For many founders, a tricky question arises when someone leaves the company: If the company has issued restricted stocks or stock options to the employee, what should the company do about their equity?

Check Previously Signed Agreements

The Founders' Agreement, Stock Purchase Agreement, Stock Option Plan, and Employment Agreement contain most of the information you need to know. When reviewing these documents, pay attention to the following:

Types of Equity

Restricted stocks and stock options are the two most common equity that startups issue to their co-founders and/or employees.

Stock options include incentive stock options (ISOs) and nonstatutory stock options (NSOs). Usually, ISOs are granted to employees, and NSOs are granted to outside directors and advisors, as well as employees. Options need to be exercised before they are truly "owned" by the optionee.

Vesting Schedule

Although each company may have different vesting schedules, the most common one is the four-year schedule with a one-year cliff. Under this situation, if the employee leaves before reaching the one-year cliff, then the entire grant is forfeited because none of the equity is vested at this point. If the employee leaves after one year but before their next vesting event, then the rest of the unvested equity is forfeited. Therefore, founders should check the vesting schedule to see whether any equity is vested.

Termination

There are two kinds of termination, for cause and without cause. The consequences for these two kinds of termination are different as well. Take stock options as an example, if the employee leaves the company without cause, they are usually granted a period of time to exercise their stock options (if they are entitled to exercise some portion of the options). A 90-day period is commonly seen in stock option plans, with some companies extending that to ten years. For employees who are terminated for cause, their exercising time period might be shorter, and if the termination reason is very serious, such as fraud or felony, the company could claw back the vested shares.

Termination is one of the triggers that accelerates the vesting schedule. Double-trigger requires termination without cause after a change of control. Single-trigger requires that either a change of control happens or termination without cause.

Clawback Provisions

The most famous case regarding clawback provisions is Microsoft's acquisition of Skype. Prior to the acquisition, Skype fired some of its executives for performance reasons, and because of the clawback provisions, these executives were forced to sell their vested shares back to the company at the original grant price. Nowadays, many companies have modified their clawback clause after the SEC's Dodd-Frank Act, which provides more employee-friendly triggers for clawback provisions.

In general, the clawback provision is a term that allows the company to repurchase the shares of departing employees. The earliest used clawback provisions may have included vested shares, but these days their focus is mostly on unvested shares. If the employee is granted stock options with early exercise rights, even if he/she exercised the options early, the company still could repurchase the unvested shares from them, at the original purchase price.

Exercising Repurchase Rights

Upon termination of the employee, the company shall deliver a written notice to the employee, stating the date, price and the total shares that the employee has previously purchased, quoting the related provisions in the stock/option purchase agreement that the employee has signed, describing how the company is going to repurchase the unvested shares (cash or other forms), and the total amount that the company is going to repurchase. If the company has issued a stock certificate to the employee before, the company needs to cancel it and issue a new certificate that applies only to the vested shares.

The repurchase price could be equal to the original purchase price or fair market value at the time of repurchase. Normally, the repurchase price for unvested shares is the original purchase price, and the price for vested shares is the fair market value.

Other Considerations

  • Update the capitalization table to reflect changes in stocks and employee options
  • Make sure the IP of the departing employee was assigned to the company
  • Obtain a release of claims from the departing employee

Bottom Line

In most cases, the unvested equity of departing employees is subject to the company's repurchase rights. It is important to check all the relevant documents and take the necessary steps to exercise such rights. It is also important to maintain the cap-table and other financial documents regarding terminations of employees. Keeping a good record of the company's documents will save you a lot of time and money in the future.