth look, read the full article.  Also, as no two situations are ever the same, make sure you consult your attorney before implementing a formal capitalization plan for your company.

About the author:

Glen Caplan

Glen’s practice consists of counseling emerging growth technology and life science companies across a broad spectrum of sectors, including networking, software systems and applications, consumer electronics, video games, retail, biotechnology, pharmaceuticals and medical devices.

Hutchison Law Group, founded in 1996, represents many of the premier technology and life science companies in the Southeast. The firm provides venture capital financing advice, merger and acquisition counsel, licensing assistance, securities law advice and intellectual property protection, employment law advice and counseling, and other business legal services to a wide variety of businesses at all stages of development.