If you have been bitten by the start-up bug and are
considering equity offers from start-ups, read on.
1.
Equity or Esops
Equity differs from Employee stock options as it makes you a
stockholder, eligible for dividends and makes you a participant in certain decision
making.
Employee stock options convert to shares only after the
options have vested and you have exercised your options. Options have a minimum vesting period of one
year as per SEBI guidelines.
Ideally, founders are granted equity or Restricted stock
units (RSUs)- equity that is granted after certain restrictions like performance,
time spent are met. RSUs can be optimized for taxes when granted at par value. Companies are reluctant to offer this as it
comes with an increased overhead of an extra stockholder and other legal
requirements like an escrow etc.
Exercising the options includes paying the exercise price and
a tax payment. In India, a perk tax is charged as per your income tax slabs on
the notional income earned by the appreciation of the underlying shares.
Ideally, the exercise
value should be at par value for employees to reap benefits of share price
appreciation.
Late stage investors often ask for an additional optional pool to be created for newer employees and may keep the exercise price at the investment price.
Find it out if the company
is willing to pay the taxes else the employee will have to bear this. This can
be quite significant and you would be paying taxes on unrealised income. The
guidelines are not clear if the loss can be adjusted in future taxes if the shares
never become liquid.
Also note that the holding period for capital gains for RSUs starts at the
day when you get them. The holding period for shares earned via stock options
start only after you have exercised the options.
Options also have an expiry period before which they need to
be exercised. A standard norm is ten years.
2.
Grant period
and vesting schedule
The stocks come to employees at a given vesting
schedule. Every year you get a
proportion of your total equity grant as defined by the company Esop policy
document
A standard norm for early stage companies is equal vesting
(25% of total stock granted) across first four years of service. Late stage
companies have a shorter vesting cycle as they are expected to be closer to a
market exit.
Early to growth stage company can have a bigger proportion (say
50%) coming in the first year and remaining divided equally across the cycle.Companies can form one single scheme for all employees or
multiple schemes.
The vesting dates are important as it gives you access to
equity for RSUs or a right to exercise the option in case of esops.Your options can vest to you on a monthly or an annual
basis.
A good norm from an employee perspective would be to have a “cliff” of
one year for the first vesting and post that the vesting to be monthly or
quarterly.
3.
Number of shares, Percentage stake ,Valuation
and Exit returns
It
is important to know your total number of shares as well as the percentage equity stake.
Angel
funded or early stage companies often do not have good benchmarks to establish
share prices. They may use aggressive revenue multiples on aggressive revenue
targets to make the offered equity valuation look attractive.
It
is important to understand the business plan, key metrics before agreeing on
such numbers.
Early
employees and significant contributors can ask for a higher percentage stake
when negotiating for their overall remuneration. There is a higher risk for
early stage companies than growth stage companies and hence a prospective
employee should accommodate for the same. One should research the norms for equity grants for his/her role.
Once
the company has an exit, often the venture investors are returned the invested
amount first (preference clause) and later the returns are divided among all
the stockholders ( this may include the venture investors). For start-ups that do not generate stellar returns this shall further dilute the returns of an employee.
4.
Impact of "Liquidation/Funding" events
Employees who are given common stocks will have their stake
diluted in the company if fresh shares are added to new investors. E-commerce
companies generally have longer gestation periods and may raise as many as five
rounds of funding – the percentage stake dilution can hence be significant.
Certain class of shares may have a clause to have a
proportionate fresh shares issued on any new share addition to keep the percentage
stake from going down.
Investors often have a preference clause and a participative
clause for next rounds of funding. This may give angel investors a way to exit their
investments to later stage investors.
Esop Policy document also may have obscure "clawback clauses"
which gives company/investors the right to purchase the shares back from an employee.The Policy document also has guidelines if the employee can
sell his shares to external parties. Also, guidelines on how the stock sale may
happen if the company goes for an IPO.
5.
Impact of "Change of control" events
Often cash strapped start-ups get merged/acquired by other
companies or key founders may leave. In such cases, the role of an employee may
not remain the same as management control changes. Few employees may also be
forced to leave the organisation. In such cases, there should be a provision for
accelerated vesting
Standard norms include “Single trigger” acceleration of
atleast one year on change of control.
“Double trigger” acceleration includes multiple events such
as change of control and employee firing. In such cases all unvested shares
should vest immediately .
6.
"Grace period" and ability to take the stocks post
termination of employment
Grace
period is the time post termination of employment in which the employee can
exercise his vested options to convert them to shares. This gives employee time
to generate funds for paying the taxes or the exercise price. If the stocks are
listed on the markets, then the employee can exercise the shares depending on
the market performance.
This
can be normally from 3 months to one year.
An employee should be able to take his stocks with him post termination
of employment.
I am also new to this and I write
this after having received 2 such offers and working at one e-commerce start-up. Several posts on
www.quora.com have helped me understand this aspect of
start-up world. Please feel free to share your suggestions.
Anuj Lakhotia
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