83(b) of the Internal Revenue Code is a niche tax-savings allowance for entrepreneurs and the tech geeks they hire (not the technical definition).
83(b) implicates the following: if you're a founder, an early employee or otherwise a recipient of RESTRICTED EQUITY ("equity" = stock or LLC units, etc. but NOT options (which aren't recognized as property by the IRS until exercise (but note that some options plans allow for early (prior to vesting) exercise and these options would be "restricted")); "restricted" = restrictions that lapse, typically due to vesting) in a start-up, then, presuming you'd rather pay less taxes than more, you should notify the IRS IMMEDIATELY upon receiving such equity (by filing an 83(b) notice).FN1
According to 83(b), if you voluntarily and timely (the 30 day(!) deadline is notoriously inflexible) notify the IRS that you've received such restricted equity, then you assume immediate income tax liability on the difference between the FMV of that equity (usually not much about zero (i.e., par value) in the inception stage of a start-up corporationFN2) and the amount you paid for that equity (usually par value or zero, as negotiated). At the future date when you later sell that equity, then you pay capital gains tax on the appreciation from the original date of purchase.FN3
If you fail to make that initial notification, you are taxed instead at each future vesting milestone (typically, at the year cliff and then monthly/annually for the next three years). This may have significant implications. For example:
Joe Founder is granted company stock at some nominal purchase (probably par value) price (say $0.01 per share) with a FMV of $0.001 per share. The stock has four year vesting with a one year cliff. Joe doesn't file an 83(b) election. At the end of the one year cliff, the stock having appreciated to $1.00/share, Joe recognizes and must taxes on $0.999/share of income for that year. As the remaining stock subsequently vests each year/month (whatever each vesting milestone is), Joe again recognizes and must pay ordinary income taxes on "income" (even though the stock is presumably illiquid and Joe can't sell it) equal to the difference between the (presumably rising) FMV of the newly vested portion and the original $0.001/share purchase price. Moreover, the company is required to pay the employer’s share of FICA tax on the income and to withhold federal, state and local income tax.
If Joe had made an 83(b) election, he would not recognize any income as the stock vests, because the 83(b) election forever freezes the income calculation as of the original grant date.
It almost always makes financial sense to file the 83(b), however, it does depend on the underlying value of the equity at the time of issuance and future prospects. In the odd circumstance that the equity at the time of grant has a material FMV AND there is a material risk that it won't increase in value (because, say, the start-up fails), you've accelerated your tax liability without receiving any benefit.
FN1. The mechanics of filing the 83(B) notice are surprisingly informal. While forms exist to facilitate the process, none are issued or required by the IRS. A handwritten note sent to your local IRS office (the full list of information that needs to be provided can be found here) would technically suffice. What really counts is the 30 day filing period. There is no extension available, or any simple cure for missing the deadline.
FN2. Note that Companies (via the Articles of Incorporation) typically assign a "par value" to stock (in some states its a requirement), which prohibits the Company from issuing stock to anyone at a price below that par value (i.e., no free stock).
FN3. The default Section 83 rule is that income (the difference between FMV and the price paid) on restricted stock is not recognized until the restrictions lapse. This rule is actually intended to benefit the taxpayer - the unique economics of start-ups undermine the intention.
Wednesday, May 25, 2011
Monday, May 23, 2011
Vesting: Single versus Double Trigger Acceleration
Most vesting provisions for restricted stock or stock options ("incentive equity") include acceleration provisions as insurance of sorts for employees and founders ("service providers"). The underlying concept is this: incentive equity typically vests on a four year schedule (as per market standard). Absent acceleration, if an event were to occur before the end of those four years - such as a sale of the all the assets of the company, a merger, or an IPO - that resulted in the service provider's termination (or resignation with good cause), then she'd lose the benefit of her expectation. She'd lose the right to the portion of the equity that hadn't vested - which happens to be precisely what certain interested parties (investors, new management/ownership, etc.) would like to see happen (because unvested restricted stock effectively vanishes and the rest of the shareholder base benefits proportionately from the reverse dilution) and why termination is such a real risk.FN1
Acceleration triggers guard against this. "Single" trigger refers to the automatic vesting of any unvested incentive equity upon the said event. "Double" trigger requires two events before the automatic vesting - not just the merger but the actual termination or early release of the service provider.
A common acceleration agreement averages the two triggers: combining 25% – 50% single trigger acceleration with 50% – 100% double trigger acceleration. Fairly convincing arguments are made that double trigger acceleration best balances the interests of service providers with interests of the company (entire shareholder base).FN2
It's all pretty straightforward stuff. One point to note: the trigger should run for a period of time before as well as after the transaction that constitutes the trigger event (or otherwise be constructed to to avoid any preemptive house cleaning before the transaction is done).
FN1.The assumptions behind the logic of what interested parties will want in the event of a merger/sale can get speculative but generally, regardless if the acquirer's interest is in company assets or people and /or if the equity at issue is unrestricted stock or stock options (Stock options, in contrast to unrestricted stock, "return" (to the extent they ever left) to the pool of stock reserved for employees (usually 5%-15% of the outstanding stock)), acceleration clauses will likely decrease the purchase price. To the extent there are provisions in place (such as unvested equity) that incentivize service providers to stick around the acquirer will see and presumably pay for that additional value. Although the acquirer could separately create (and pay for) an employee/management retention mechanism as part of the deal, that payout would (for the rational acquirer) carve-out from the overall deal value, reducing the consideration allocated to the target company stockholders. Note here the conflict of interest between VC investors and the service providers being bought out).
FN2. A variation suggested here is single trigger plus a minimum X (say 12) months of service before the out.
Wednesday, May 4, 2011
Warrants and Employee Stock Options
Employee stock options and warrants (both give the holder the right to purchase a security at a set price, usually referred to as the "exercise" or "strike" price) function in about the same way but have two basic structural differences (which explain why warrants tend to go to advisor/investor types while options go to employees).FN1
First, from the issuing company's perspective, warrants behave like a financing (albeit with no initial servicing costs like dividends or interest) whereas stock options behave like an employee incentive. This is because although both warrants and stock options are derivative instruments (the value is not in the thing itself but in its derived value from an actual security (i.e., stock)), the stock ultimately issued for a warrant is newly issued stock - prior to the issuance it did not exist - similar to the way new stock is issued to VCs when they make an investment in a start-up.
The stock issued for an exercised option, by contrast, is derived from the previously existing "stock option pool" (which usually comprises somewhere between 5-20% of the outstanding (i.e., already issued) stock of a company).FN2 Thus as a consequence, the exercise of warrants (like the issuance of preferred stock in a seed or series financing), necessarily dilutes existing shareholders (which is a significant event for the company). The exercise of stock options, by contrast, just consumes some portion of the shares set aside for the stock option pool.
Second, from the holders' perspective, a stock option is less valuable because it is subject to a set of restrictions.FN3 While in most cases a warrant implicates the right to purchase the underlying stock at any point in the future at the holder's reasonable discretion (and in some cases the right to transfer that right), a stock option i) can almost never be transferred, ii) is subject to a vesting period and iii) has a limited exercise period (meaning, the stock option, once fully vested (usually four years down the road), has to be exercised within a few months or a year after vesting).FN4
FN1. This discussion solely addresses the common use of employee stock options and warrants in a start-up context. Stock options and warrants can be manifested in myriad ways - practices outside the U.S. in particular add additional complexity.
FN2. If you get fancy, you can argue that if a company does not presume the existence of a employee stock option pool, the relevant distinction between warrants and employee stock options gets exceedingly small.
FN3. Usually. While employee stock options are highly standardized, the terms of warrants are highly customizable.
FN4. The tax implications of warrants and employee stock options depend on the circumstances. As a general matter, warrants are a taxable event upon issuance but options are not, provided, however, that the warrants were issued as part of a financing while the stock options were issued in exchange for future services. If the warrant is compensatory, taxability is deferred under section 83 until exercise.
First, from the issuing company's perspective, warrants behave like a financing (albeit with no initial servicing costs like dividends or interest) whereas stock options behave like an employee incentive. This is because although both warrants and stock options are derivative instruments (the value is not in the thing itself but in its derived value from an actual security (i.e., stock)), the stock ultimately issued for a warrant is newly issued stock - prior to the issuance it did not exist - similar to the way new stock is issued to VCs when they make an investment in a start-up.
The stock issued for an exercised option, by contrast, is derived from the previously existing "stock option pool" (which usually comprises somewhere between 5-20% of the outstanding (i.e., already issued) stock of a company).FN2 Thus as a consequence, the exercise of warrants (like the issuance of preferred stock in a seed or series financing), necessarily dilutes existing shareholders (which is a significant event for the company). The exercise of stock options, by contrast, just consumes some portion of the shares set aside for the stock option pool.
Second, from the holders' perspective, a stock option is less valuable because it is subject to a set of restrictions.FN3 While in most cases a warrant implicates the right to purchase the underlying stock at any point in the future at the holder's reasonable discretion (and in some cases the right to transfer that right), a stock option i) can almost never be transferred, ii) is subject to a vesting period and iii) has a limited exercise period (meaning, the stock option, once fully vested (usually four years down the road), has to be exercised within a few months or a year after vesting).FN4
FN1. This discussion solely addresses the common use of employee stock options and warrants in a start-up context. Stock options and warrants can be manifested in myriad ways - practices outside the U.S. in particular add additional complexity.
FN2. If you get fancy, you can argue that if a company does not presume the existence of a employee stock option pool, the relevant distinction between warrants and employee stock options gets exceedingly small.
FN3. Usually. While employee stock options are highly standardized, the terms of warrants are highly customizable.
FN4. The tax implications of warrants and employee stock options depend on the circumstances. As a general matter, warrants are a taxable event upon issuance but options are not, provided, however, that the warrants were issued as part of a financing while the stock options were issued in exchange for future services. If the warrant is compensatory, taxability is deferred under section 83 until exercise.
Sunday, May 1, 2011
Trade Libel
The spectacular growth of user-generated content via twitter, Facebook, Yelp, wikis, video-sharing sites and anything else designated Web 2.0 has given new valence to online character and trade assassination and the legal issues (primarily, defamation) that go along with it.
So far website owners haven't had much to worry about. Under §230 of the Communications Decency Act ("CDA") online service providers (anyone offering a product that allows users to interact and collaborate with each other in a social media dialogue) are generally immune from lawsuits that seek to hold them liable for speech posted by their users. As a consequence the majority of attention in this field has gone to the issue of personal libel and the the liability of individuals like Courtney Love and fashion bloggers who end up tweeting or blogging allegedly scurrilous things about personal enemies.
Trade libel (or commercial disparagement), however, may quietly become a bonafide risk for companies operating in the social media space.FN1 Several court decisions, most notable the Roommates.com case, indicate that immunity under CDA is not absolute.
The risk here is restricted to companies that can be said to have reasonably contributed to or encouraged unlawful conduct by its users. Fair Housing Council of San Fernando Valley v. Roommates.Com (2008) 521 F.3d 1157 (which involved an Internet website that facilitated postings inquiring about the race of a prospective renter) is the prevailing guide on the matter, the court having said (albeit in dicta) that where the service provider “solicits” or otherwise actively participates in generating illegal or defamatory content, then the immunity provisions of the CDA may not apply.
Social media is new enough as a business practice that the relevance of Fair Housing is at best speculative and, further, the practical risk of trade libel may be minimal to most social media companies, however, to the extent a company is specifically modeled to provide a forum for consumers to criticize or complain about businesses (see e.g., ripoffreport.com, complaints.com, etc) and to promulgate such criticisms and complaints, legal exposure is there.
FN1. Trade libel in California is defined as an "intentional disparagement of the quality of property, which results in pecuniary damage to plaintiff." Erlich v. Etner (1964) 224 Cal.App.2d 69, 73, 36.
So far website owners haven't had much to worry about. Under §230 of the Communications Decency Act ("CDA") online service providers (anyone offering a product that allows users to interact and collaborate with each other in a social media dialogue) are generally immune from lawsuits that seek to hold them liable for speech posted by their users. As a consequence the majority of attention in this field has gone to the issue of personal libel and the the liability of individuals like Courtney Love and fashion bloggers who end up tweeting or blogging allegedly scurrilous things about personal enemies.
Trade libel (or commercial disparagement), however, may quietly become a bonafide risk for companies operating in the social media space.FN1 Several court decisions, most notable the Roommates.com case, indicate that immunity under CDA is not absolute.
The risk here is restricted to companies that can be said to have reasonably contributed to or encouraged unlawful conduct by its users. Fair Housing Council of San Fernando Valley v. Roommates.Com (2008) 521 F.3d 1157 (which involved an Internet website that facilitated postings inquiring about the race of a prospective renter) is the prevailing guide on the matter, the court having said (albeit in dicta) that where the service provider “solicits” or otherwise actively participates in generating illegal or defamatory content, then the immunity provisions of the CDA may not apply.
Social media is new enough as a business practice that the relevance of Fair Housing is at best speculative and, further, the practical risk of trade libel may be minimal to most social media companies, however, to the extent a company is specifically modeled to provide a forum for consumers to criticize or complain about businesses (see e.g., ripoffreport.com, complaints.com, etc) and to promulgate such criticisms and complaints, legal exposure is there.
FN1. Trade libel in California is defined as an "intentional disparagement of the quality of property, which results in pecuniary damage to plaintiff." Erlich v. Etner (1964) 224 Cal.App.2d 69, 73, 36.
Monday, April 18, 2011
The Cumulative Dividend
In connection with term sheets and the raising of capital, dividend preferences (a dividend is an annual distribution of profits to shareholders, generally paid in cash or stock) are rarely a meaningful negotiating point, for three main reasons.FN1 First, investor-backed start-ups rarely generate profits early on, so there's probably nothing to distribute and the issue is moot. Second, even if that doesn't prove the case, the founders understand any profits should be re-invested in the growth of the company. Third, unlike, say, private equity guys (who are investing big money (usually more than $50MM) with lowered expectations for return multiples on invested capital), VCs and angels are less focused on percentage annual yields than the long term multiple they'll get back from the investment. "The juice," as one commentator says here, "from the dividend is nice [for VCs], [but] it doesn't really move the meter in the success case".
What you get in 10% or so of financings,FN2 however, is investors asking for dividends that accrue and accumulate from one year to the next. Such dividends are called "cumulative' and are akin to roll-over minutes with a phone plan. To the extent a dividend is not declared (by the BoD) during a particular year, the dividend is carried forward to the next year. (Non-cumulatives (“when, as and if declared” dividends) do not carry-over).FN3
The argument from investors is that the cumulative dividend is necessary as reasonable down-side protection to guarantee a minimum annual rate of return on investment (often in the range of 5-10%).FN4
This wouldn't have an immediate impact on the company's cash position but if the investment remains outstanding for an extended period the effect could be large (and also generally doesn't reflect well (to future investors, potential lenders (i.e. creditors, etc.) on a balance sheet since the dividends are liabilities).
The move for the company is to concede to cumulative but establish conditions that ensure the cumulative dividends act as a protective device rather than a windfall. Allow unpaid accumulations to factor into the liquidation preference (or maybe even the redemption price) but not the conversion price (the rate at which the preferred stock converts into common stock).
The former scenario is not only the most common formulation - giving investors an increased share of the proceeds in the event of a sale - but the one that best serves to return investors some portion of their money back in the event the company needs to be sold on the cheap or liquidated due to insolvency.
The latter scenario, however, could have an enormous impact in the case of a successful company exit (e.g., an IPO) because it increases the investor's pro rata entitlement to proceeds and should be resisted for this reason (absent a cap to the investor's return or some other special story).
FN1. Language in term sheet in connection with dividends will read something like, "Dividends: The holders of the Preferred shall be entitled to receive [non-]cumulative dividends in preference to any dividend on the Common Stock at the rate of [x%] of the Original Purchase Price per annum[, when and as declared by the Board of Directors]. The holders of the Preferred also shall be entitled to participate pro rata in any dividends paid on the Common Stock on an as-if-converted basis.”
FN2. 10% number is from Fenwick and West, reporting in 2010.
FN3. If the non-cumulative is not declared by the BoD at year's end, it is extinguished and begins accruing anew the following year.
FN4. The logic of this can be deceptive. In a way it seems reasonable for the investors to receive some kind of interest return (in the form a dividend) for the time value of their investment. But note that investors have (almost always) an uncapped upside participation right. That's what they're buying: an equity instrument not a debt instrument.
What you get in 10% or so of financings,FN2 however, is investors asking for dividends that accrue and accumulate from one year to the next. Such dividends are called "cumulative' and are akin to roll-over minutes with a phone plan. To the extent a dividend is not declared (by the BoD) during a particular year, the dividend is carried forward to the next year. (Non-cumulatives (“when, as and if declared” dividends) do not carry-over).FN3
The argument from investors is that the cumulative dividend is necessary as reasonable down-side protection to guarantee a minimum annual rate of return on investment (often in the range of 5-10%).FN4
This wouldn't have an immediate impact on the company's cash position but if the investment remains outstanding for an extended period the effect could be large (and also generally doesn't reflect well (to future investors, potential lenders (i.e. creditors, etc.) on a balance sheet since the dividends are liabilities).
The move for the company is to concede to cumulative but establish conditions that ensure the cumulative dividends act as a protective device rather than a windfall. Allow unpaid accumulations to factor into the liquidation preference (or maybe even the redemption price) but not the conversion price (the rate at which the preferred stock converts into common stock).
The former scenario is not only the most common formulation - giving investors an increased share of the proceeds in the event of a sale - but the one that best serves to return investors some portion of their money back in the event the company needs to be sold on the cheap or liquidated due to insolvency.
The latter scenario, however, could have an enormous impact in the case of a successful company exit (e.g., an IPO) because it increases the investor's pro rata entitlement to proceeds and should be resisted for this reason (absent a cap to the investor's return or some other special story).
FN1. Language in term sheet in connection with dividends will read something like, "Dividends: The holders of the Preferred shall be entitled to receive [non-]cumulative dividends in preference to any dividend on the Common Stock at the rate of [x%] of the Original Purchase Price per annum[, when and as declared by the Board of Directors]. The holders of the Preferred also shall be entitled to participate pro rata in any dividends paid on the Common Stock on an as-if-converted basis.”
FN2. 10% number is from Fenwick and West, reporting in 2010.
FN3. If the non-cumulative is not declared by the BoD at year's end, it is extinguished and begins accruing anew the following year.
FN4. The logic of this can be deceptive. In a way it seems reasonable for the investors to receive some kind of interest return (in the form a dividend) for the time value of their investment. But note that investors have (almost always) an uncapped upside participation right. That's what they're buying: an equity instrument not a debt instrument.
Thursday, March 31, 2011
Stock Option versus Restricted Stock Awards
In most scenarios it benefits both the company and employees to give employees equity in the company. The employees are inspired by a sense of ownership and the company saves some cash. The trickier question is one of form: does the company offer stock options or restricted stock?
The mechanics of stock options are pretty basic: the company grants to the employee a call option to purchase - at a discount - X number of shares of the company's common stock. The discount is called the "exercise" (or "strike") price. Under this scenario, on the date the employee wants to sell and profit from his stock award, he purchases up to X number of shares and then turns around and sells the shares at a (presumably) much higher market value price and pockets the difference.FN1
Restricted stock, by contrast, is a straight gift of stock.FN2 The employee does not need to outlay any money. The "restricted" part is the caveat: the company retains the conditional right to purchase the stock back from you at some super cheap price - and usually this right expresses itself through a vesting requirement (i.e., although the stock is a straight gift it requires the employee to stick around the company for a certain period of time (market standard is 4 years to receive the full amount, with 1/4 of the total becoming available each year)).FN3
These structural differences implicate three main issues.
First, restricted stock gives the employee real as opposed to theoretical (in the case of options) value, and such real value is taxable to the employee upfront (stock options will not be taxed until the option is exercised (if ever)).FN4 So long as the initial value of the stock is low (such as in a start-up situation) this is probably to the advantage of the employee. The payment of that initial income tax aside, the employee won't pay any taxes until he sells the stock, at which point, so long as certain holding requirements are met, the tax will be capital gains rather than (historically higher) income tax.
By contrast, stock options will almost always result in ordinary income to the recipient when exercised (at least in the typical case where the underlying stock appreciates prior to exercise of the option).
Second, the grant of stock options require as a predicate the determination by the company of the "exercise" price. Because Section 409A of the Internal Revenue Code requires that the exercise price must be equal to (or greater than) the fair market value of the underlying stock as of the grant date, the company must coordinate (by the time of the grant) (i) an independent appraisal or (ii) if the company is an “illiquid start-up corporation,” a valuation of a person with “significant knowledge and experience or training in performing similar valuations” (who could be a company employee), which costs time and money.
Third, stock options give employees only the opportunity to benefit from the increase in the company’s value. If at a future date the market value of the shares drops beneath the exercise price per share (which is fixed to the time of the grant) then the stock options will be worthless.FN5
FN1. Two caveats here. First, in most cases, stock options are qualified/restricted by "vesting", which means that the right won't actually be triggered until a future date. Prevailing standards put the right to purchase 1/4 of the shares at the 1 year anniversary of the start date, 1/2 the shares become available to purchase at the 2 year anniversary, 3/4 on the third and all the shares on the 4th anniversary. In addition, most vesting provisions include acceleration clauses which accelerate vesting in the event of certain transactions (usually an IPO or acquisition). Second, more sophisticated service providers may exercise the option to purchase their stock before they intend to sell (because, essentially, the appreciation prior to exercise is taxed as income and the appreciation post exercise is taxed as capital gain).
FN2. Both stock options and restricted stock are sourced from the "incentive equity pool" of common stock reserved for employees. In most funded start-ups this pool will represent between 5-15% of the issued stock.
FN3. Restrictions can also be some sort of performance condition, such as the company reaching earnings per share goals or financial targets.
FN4. In most scenarios the employee will want to file here what is termed an "83(b) election" with the IRS so as to be taxed immediately upon the grant for the value (if any) of the restricted stock. If he doesn't make that filing within 30 days of the grant then he will be taxed incrementally over time as the restrictions to the stock disappear (i.e., the stock vests) - which can be prohibitively unaffordable if the stock appreciates significantly (yet remains illiquid).
FN5. Stock options have fallen out of favor during the last (markedly volatile) decade or so precisely due to this possibility.
The mechanics of stock options are pretty basic: the company grants to the employee a call option to purchase - at a discount - X number of shares of the company's common stock. The discount is called the "exercise" (or "strike") price. Under this scenario, on the date the employee wants to sell and profit from his stock award, he purchases up to X number of shares and then turns around and sells the shares at a (presumably) much higher market value price and pockets the difference.FN1
Restricted stock, by contrast, is a straight gift of stock.FN2 The employee does not need to outlay any money. The "restricted" part is the caveat: the company retains the conditional right to purchase the stock back from you at some super cheap price - and usually this right expresses itself through a vesting requirement (i.e., although the stock is a straight gift it requires the employee to stick around the company for a certain period of time (market standard is 4 years to receive the full amount, with 1/4 of the total becoming available each year)).FN3
These structural differences implicate three main issues.
First, restricted stock gives the employee real as opposed to theoretical (in the case of options) value, and such real value is taxable to the employee upfront (stock options will not be taxed until the option is exercised (if ever)).FN4 So long as the initial value of the stock is low (such as in a start-up situation) this is probably to the advantage of the employee. The payment of that initial income tax aside, the employee won't pay any taxes until he sells the stock, at which point, so long as certain holding requirements are met, the tax will be capital gains rather than (historically higher) income tax.
By contrast, stock options will almost always result in ordinary income to the recipient when exercised (at least in the typical case where the underlying stock appreciates prior to exercise of the option).
Second, the grant of stock options require as a predicate the determination by the company of the "exercise" price. Because Section 409A of the Internal Revenue Code requires that the exercise price must be equal to (or greater than) the fair market value of the underlying stock as of the grant date, the company must coordinate (by the time of the grant) (i) an independent appraisal or (ii) if the company is an “illiquid start-up corporation,” a valuation of a person with “significant knowledge and experience or training in performing similar valuations” (who could be a company employee), which costs time and money.
Third, stock options give employees only the opportunity to benefit from the increase in the company’s value. If at a future date the market value of the shares drops beneath the exercise price per share (which is fixed to the time of the grant) then the stock options will be worthless.FN5
FN1. Two caveats here. First, in most cases, stock options are qualified/restricted by "vesting", which means that the right won't actually be triggered until a future date. Prevailing standards put the right to purchase 1/4 of the shares at the 1 year anniversary of the start date, 1/2 the shares become available to purchase at the 2 year anniversary, 3/4 on the third and all the shares on the 4th anniversary. In addition, most vesting provisions include acceleration clauses which accelerate vesting in the event of certain transactions (usually an IPO or acquisition). Second, more sophisticated service providers may exercise the option to purchase their stock before they intend to sell (because, essentially, the appreciation prior to exercise is taxed as income and the appreciation post exercise is taxed as capital gain).
FN2. Both stock options and restricted stock are sourced from the "incentive equity pool" of common stock reserved for employees. In most funded start-ups this pool will represent between 5-15% of the issued stock.
FN3. Restrictions can also be some sort of performance condition, such as the company reaching earnings per share goals or financial targets.
FN4. In most scenarios the employee will want to file here what is termed an "83(b) election" with the IRS so as to be taxed immediately upon the grant for the value (if any) of the restricted stock. If he doesn't make that filing within 30 days of the grant then he will be taxed incrementally over time as the restrictions to the stock disappear (i.e., the stock vests) - which can be prohibitively unaffordable if the stock appreciates significantly (yet remains illiquid).
FN5. Stock options have fallen out of favor during the last (markedly volatile) decade or so precisely due to this possibility.
Monday, March 28, 2011
Contracts and Electronic Signatures
It's unnecessary to sign commercial contracts with a pen but the practice persists.FN1
The federal Electronic Signatures in Global and National Commerce Act, enacted in 2000 (note the federal law does not apply to intra-state transactions) and most states (due to the Uniform Electronic Transactions Act being adopted by most states) allow electronic signatures (or signature via an electronic record) for the valid execution of a contract. Neither law imposes a rigid format on the signature, so the fact that there isn't a “digital signature” - i.e., something like "/s/ Firstname Lastname" - doesn’t affect the fact that you can be deemed to have signed a contract by email correspondence.
Manual signature remains the custom in part because manual signature is a pretty effective authentication of the signator's willful and knowing acceptance of the terms of the contract (because a manual signature is personally identifiable in a (somewhat) unique way). Thus, reliance on an electronic signatures demands i) some proof of identity - something to verify that the putative signator's brother/aunt/stalker didn't send the electronic signature and ii) something to indicate that the signator knew what he was agreeing to (which is why when you go to amazon or bestbuy.com or wherever they require you to scroll down through terms and conditions or check some box (or an equivalent)) before you click through.
To the extent there is a mechanism in place that addresses these two issues statutory requirements will be satisfied. In most cases, verbal confirmation followed by an email from the signator enclosing the signature page with his electronic signature (first and last name) should suffice.
The effect of this, beware, cuts two ways. First, it means the process for executing a contract has been simplified. Second, however, it means e-mail correspondence may have unintended results. A vaguely worded or poorly thought through email can trigger all the responsibilities and obligations of an agreement. (Note that this could happen AFTER the agreement has been executed.FN2).
FN1. Note that certain contracts, such as trusts and certain real estate contracts, still require old school, manual signature and probably will for a good while longer.
FN2. E.g., in Stevens v. Publicis, S.A. (2008) the New York State Supreme Court held that a written agreement could be modified (i.e., amended) by e-mail correspondence.
The federal Electronic Signatures in Global and National Commerce Act, enacted in 2000 (note the federal law does not apply to intra-state transactions) and most states (due to the Uniform Electronic Transactions Act being adopted by most states) allow electronic signatures (or signature via an electronic record) for the valid execution of a contract. Neither law imposes a rigid format on the signature, so the fact that there isn't a “digital signature” - i.e., something like "/s/ Firstname Lastname" - doesn’t affect the fact that you can be deemed to have signed a contract by email correspondence.
Manual signature remains the custom in part because manual signature is a pretty effective authentication of the signator's willful and knowing acceptance of the terms of the contract (because a manual signature is personally identifiable in a (somewhat) unique way). Thus, reliance on an electronic signatures demands i) some proof of identity - something to verify that the putative signator's brother/aunt/stalker didn't send the electronic signature and ii) something to indicate that the signator knew what he was agreeing to (which is why when you go to amazon or bestbuy.com or wherever they require you to scroll down through terms and conditions or check some box (or an equivalent)) before you click through.
To the extent there is a mechanism in place that addresses these two issues statutory requirements will be satisfied. In most cases, verbal confirmation followed by an email from the signator enclosing the signature page with his electronic signature (first and last name) should suffice.
The effect of this, beware, cuts two ways. First, it means the process for executing a contract has been simplified. Second, however, it means e-mail correspondence may have unintended results. A vaguely worded or poorly thought through email can trigger all the responsibilities and obligations of an agreement. (Note that this could happen AFTER the agreement has been executed.FN2).
FN1. Note that certain contracts, such as trusts and certain real estate contracts, still require old school, manual signature and probably will for a good while longer.
FN2. E.g., in Stevens v. Publicis, S.A. (2008) the New York State Supreme Court held that a written agreement could be modified (i.e., amended) by e-mail correspondence.
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