To keep on talent, it’s frequently imperative that a startup and small business offer
significant equity packages to offset below market salaries.
When designing an equity incentive plan for your company, consider the following: (i)
which individuals you would like to reward, (ii) the specific types of awards that provide
the most fitting incentives for those who participate in the plan (e.g. stock options, stock
appreciation rights, phantom stock), and whether or not the plan meshes well with the
existing compensation program.
Once a general outline of equity awards has been established, the startup must consider
how much of the cap table will be comprised of the equity incentive plan. Because an
equity plan will likely be used for several years, the startup should estimate the number of
shares that will be needed to cover future grants for the coming years. Private companies
typically have only a handful of controlling shareholders and therefore can obtain the
necessary shareholder approval to amend the plan to increase the share reserve at any
time. Nevertheless, it’s typically advisable to reserve enough shares for three year's worth
of grants for administrative convenience.
After you are finished with figuring out the plan’s share reserve, you must determine the
actual individuals who are eligible. This generally includes employees, consultants, non-
employee directors and advisors. This may seem like an obvious step, but an important
one nonetheless to think about ahead of time.
Have your plan eligibility sorted out? Great. Now it is imperative that you determine how
(and by whom) the plan will be administered. In other words, will the board of directors,
the compensation committee, or another committee entirely be in charge of governing the
plan? And out of those options, what would be the scope of the administrator’s authority,
and whether they would be secured against expenses incurred related to any action they
become involved in? For most startups the easiest path forward is to have the startup’s
board of directors act as the administrator as the company’s framework is not built to
include numerous committees.
Vesting is also an important detail to address as you begin to put the equity incentive plan
together, including how much freedom the administrator will have to determine vesting
when grants are made. A few options are: a general provision that contemplates vesting,
but provides flexibility to set vesting schedules in award agreements, a minimum vesting
schedule, or a provision that either establishes the circumstances under which vesting will
accelerate, or gives the administrator this power.
Now you should figure out the acceptable ways that participants in the plan can pay the
exercise price (the price per share at which the owner of a traded option is entitled to buy
or sell the underlying security) for stock options. This could include providing a cash
payment, delivering previously owned shared to the company, or net exercise (the cost of
the exercise is paid with a portion of the shares being exercised).
Next, is it important to consider some smaller, but equally important details, such as the
circumstances under which awards may be transferred, whether or not to include a
“clawback” provision (money that has already been paid must be paid back under certain
conditions), and if you should include a forfeiture provision that causes a participant to
forfeit equity rewards if he/she is terminated or engages in inappropriate activity.
We’re on the home stretch! Finally, think about whether awards should be subject to
things such as confidentiality provisions or solicitation restrictions. After you are done
with this, you’ll have a solid framework for an equity incentive plan.
Certainly fair from an all encompassing discussion, and a well crafted equity incentive
plan for a private company can involve a host of other issues that should be addressed
with counsel. Have questions or comments? We’d love to hear from you.
You can reach us at (415)949-0795 or hello@archetypelegal.com.
Disclaimer: This post discusses general legal issues and developments and intended to
serve as informational only and may not reflect the most current law in your jurisdiction.
These informational materials are not intended, and should not be taken, as legal advice
on any particular set of facts or circumstances. No reader should act or refrain from
acting on the basis of any information presented herein without seeking the advice of
counsel in the relevant jurisdiction. Archetype Legal PC expressly disclaims all liability
in respect of any actions taken or not taken based on any contents of this article
